Russia’s invasion of Ukraine was a wake-up call to all western governments. Alongside China’s rise, the threat of a nuclear-armed Iran and instability in Africa, the new era of global conflict has forced governments around the world to commit to more defense spending.
Will voters around the world accept the high price of military deterrence?
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Russia’s invasion of Ukraine was a wake-up call to all western governments. Alongside China’s rise, the threat of a nuclear-armed Iran and instability in Africa, the new era of global conflict has forced governments around the world to commit to more defense spending.
Will voters around the world accept the high price of military deterrence?
Patrick's Books:
Statistics For The Trading Floor: https://amzn.to/3eerLA0
Derivatives For The Trading Floor: https://amzn.to/3cjsyPF
Corporate Finance: https://amzn.to/3fn3rvC
Patreon Page: https://www.patreon.com/PatrickBoyleOnFinance
Buy Me a Coffee: https://buymeacoffee.com/patrickboyle
Visit our website: www.onfinance.org
Follow Patrick on Twitter Here: https://twitter.com/PatrickEBoyle
The peace dividend was an idea popularized by George Bush Senior and Margaret Thatcher in the wake of the collapse of the Soviet Union. The term was used to describe the economic benefits of reduced defense spending. It meant different things to different people; to some it meant lower taxes, but the most common interpretation was that government spending on “social needs” would increase as defense spending was cut.
After the fall of the Berlin wall, western countries did indeed spend a lower and lower share of their GDP on defense which you can see in this chart, and if we look at defense spending as a multiple of healthcare spending, we can see that in both the United States and the UK the peace dividend helped fund other popular spending priorities. The trillions of dollars that had been spent on Cold War armies and weapons systems were slowly being diverted to things like health care, housing and schools.
In the thirty years since the fall of the Iron Curtain, western democracies came to believe that the era of global confrontation was in the past. The new era — when security took a back seat to trade and economic growth — ended abruptly with Russia’s invasion of Ukraine last year. Of course, it’s not just Russia, the US National Defense Strategy, released last year, bluntly stated that China represents “the most comprehensive and serious challenge to U.S. national security.” On top of that the recent events in Israel and Gaza have the potential of turning into a larger regional conflict. The threat of nuclear armed Iran and north Korea continue to grow, and instability in West Africa has reached a six year high. The peace dividend may well be a thing of the past.
It’s not the first time that we’ve thought that we were in a new era of peace either. In 1910, the British journalist Norman Angell, published an extremely influential book – The Great Illusion. It sold more than a million copies and was translated into twenty-two languages. It was discussed by the leading statesmen and diplomats of the day. Even Kaiser Wilhelm was said to have expressed some interest in its theories. The book argued that new economic factors meant that we had reached a point in history where there would be no more wars. The book didn’t focus on the cruelty of war but on its economic futility - which made it unacceptable as an instrument of state. The core argument was that in the new interconnected global economy that had recently developed, commercial and financial linkages between countries had become so extensive that no rational leader could contemplate starting a war as the economic chaos that would result from conflict would harm all sides and the victor would lose as much as the vanquished.
The British Committee of Imperial Defense had hearings on “trade in time of war” in 1912. The Chairman of Lloyds testified to the committee that much of Germanys merchant marine was insured through Lloyds of London, and in the event of war, were German ships to be sunk by the Royal Navy, Lloyds would be both honor bound, and according to its lawyers legally obliged to cover the losses. Conflicts between modern nations were all cost and there was no benefit.
According to Angell, the economic interdependence between industrial countries would be "the real guarantor of the good behavior of one state to another." Angell was right about the meager benefits and high costs of war, but was wrong about the rationality of nations. The years that followed saw the worst conflicts in human history.
A new edition of The Great Illusion – which is today known as the “interwar edition” was published in 1933, the year Angell was awarded the Nobel Peace Prize.
Military spending by European NATO members and Canada reached a low point in 2014 as the demand for military hardware plummeted. After Russia annexed Crimea that year, defense budgets started to rise, but most countries still fell well below NATO’s target of 2 percent of national output.
Last year we saw the largest increase in military spending in Europe in thirty years. These defense demands, which are likely to last well beyond an end to the war in Ukraine, come at a time when many countries are facing huge spending needs for rapidly aging populations, as well as having made large financial commitments to green policies.
Once the cold war had ended, there was an idea that we were living in a unipolar world where the United States had no pure military rival. In the 1990’s political leaders around the world believed that China would move towards liberalization over time. This was already happening economically and was expected to happen politically too. There was a similar expectation of Russia. The more countries traded with each other the less likely conflict seemed to be.
