During her final fiscal address in March, Rachel Reeves articulated the government’s ambition to transform the UK into a “defense industrial superpower.” This statement followed the German government’s surprising announcement of an open-ended defense spending fund, which has unsettled financial markets. Berlin plans to exempt military expenditures exceeding 1% of GDP from its traditionally stringent fiscal regulations.

Recent developments from the European Commission indicate that member states will be permitted to borrow funds for defense projects without facing penalties under the EU’s debt management frameworks. So far, 15 of the 27 EU nations have expressed intentions to utilize this opportunity. Additionally, the EU is anticipated to approve a €150 billion loan facility for member states to finance military assets, including weapons and missile defense systems.

This surge in defense budgets from nations that historically favored social welfare programs over military expenditures raises the notion of a new form of military Keynesianism. Essentially, governments that once prioritized fiscal discipline are now pivoting towards funding military enhancements, aiming to improve safety while simultaneously fostering job creation and regional industrial revitalization, thereby spurring much-needed economic growth.

Reeves emphasized the economic rationale behind defense spending, stating it would empower UK firms to “purchase, produce, and provide goods locally.” She envisions benefits from re-militarization reaching all corners of the country through “new business ventures for UK technology companies” and investments in “innovative technologies like drones and AI-driven weaponry.”

The government’s ambitions for increasing defense spending are relatively conservative. Labour has proposed raising the military budget from 2.3% to 2.5% of GDP by 2027-28, translating to an additional £6 to £8 billion, funded entirely through cuts to the overseas aid budget.

Reeves has also suggested that the goal should escalate to 3% of GDP in the next parliamentary term, potentially leading to an extra £17.3 billion in spending by the decade’s close, as projected by the Office for Budget Responsibility.

However, the UK government is constrained by its fiscal policies and is facing challenges in stimulating growth. Could increased defense spending inadvertently become a source of employment and prosperity? Is this an essential growth strategy or a misguided economic measure imposed by external pressures, such as the influence of the subsequent Trump administration in the United States?

Most economists outside the U.S., which maintains a considerable defense budget, have not paid much attention to these developments. In Western Europe, defense spending has been in decline, dropping from oscillating around 10% of GDP in mid-20th century Britain to roughly 2% of GDP in recent years.

The resurgence of the defense and security sectors within industrial policy is prompting economists to develop new models aimed at maximizing the economic benefits of defense expenditures. Paolo Surico, a professor of economics at the London Business School, is one of the economists investigating the macroeconomic implications of defense spending. His insights were referenced by Reeves in her spring speech, and he has been advising Treasury officials on optimal allocations for defense funds. Surico advocates for prioritizing research and development within military technology rather than merely increasing expenditures on personnel and arms.

Surico told The Times that investing in startups focused on next-generation military technologies could be a “high-risk, high-reward” approach. He noted that for governments to maximize the macroeconomic impact of their defense budgets, a substantial portion should be allocated for public R&D. This focus should be directed towards domestic and European firms to ensure that any productivity benefits remain homegrown.

Economists gauge the potential growth effects of government spending through a metric known as the “fiscal multiplier,” which assesses how additional public expenditure affects national income. Surico’s findings suggest that traditional military spending on salaries and equipment yields a limited multiplier effect of 0.6 to 1 for every £1 spent within approximately four years. In contrast, focusing on research and innovation could theoretically yield a multiplier effect as large as 2 over decades, signifying that every £10 billion spent might lead to a £20 billion increase in GDP.

However, such long-term projections are inherently uncertain, as they hinge on the prospect of state investment driving technological breakthroughs in an era characterized by significant innovations like the internet and AI.

The United States stands as a benchmark for successful military initiatives resulting in civilian technologies, but European defense spending has historically lacked such positive economic returns. A recent European Commission study found no concrete correlation between military expenditures and economic growth across 15 European nations over a span of 50 years beginning in the 1960s.

Ethan Ilzetzki, an associate professor at the LSE, pointed out that a genuine growth dividend is more plausible if governments resort to borrowing rather than implementing tax hikes to finance increased spending. While Brussels has made strides in relaxing fiscal rules, the UK has yet to clarify how a potential 3% GDP commitment for defense would be financed, leaving the Chancellor under pressure to meet fiscal targets.

“There’s no certainty that borrowing for defense will be self-sustaining,” Ilzetzki remarked. This uncertainty is exacerbated by the UK’s reliance on foreign sources for roughly 50% of its defense equipment and about 75% from the EU, the bulk provided by U.S. companies that are poised to benefit as European defense budgets grow.

Even if contemporary military investments could foster future technological advancements, the belief that these efforts will lead to job creation for domestic workers or reverse the decline of British industry is questionable. Khem Rogaly, a research fellow at Common Wealth, cautioned that while real-term defense spending has slightly increased since the 1980s, employment in the defense sector has halved. “Direct and indirect expenditures from the Ministry of Defence account for only 0.9% of total jobs in the UK,” Rogaly stated.

Rogaly warned that the UK’s approach is more aligned with “military austerity” rather than military Keynesianism, given that it diverts funds from other critical industrial policy instruments like the National Wealth Fund. “This strategy lacks a serious focus on industrial development or job creation,” he concluded.

A possible optimistic outcome of the pressing need to fund defense in Europe is the call for the EU to advance toward fiscal federalism, potentially involving collective debt issuance by Brussels to tackle common security challenges. Shaan Raithatha, a senior economist at Vanguard, articulated that the current climate is ripe for member states to unify their resources to address security requirements.

“Efficient procurement would mitigate fragmentation,” he noted. “This represents Europe’s second ‘whatever it takes’ moment—a once-in-a-lifetime opportunity to establish lasting EU-level fiscal policies.”