DEFENSE BUDGETS AND STATES’ ECONOMIES

by Giancarlo Maragucci

 

Within the formation of economy, States aim to fulfill their requirements and to protect themselves from the threats of other Countries or Non-State actors, therefore they always separate a portion for military spending from their budget. Two great wars took place in the world which shattered States’ economies, the First World War (WWI 1914-1918) and the Second World War (WWII 1939-1945). State economies were effected so badly in WWI that was seen as one of the main reasons of global Great Depression in 1930’s, and also WWII left many Countries on their knees, saved only by huge investments from other Governments (e.g. the US Marshall’s Plan). During the Cold War (1947-1991), the Western and Eastern blocs looked at each other as threats and escalated their defense spending extraordinarily in order to increase their respective power of deterrence. With the collapse of Soviet Union all Countries around the world, with few exceptions, decreased their spending for the military capabilities, even if in the last 10-15 years the trend has reversed for many due to new threats and regional unstable situations.

Usually Defense spending is the national share to provide security against internal and external threats and they are composed of production (or import from other countries) of equipment – including their maintenance, expenditures for Research and Development (R&D) activities and costs for personnel – including their training.
In some way as a general perception Defense and Welfare investments are opponents, money invested for the military is likely to retard economic growth, money subtracted to education, health and infrastructure, and this is the reason why spending on the economy is one of the most discussed subjects today.
The Classical school argues that a higher level of military spending will lead to an increase in the interest rate, which will crowd out the private investment, while the Keynesian school of thought contends that an increase in the military burden stimulates demand, increases purchasing power and national output, and creates positive externalities. Several studies have been conducted in the last 20 years, leading to different results; in some cases, it was stated that military spending negatively affect economic growth, others concluded that military spending positively affect economic growth and some others found that there is a causality or even no relation between military spending and economic growth. So, what is the true? [1] First we should understand what the cost of war is.

There is no such thing as an inexpensive war. [2] First, there is the human cost in loss of life and in the physical and psychological maiming of healthy people. While the personal cost of such loss is immeasurable, the economic cost to society can be estimated. This measure was first proposed by a French economist, Jean-Baptiste Say, in 1803. He asserted the principle that war costs more than its direct expenses, for it also costs what its casualties (military and civilian) would have earned throughout their lifetimes if they had never participated in war.
Second, war has economic costs arising from the destruction of buildings, productive farmlands and forests, public services such as waterworks, electricity-generating and distribution systems, roads, bridges, harbors, and airfields, and all manner of personal and corporate property such as homes, possessions, factories, machinery, vehicles, and aircraft.
War, therefore, destroys physical capital that has been created by previous economic activity.

 

Reconstruction after war is a particular economic burden because the finance, imported capital goods, and labor used in reconstruction merely restore the losses a country has sustained, rather than adding to the stock of capital available to its economy. Thus, even if it manages to restore all its physical losses, it uses scarce resources that would otherwise have been available for extending and improving economic activity. As most wars since 1945 have occurred in the Developing World, some of the world’s poorest countries have suffered the most from the economic losses of war.
In summary, the total costs of war include the cost of the foregone use of the economic resources used up in the conflict. These include the cost of the foregone lifetime earnings of those killed in the war, the cost of lifetime medical care for those permanently incapacitated by the war, the cost of replacing the physical capital destroyed or damaged by the war, the cost of supplying the armed forces with the weapons of war, the cost of sustaining the armed forces and those in support functions (including their pay and pensions), and the losses to the economy caused by the diversion of resources from peaceful investment in future economic capacity.

As war is expensive, countries aim to avoid its costs and remain independent within sovereign borders. In the absence of a universally binding and verifiable agreement to abolish war, the best option is to deter those countries prone, by their history or by the policies of their governments, to resolve disputes by resorting to war.
Deterrence though has two aspects. First, by allocating resources for a minimum level of military capability, a nation ensures that it can resist an attack by a potential aggressor and severely damage the aggressor’s economy and territory. In this way the costs to the aggressor of initiating a war will far exceed any likely gains. Second, by making credible its willingness to use military force, should it prove necessary to do so, the nation aims to leave potential aggressors in no doubt of the consequences they will suffer if they are tempted to launch an attack.
Deterrence then, while expensive, is incomparably less expensive than war.
The study of its expense constitutes the subject matter of so-called defense economics.

Security expenditures for both external defense and internal law and order account for major shares of government expenditures. In many low-income countries, these expenditures often exceed 20–30 percent of the state budget and more than 10 percent of the country’s GDP.
The higher-income countries, while spending higher absolute amounts on defense, tend to spend smaller proportions of state expenditure (under 15 percent) and smaller proportions of GDP (under 5 percent).

Within the higher-income countries there are notable differences in the amounts spent on defense. The United States and Britain have spent relatively high proportions (5 to 10 percent) of their GDP on defense since 1955, compared with Japan, which has spent less than 1 percent of GDP over the same period. Germany and France also have tended to spend a smaller proportion of their GDPs than Britain on defense.
If defense spending competes with economic growth in the capitalist economies, contributing to inflation, low investment, and lower living standards, then it must have a devastating impact on poorer economies of the world. But history is not always applying logic. Throughout the years many governments have been willing to engage in war only if it suited their interests as they perceived them, instead many others have also been dragged into wars when cooler calculations might have encouraged them to remain at peace.