This point of view made perfect sense – just like Angell’s arguments had in 1910, but just because something makes sense, doesn’t mean it is what will happen.
In the early 2000s, Germany spent as little as 1 per cent of GDP on defense because, as the thinking went, “why maintain a large defense force…when all our neighbors appear to be friends?” A German finance ministry assessment this summer showed that the nation only had a stock of 20,000 155mm artillery shells in stock, enough for less than three days of fighting.
Last year, the Center for Strategic and International Studies, conducted a war game involving a Chinese invasion of Taiwan. The exercises revealed how quickly the United States would run through its current supply of weapons defending Taiwan. Certain critical supplies—like long-range, precision-guided munitions—would likely run out in less than a week. The United States is not set up to quickly replenish those stocks.
The urgent need to fortify defenses in Europe against Russia has now forced European leaders to make extremely difficult budgetary decisions that can be expected to affect peoples’ everyday lives in the coming years. Will the increased military spending come at the cost of reduced public services, and if not, how will it be paid for? Through higher taxes, more borrowing? Or both?
There appears to be public support for at least some of this renewed defense spending in Europe, as illustrated by Finland and Sweden’s new desire to join NATO. In most of Europe, however, the painful budgetary trade-offs that will be required to significantly increase defense spending have not yet trickled down to daily life. Much of the belt-tightening last year that affected households was the result of rising energy prices and inflation.
A senior NATO official was quoted in the FT recently as saying “Leaders have signed up to a generational shift in defense policy. But I wonder if they fully understand the costs or have told their finance ministers.”
Governments around the world on both sides of any conflict are realizing that the technological sophistication of modern weaponry can make defense spending cripplingly expensive. Russia’s war on Ukraine, has shown that modern conflicts are not all about high tech weaponry; tanks, artillery and ground troops are still as necessary as they have ever been. Being fully prepared in this day and age means having both modern sophisticated weaponry along with traditional weaponry and the industrial base to support them.
Western governments have not yet communicated to their citizens the costs or the implications of new military expansion. Boris Pistorius – The German defense minister told his counterparts in Europe this summer that convincing electorates of the need to spend more on defense requires “a totally changed mindset.”
Defense specialists argue that investing in deterrence is less expensive than dealing with the costs of conflict and that by preparing for war, peace can be preserved. Of course, one of the risks of rearming is that opponents might see increased military spending as a provocation.
While all NATO members have committed to spend 2 per cent of GDP on defense, currently only 11 of the 31 members do, but that might be already in the process of changing.
President Emmanuel Macron of France promised to increase French military spending by forty percent through 2030 and to “transform” France’s nuclear-armed military. “France has entered into a war economy that I believe we will be in for a long time,” Macron said in a speech shortly after announcing his spending plans.
In France, government spending as a percentage of GDP, is already the highest in Europe and almost half of that spending went on the nation’s social safety net, which includes unemployment benefits and pensions. Debt has rapidly increased in the wake of the pandemic. Yet Macron has promised not to increase what is already one of the highest tax levels in Europe for fear of scaring off investors. There is no way that the French will not feel a pinch with this increased military spending.
The British Prime Minister Rishi Sunak pledged in March to increase military funding by $6 billion dollars over the next two years in response to Russia’s invasion of Ukraine and the “epoch-defining challenge” posed by China. This increase was only half of what its defense secretary reportedly wanted. Britain is one of the few NATO members that actually meet Nato’s “guideline” of spending at least 2 per cent of GDP on defense.
On the same day that the British government announced this additional spending, teachers, doctors and transport workers went on strike over pay and working conditions. The budget did include a $4 billion dollar increase for the NHS over the same two-year period. But as you can see there are difficult tradeoffs to be made, and lots of people will be unhappy no matter what decision is made.
The US, UK and Australia have also unveiled plans for an expensive fleet of nuclear-powered submarines in the Pacific as part of their “Aukus” alliance along with cooperation on hypersonic missiles, AI and quantum computing.
Germany, the largest and most powerful economy in Europe, has consistently spent less on defense as a percentage of GDP than either France or Britain did since the reunification of Germany. (At times in the more distant past they have been quite big military spenders – but not recently) Germanys shift in spending is possibly the most dramatic in Western Europe, with the German chancellor Olaf Scholz having announced a special $112 billion defense fund last year. The German defense minister asked for an additional $11 billion for next year and this pot of money does not include any spending for ammunition – which as I mentioned earlier – they are quite low on. When this fund is depleted, Germany will need to find an additional $38 billion dollars to level up with its NATO partners.
