What bigger military budgets mean for the economy

IN THE WAKE of the war in Ukraine, military budgets around the world are about to get bigger. This is most notable in Europe, where the threat of Russian aggression looms largest. Germany, Italy and Norway, among others, have already decided to spend more on defence. America and China, the world’s two biggest military spenders, are also ramping up their allocations. Pressure on smaller countries to do likewise seems inevitable. What are the economic consequences of this push? When governments spend more on soldiers and arms, they have less available for other things. A common assumption, therefore, is that extra spending on armies is harmful to growth and development. But the relationship is not so straightforward. In some cases bigger defence budgets may in fact yield substantial economic benefits.

That there is a trade-off between spending on the army and on, say, roads or hospitals is a lesson that students of economics internalise early on. The classic model for illustrating the concept of opportunity costs is guns versus butter: the more you produce of one, the less you can of the other. In any given year, that simple model holds true. Governments have finite budgets, which can only be pulled in so many different directions.

It is thus easy to see how spending on defence, taken to an extreme, could be corrosive for an economy. If a government shortchanges the education system in order to buy shiny new weapons, the long-run impact on productivity and, ultimately, growth would be baleful. Some economists think America is nearing that danger zone. The RAND Corporation, an influential think-tank supported by the Air Force, not exactly known as a peacenik outfit, published a report in 2021 laying out two risks. First, when the government allocates money to defence at the expense of infrastructure, that may undermine long-run growth prospects, since America has a pressing need for better roads, ports and more. Second, defence spending contributes to the public-debt load. In both cases, the analysts conclude, anything that erodes America’s economic strength will ultimately hurt the armed forces.

Perhaps there is something to the point that these trade-offs are damaging to the economy at America’s levels (over the past decade its military budget averaged more than 4% of GDP, second-highest in the OECD club of wealthy countries). But a complication emerges when examining trends over time. The OECD member that spends the most on defence, at about 6% of GDP, is Israel. It also consistently boasts one of the fastest-growing economies in the group. By contrast, Japan is one of the lowest military spenders as a share of GDP in the OECD, and one of the slowest growers. In fact, it is almost impossible to discern a pattern in the data: there are also countries such as Ireland, with military budgets similar to Japan’s and growth records similar to Israel’s. A basic regression reveals no consistent relationship between GDP growth and military spending for the 38 countries in the OECD.

A sprawling body of research has come to a similar, albeit more nuanced, conclusion. In a discussion paper at Monash University in 2014, Sefa Awaworyi Churchill and Siew Ling Yew examined 42 separate studies. Effects are generally quite small, but they found two distinct categories: military expenditure in poorer countries is often detrimental to growth, whereas in wealthier countries it is more likely to be beneficial. One possible reason, they suggest, is weaker governance in developing countries; a big military budget is a juicy target for corrupt officials. Another possibility relates to the gun-versus-butter framework. The potential returns on civilian investments, from health care to education, are so great in poor countries that military spending has a particularly high opportunity cost. In rich countries with good schools and hospitals, the opportunity costs ought to be lower.

One way in which defence spending might be said to boost the economy is as a jobs programme. If the armed forces were a corporation, they would be America’s largest employer with 2m workers (counting active-duty personnel and civilians), beating Walmart and Amazon. That said, it would be an eye-wateringly expensive jobs scheme, running at nearly $400,000 per employee a year.

Defence spending may deliver better returns as an undeclared form of industrial policy. In a paper last year Enrico Moretti of the University of California, Berkeley, and two colleagues looked at government funding for research and development (R&D), with a focus on defence spending, in OECD countries. On average, they found that a 10% increase in government-financed R&D leads to a 5% increase in privately financed R&D in the targeted firm or industry. Moreover, there are knock-on benefits for productivity. If France and Germany raised their defence spending to roughly the same level as in America, Mr Moretti estimates that their productivity growth rates would be slightly higher as a result.

Dividends of deterrence

An obvious objection is that the government could achieve the same results by supporting R&D in general, without pumping money into the armed forces. In an economic sense that may be true. But there is a political constraint—namely, how to marshal support for experimentation that may fail. Public support for defence is less susceptible to mood swings. Without having to worry about its next grant application, the American military system has been free to churn out innovations, from duct tape to the internet, without which modern life would be scarcely imaginable.

Important as it is to trace the impact of military spending on growth or innovation, such exercises risk missing the wider context as demonstrated by Russia’s war in Ukraine. A foundational element for any successful economy is peace and stability, giving firms the confidence to invest and people the space to flourish. Textbooks may talk of guns or butter. But in a world unsettled by revanchist powers, the truth is that it is both guns and butter. A strong defence is, regrettably, a necessity for a strong economy. ■

Read more from Free Exchange, our column on economics:
China has a celebrated history of policy experiments (Apr 9th)
Will dollar dominance give way to a multipolar system of currencies? (Apr 2nd)
Have economists led the world’s environmental policies astray? (Mar 26th

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