A major modern war can divert up to 60 percent of a country’s GDP, and main aim for the Government is to prevent inflation escalation, that is possible by reducing civilian consumption through imposing taxes at levels sufficient to force consumers to forego bidding for goods and services. Taxation acts both to raise necessary finance and simultaneously to reduce aggregate demand, which releases the resources needed for the war effort. The latter represents a substantial expansion of production, for which producers receive wages and profits. When these same producers attempt to spend their incomes, they face a diminished quantity of civilian goods available for purchase. They must either face rapidly rising prices or they must restrain—or be restrained—from spending. A war economy therefore imposes higher taxes on wages and profits to reduce demand.

To conduct a major war without such an austerity program risks inflation.
If inflation is a risk during a war, recession is another risk at the end of it. The massive expansion in production to provide resources for the war effort, if suddenly contracted by the cancellation of all defense contracts, throws large numbers of people out of work. The unemployed reduce their consumer spending, causing further cuts in aggregate demand, which creates further unemployment.
World War I was followed by recession, since the destruction was mainly human and the cost was mainly in war materials, while recession was averted at the end of World War II by reconstruction of the cities and economies of Western Europe and Japan. Reconstruction rapidly transformed the war economies into mass consumer economies supported by the pent-up demand that had been frustrated by the lack of civilian goods and by high taxes during the war. In Europe’s case there was a transfer of capital from the United States through the Marshall Plan. As the war economies were dismantled, economic growth surged, and those countries that did best economically were those that dismantled their highly regulated, government-controlled war economies quickest, like Germany.

 

Today a common terminology is used among the experts, like Military Budget (or military expenditure), also known as a defense budget, that is the amount of financial resources dedicated by a nation to raising and maintaining an armed forces or other methods essential for defense purposes. Military budgets often reflect how strongly an entity perceives the likelihood of threats against it. Then we have Economic Militarism that expresses the ideology surrounding the use of military expenditure to prop up an economy, or the use of military power to gain control or access to territory or other economic resources. Thus a link between results (or output) and military expenditure can be made, and this depends on (1)threat faced, (2)productivity of factors, (3)degree of the military utilization, (4)finance method of military spending and (5)its externalities and effectiveness of this military spending in countering the treaty.

Therefore, a same amount of military spending in different countries can have wide-ranging effects, such as Demand-Effect, Supply-Effect and Security-Effect.
The economics of defense or defense economics is a subfield of economics, an application of the economic theory to the issues of military defense. It thus uses macroeconomic and microeconomic tools such as game theory, comparative statistic, growth theory and econometrics.
As the largest military alliance of the world, NATO [3] collects defense expenditure data from Allies on a regular basis and presents aggregates and subsets of this information. Each Ally’s Ministry of Defense reports current and estimated future defense expenditure according to an agreed definition of defense expenditure. The amounts represent payments by a national government actually made, or to be made, during the course of the fiscal year to meet the needs of its armed forces, those of Allies or of the Alliance.

A major component of defense expenditure is payments on Armed Forces financed within the Ministry of Defense (MoD) budget. Armed Forces include Land, Maritime and Air forces as well as Joint formations such as Administration and Command, Special Operations Forces, Medical Service, Logistic Command etc. They might also include “Other Forces” like Ministry of Interior troops, national police forces, gendarmerie, carabinieri, coast guards etc. In such cases, expenditure should be included only in proportion to the forces that are trained in military tactics, are equipped as a military force, can operate under direct military authority in deployed operations, and can, realistically, be deployed outside national territory in support of a military force. Also, expenditure on Other Forces financed through the budgets of ministries other than MoD should be included in defense expenditure.
NATO uses United States dollars (USD) as the common currency denominator.

Estimates of the threat of a Soviet invasion across the German border determined the nature of NATO’s response for more than 40 years. While NATO planners considered their own forces to be technologically superior to the Soviet forces, they were nevertheless mindful that the Soviet Union had a decisive quantitative superiority in conventional forces (more tanks, armored vehicles, artillery, combat aircraft, and troops). The threat of a land-based invasion by Soviet forces, which the planners considered to be virtually unstoppable, led directly to the decision to deploy nuclear weapons as the ultimate deterrent against an invasion of Western Europe.

Nobody could survive a major nuclear war in Europe. The damage to the Soviet Union from an American nuclear strike could be matched only by the damage to the United States from a Soviet nuclear strike. Because each country has maintained sufficient nuclear forces to respond in kind to a first strike by the other, a nuclear exchange could be suicidal for both.
The United States from 1940 through 1996, spent nearly $5.5 trillion on nuclear weapons and weapons-related programs, in constant 1996 dollars [4].

The possession of nuclear weapons by some NATO countries (the United States, United Kingdom and France) did not obviate the need for expenditure on conventional armed forces, and in 2018 World military expenditure was estimated to be $1822 billion, 76 per cent higher than the post-cold war in 1998, and it represents the 2.1% of global GDP. What is the impact of military expenditures to national economies? Is there any relation between Defense costs and welfare? The answer is: it depends.

The United States, with its major military providers of systems, weapons and know-how, and the largest military organizations of the world, connects the Defense spending with welfare, and this justifies the American strong military commitment all around the world. On the other side, small economies but in high threat regions must sacrifice the public welfare in order to maintain a high level of national deterrence and security. In between all the others, where the Defense budget is more an internal political speculation tool for the Governments.

 

Notes/Endnotes

[1] Suna Korkmaz, “The Effect of Military Spending on Economic Growth and unemployment in Mediterranean Countries”, www.econjournals.com, 2015
[2] Defense economics — Britannica Online Encyclopedia, 2018
[3] Defence Expenditure of NATO Countries (2010-2017), 2018
[4] Schwartz, “Atomic Audit: The Costs and Consequences of U.S. Nuclear Weapons Since 1940”, Brookings, 1998
[5] Trends In World Military Expenditure, 2018, SIPRI Fact Sheet, 2019