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Monday 25 July 2016


Why defence spending can help to promote longer-term growth

Defence spending is being cut across much of the developed world. The budgetary motivations for this are clear; the strategic, geopolitical and terrorism-related implications less so. But what are the macroeconomic implications?

Aircraft Hawk Advanced Jet Fighter
Probably the single most macro-economically significant long-term aspect of defence expenditure is that, if it is inadequate, the country and its trading becomes at risk. Photo: BAE Systems

When spending in other areas, such as transport or housing or public sector wages, is cut or raised, there is often widespread debate and reflection upon the macroeconomic implications. So what about defence?

Most people’s first instinct is probably to think that defence spending cuts must be a macroeconomic boon. After all, during the Cold War the very high proportion of Soviet GDP that had to be devoted to defence expenditure, relative to the proportions spent in the West, was a constant drain.

The large increase in Western defence expenditure in the Reagan period, including on exotic technological projects such as the Strategic Defence Initiative, is often claimed to have been itself a form of Clausewitzian Total War, breaking the Soviet economy in the attempt to keep up.

In the 1990s there was widespread talk of a “peace dividend” as defence spending could fall in the new post-Soviet world.

In economics, an analogy is often drawn between an “arms race” in defence and an “arms race” in advertising. The idea is that, if one’s competitors did not spend much on defence/advertising, one’s country/business would not need to itself.

The reversal of arms race expenditure is therefore seen as a straightforward economic gain, as resource devoted to activities that have no purpose other than matching opponents’ expenditure can be rediverted to more productive uses. But that is far from the end of the story in the macroeconomics of defence.

For defence expenditure has many growth-promoting aspects. First, and most straightforwardly, there are the short-term “multiplier” effects of expenditure.

Just as capital expenditure on a road can in principle be growth-promoting, so can expenditure on an aircraft hangar. The defence sector is rather complex, and can be seen as a combination of other sectors – manufacturing, research and development, human resources management, and so on.

But just as macroeconomic multiplier effects of, say, cuts to schools spending should not be ignored, neither should the multiplier impacts of cuts to defence spending. Multiplier impacts are short term, and might in principle substitute for other investment impacts. But some defence expenditure is important in promoting longer-term or underlying growth.

For one thing, it is widely acknowledged that many defence projects (perhaps especially those during major wars) accelerated the development of technologies that then had direct or indirect non-military applications. The computer (developed for code-breaking) and the jet engine (developed for fighter planes) are two particularly famous Second World War examples.

There is, of course, the possibility of government directly funding research projects without beginning with a military application, but the presence of a military purpose means that governments are much more likely to see an immediate value in sponsoring research, and also provides a focus to that research so that more rapid progress is made (rather than research just being general and hence diffuse, and hence petering out in many unproductive dead-ends).

Technology spillovers have obvious potential value for consumers and industry. But they also (partly because of that) enhance the medium-term growth rate of the economy. There has been a recent suggestion that current poor growth is not an aberration but, instead, entry into a new long-term growthlessness.

The well-known academic Robert Gordon and others have suggested that this is because the key innovation-drivers of growth have been exhausted and there are fewer great new idea seams for growth to mine out. Defence expenditure could be a source of such groundbreaking innovations in the future, as it has been in the past.

Probably the single most macro-economically significant long-term aspect of defence expenditure is that, if it is inadequate, the country and its trading becomes at risk. Defence protects property rights and trade through sea and air and through otherwise potentially dangerous land routes, and also, these days, cyber-defence protects us in cyber-space.

We can think of this form of defence in two ways. First, it could be seen as preventative expenditure – like spending money on going to the dentist for regular check-ups so as to avoid the huge expenditure and pain of a root canal.

We can think of this as the deterrence aspect of defence. Secondly, it could be thought of as rather like an insurance policy. In the event that some significant foreign power starts becoming unfriendly and aggressive, we have available some resources to reduce the impact of that aggression upon us.

If defence is inadequate, it prevents/deters too little and is insufficiently powerful as insurance.

That will have macroeconomic implications, because if property rights and trade are not secure or there is the risk even of invasion or other attack (events potentially at least similar in macroeconomic effect to a major devastating earthquake or volcano), businesses will not invest and consumers may be excessively short-termist.

If we are not defended well, tomorrow cannot be relied upon to come. If there may not be a tomorrow, there is much less point in investing or innovating today, so growth will be poorer.

Of course, not all military expenditure is really for “defence”, even indirectly (where “indirectly” might mean, say, fighting a war or terrorism in a foreign country precisely so it did not need to be fought at home).

Instead of defence, some military power is used to protect the innocent in other countries from oppression by wicked rulers, or to project our values and other moral projects and purposes.

This is often seen as a macroeconomic sacrifice, albeit perhaps a worthy one (one sees common references to “blood and treasure”). But having a clear moral purpose could be macroeconomically valuable.

A society without some uniting goal (“the glory of Rome”, “finding a sea route to India”, “landing on the moon”, “spreading Christianity and Capitalism”) can degenerate into decadence.

Think of the decadence of the late phase of the Roman Empire. A decadent society is unlikely to have a good long-term growth rate. Its citizens are unlikely to be as productive, as they drown their apathy in short-term thrills. Ideas are likely to stagnate.

Making short-term sacrifices for long-term goals, such as saving up to invest, or giving up time to research a potentially groundbreaking innovation, will not seem to have a point. The use of the military for moral purposes could lessen decadence and promote growth.

Thus, overall, we have seen although there is a case that defence cuts could promote growth, they could also damage it, especially over the longer term. One way or another, we should expect an impact.

Andrew Lilico is managing director of Europe Economics


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