This week the Prime Minister announced that UK defence spending will now be raised from 2.3% to 2.5% of national income in 2027, funded by cutting overseas aid from 0.5% to 0.3%. The politics around this switch are controversial – the minister responsible for aid has just resigned in protest – but the economics is relatively straightforward.
First, defence is a textbook example of a ‘public good’ which cannot just be left to the markets. In particular, it is ‘non-excludable’, meaning that no-one in the country can be prevented from benefiting even if they fail to contribute to the cost. Other examples of ‘public goods’ include environmental protections, such as flood defences, and the criminal justice system.
This ‘free rider’ problem limits the incentive for private firms to provide defence services direct to consumers, so the state has to step in with mandatory taxation.
Overseas aid can also be a ‘public good’ – at least, those projects which are not wasteful, or actually counter-productive. UK taxpayers might be better off too if people living in other countries are healthier (fewer pandemics), richer (more trade), or happier (fewer asylum seekers, terrorists, and hostile states).
But the benefits are still felt primarily in these other countries, and the case for overseas aid does more often come down to pure altruism. It is therefore more appropriate to fill any funding gaps with private charity rather than state compulsion.
Some also argue that aid can enhance the UK’s global reputation and contribute to ‘soft power’. But if the money is not well spent, we could just look like mugs (which, I would argue, is the main takeaway from the proposed deal to hand over the Chagos islands).
Second, the switch from overseas aid to defence spending could provide a (very) small net boost to the UK economy. This is about the ‘fiscal multipliers’, or the impact that an increase in government spending might have on overall national income.
The multipliers for defence are low compared to, say, spending on infrastructure, and the impact on the level of GDP will fade over time (unless the increased spending also boosts the supply-side potential of the economy, which seems unlikely). But compared to overseas aid, more of the defence budget is, of course, spent at home.
Third, the switch will not worry the bond markets, which is important given the vulnerability of the public finances to even small increases in the cost of borrowing.
Businesses and consumers may be reassured too that the seemingly inevitable increases in defence spending are not being funded by further tax hikes, or cuts in local services (although this threat has not entirely lifted given the government’s commitment to raise defence spending to 3% of GDP ‘in the next Parliament’).
This leaves plenty of questions unanswered. What is the appropriate amount of national income to spend on defence? What will count as ‘defence spending’, and could the existing budget be used more efficiently? Will an increase in spending (inputs) actually improve defence capabilities (outputs), and ultimately make us safer (the desired outcome)?
More positively, will higher defence spending in the UK have additional benefits, such as encouraging allies to raise their spending too, and maintaining good relations with the US?
In short, there is a lot to consider here. But at first sight, the switch from overseas aid to defence does makes sense.
Ps. strictly speaking, the aid budget is set as a percentage of GNI, rather than GDP, with the difference between the two explained well by the ONS here. In short, GNI is the better indicator of the resources available to UK residents but, unlike in Ireland, there is not a huge difference between the two.
Plain-speaking Economics 