Japan's defense ministry asked in August for a record $53 billion dollars for the 2024 fiscal year, seeking to double defense spending to 2% of GDP by 2027 as it faces an increasingly assertive China and an unpredictable North Korea. The question of how to fund this increase has divided the nation already struggling with ballooning social security costs.
Denmark's parliament voted earlier this year to abolish a springtime public holiday to boost spending on the military. The cancellation will provide an additional four hundred million dollars to be used on the defense budget according to the government. There were protests, but Denmark's government said that the extra money was needed to raise the defense budget to NATO’s target of 2% of GDP by 2030, instead of 2033 as had been previously planned. This change of plan was due to Russia's invasion of Ukraine, according to the Danish government.
Sweden, which has applied for NATO membership, announced in September that it planned to raise defense spending by more than twenty five percent to meet the military alliance’s target of 2 per cent of GDP.
Obviously, the closer you get to Russia the more you see countries start to worry. Poland has pledged to spend 4 percent of its national output on defense.
Russia’s budget for 2024 provides for an increase of 68 percent for defense compared to the previous year. This would bring spending to six percent of GDP. In contrast, spending on education and health in Russia has been frozen at 2023 levels, which corresponds to a spending cut when adjusted for inflation.
Due to the high rate of injuries of Russian soldiers, healthcare expenses and financial aid for relatives of those killed increased over the year.
Taiwan's 2023 defense budget of around $25 billion dollars represents around 2.6% of GDP and is a 10% increase from the prior year.
Taiwan unveiled its first domestically built submarine last month, demonstrating its determination to push back against growing military pressure from China. Many US defense experts see the project as a distraction from Taiwan’s need to quickly build stocks of cheap and mobile munitions and strengthen its defenses against a ground invasion force.
Taiwanese strategists argue that submarines could greatly complicate operations by China’s Navy in the straits north and south of Taiwan.
China claims to be spending $300 billion dollars a year on defense but assessments by US intelligence agencies and the highly regarded Swedish defense think tank SIPRI — put the number at $700 billion dollars per year. This is not too far from the US defense budget of $900 billion per year.
North Korea spends 26% of its GDP on its military – the highest proportion of any country in the world. The rest of the budget is spent on haircuts and food for Kim Jong Un.
US spending grew by less than inflation last year, though it is set to accelerate in 2023. Surveys in the United States show that only 1 per cent of respondents cite national security as their main concern. The US’s military budget is already twice that of all other NATO members combined. The US is forecast to run budget deficits of 6 per cent of GDP a year for the next decade and by 2053 federal debt will be twice GDP, according to estimates from the Congressional Budget Office.
The US makes a significant contribution to the defense of its allies around the world but if these countries refuse to shoulder more of the cost as the geopolitical situation heats up the US could lose enthusiasm.
While the US does have a huge defense budget, a recent article by Michael Brenes – of Yale University - in Foreign Policy Magazine argued that the war in Ukraine revealed serious problems in Americas ability to manufacture weaponry.
Following Russia’s invasion of Ukraine, the United States provided the Ukrainian military with a range of weapons, that were critical in helping halt Russia’s invasion. But the rate at which soldiers are using ammunition in Ukraine strained the U.S. defense industrial base. This isn’t really new, as US soldiers in Afghanistan and Iraq complained in the past about being undersupplied.
The conflict in Ukraine has so far been a war of warehouses where many of the weapons systems and munitions came directly from U.S. inventories, depleting the nation’s stockpiles. Brenes argues that the United States needs to have the industrial base to ramp up production in times of conflict.
The war in Ukraine has demonstrated that great-power wars are industrial conflicts. The effort to deploy, arm, feed, and supply forces is a huge task, and the consumption and destruction of military equipment requires a large-scale industrial base for resupply.
The U.S. Army plans to increase production of artillery shells by 500 percent within two years to replenish stockpiles sent to Ukraine—this is the largest production expansion since the Korean War.
A lot of difficult financial trade-offs lie ahead in every country in the world. Reduced defense spending in countries around the world helped governments to increase spending on social programs without big tax or debt increases over the last thirty years. Governments have done little to explain to their populations the implications of the geopolitical tensions that we see today and the increased military spending that is happening in every large country in the world. Norman Angell was right in 1910 about the futility of war, both from an economic and social perspective, but one of the flaws in economic thinking is to assume that people always make rational decisions.
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