Raising defence spending will be a hard sell. But politicians must not shy away from this fight, and innovative “defence bonds” may help to win it.
John Healey’s resignation as Defence Secretary today may well be the fatal blow to Keir Starmer’s premiership, leaving Andy Burnham to deliver the last rites. Everything that has happened this week symbolises the chaos at the heart of this government, including the inability to deliver a credible plan and the lack of leadership from No.10.
As it stands, the government is planning to raise defence spending by just 0.08% of GDP between 2027-28 and 2029-30, to 2.68%. This would leave it well short of the 3% ambition ‘in the next parliament’, let alone the new Nato target of 3.5% by 2035.
The right amount to spend on defence should, of course, primarily be a decision based on national security. But my turf is economics, so here are three points from that perspective.
First, defence is a textbook example of what economists call a ‘public good’. In technical terms, the benefits of defence are both “non‑rival” (one person’s protection does not come at the expense of another) and “non‑excludable” (no-one can be prevented from benefiting even if they fail to contribute to the cost).
This means that even a Government that is determined to reduce the size of the state should be willing to spend more on defence, because this cannot be left to private markets. But equally, the benefits of defence spending are not as tangible as expenditure on many other goods and services. This requires a lot more political will, which is currently lacking in the UK.
In contrast, the Nordic and Baltic countries, as well as Germany and Poland are much more wary of the Russian threat. They also have much lower levels of government debt and are therefore both willing and able to increase defence spending more quickly.
Second, could more defence spending also be good for growth?
The short answer is ‘not necessarily’. The overall impact on the economy will depend on many factors, including how the additional spending is financed, and whether there is enough spare capacity to meet the additional demand.
Compared to public investment in, say, infrastructure projects, defence spending is less likely to increase the productive potential of the economy. More investment and jobs in defence might then just mean less investment and fewer jobs elsewhere. Inflation could also be higher.
Nonetheless, there may be a helpful regional dimension. An increase in defence spending will probably favour regions outside London and the Southeast, supporting areas with more military bases and which are more dependent on manufacturing than services.
It is also likely that that these areas might have more spare resources to divert to defence-related activities. This includes more people who would otherwise be unemployed, as ongoing deindustrialisation frees up more capacity in manufacturing and allied sectors such as steel production.
But there are also dangers in viewing defence spending as a tool of industrial or regional policy. The track record of defence procurement is terrible, partly because of a preference for “buying British” rather than sourcing kit from other countries that has already been proven to work.
Third, where will the money come from, especially to finance an increase in defence spending to 3-3.5% of GDP?
Under the current Government, the most likely answer still seems to be some combination of higher taxes and higher borrowing (the latter allowed by the fact that so much of defence spending can be classified as ‘investment’). This could simply divert spending from the private sector and push up interest rates even further.
Some have proposed a hypothecated tax purely to fund additional defence spending. This could be modelled on the Health and Social Care Levy, a top-up to national insurance announced when Rishi Sunak was chancellor (though it was never actually implemented). But this would just be more tax by another name.
A better solution would, of course, be to fund increased defence spending from savings elsewhere in the government’s budget. This has already been done by cutting overseas aid. A future government might target savings on welfare spending and “net zero” projects, or roll back plans to splash more cash on an activist “industrial strategy”.
As a stop gap, another option would be the issuance of “defence bonds”. These could be similar to the existing “green gilts”, or the saving schemes that were run during the two World Wars. But a more imaginative proposal is to issue special zero-coupon bonds where any capital gains would be exempt from inheritance tax. These bonds would not pay regular interest – an immediate saving for the government.
Admittedly, as the Treasury has been keen to point out, more borrowing to pay for defence would still be more borrowing, and future tax revenues might be lower. But demand for new savings products that are both “patriotic” and free from inheritance tax is likely to be high, which should reduce the average cost of borrowing. This idea is therefore worth taking seriously.
In summary, raising defence spending will be a hard sell. But politicians must not shy away from this fight, and innovative “defence bonds” may help to win it.
Plain-speaking Economics 