Can the UK government afford to go faster on defence?
Prime Minister Sir Keir Starmer幼女视频檚 pledge after the to 幼女视频済o faster幼女视频 on increasing UK defence spending is good news for the struggling manufacturing industry. It幼女视频檚 one of the few realistic levers left to revive the sector. But, only if public funding, domestic supply chains and financing keep pace.
Building capacity in the UK defence sector
Accelerating UK defence spending may be necessary, but it confronts policymakers with some hard economic truths.
Without a clear funding framework and the procurement infrastructure promised in the delayed Defence Investment Plan (DIP), higher defence spending alone won幼女视频檛 strengthen the UK幼女视频檚 armed forces or the wider economy. Even once extra funding is in place, and the DIP finally published this spring, more action is needed to kick-start UK defence supply chains.
The UK's defence industry and wider manufacturing base face well-publicised productivity, skills and financing challenges. The underlined these in its recent report. This criticised the nation幼女视频檚 over-reliance on the US and governments幼女视频 low investment in critical capabilities. BAE Systems 鈭 Europe's biggest defence contractor 幼女视频 shows the extent of the sector幼女视频檚 capacity limits. As governments hike defence spending, this month it reported a record order backlog of 拢83bn.
UK manufacturing benefits from higher defence spending
UK manufacturing output remains below pre-pandemic rates. For comparison, the services sector has grown by about 8% in this time. Higher defence spending 鈭 especially capital expenditure 幼女视频 combined with more agile UK-based supply chains could change this.
The UK automotive sector offers one solution to the capacity question. Last year, motor manufacturers experienced the lowest vehicle production levels since 1952. A pivot to defence production would reduce these capacity restraints.
What幼女视频檚 more, almost 70% of defence spending happens outside London and the south-east of England. Channelling defence spending through domestic firms would provide meaningful support to regional manufacturing. So too if UK SMEs can capture a bigger slice of the defence budget than they do currently 幼女视频 4% 幼女视频 and banks addressed financing obstacles. Lenders幼女视频 ESG criteria and the risks and costs of defence research and development (R&D) currently often restrict access to capital for conventional weapons and dual-use technologies.
The government幼女视频檚 new SME defence spending targets and must therefore be backed by stable long-term plans. Consistency here would give UK manufacturers the confidence to make the necessary investments.
Paying for greater UK national security
The industrial constraints and opportunities are clear. The question now is whether the government can actually fund these ambitions.
The UK government幼女视频檚 current plans see the defence budget increasing from 2.3% of GDP to 2.5% by 2027. That幼女视频檚 an extra 拢5bn a year. Raising this to 3% of GDP, as Sir Keir Starmer幼女视频檚 signalled, would cost another 拢15鈭20bn a year. Getting to 3.5% by 2035 would require, in cash terms, another 拢20bn.
The UK幼女视频檚 fiscal environment is already tight. Extra defence funding would mean taking one of three approaches: deeper cuts to spending elsewhere, higher taxes or the Chancellor flexing the fiscal rules to allow for more borrowing. That leaves some tough fiscal choices if the government really does want to 幼女视频済o faster幼女视频 on defence spending.
Three ways to fund higher UK defence spending
Re-allocating spend
The government transferred around 拢6bn from the overseas aid budget to defence spending to fund the initial step to 2.5%. The remaining aid budget is about 拢8bn 鈭 not enough to cover even half of the extra required. Most government departments outside of health and defence will already have budgets squeezed, making lots of further small cuts difficult. Welfare and health and social care are the only two areas of spending large enough to generate savings of the size needed. Welfare spending is set to rise by 拢75bn by the end of the decade. Health and social care is forecast to rise by 拢37.9bn by 2030. Either would be a tough, if not impossible, political choice.
Raising taxes
There幼女视频檚 a strong argument that a permanent defence spending increase should be funded by a permanent tax increase. It would take the equivalent of another 3鈭4p on the basic rate of Income Tax. However, the UK tax burden is already set to rise to its highest level since the second world war by 2030. Adding another 0.5% of GDP would be politically difficult and potentially economically damaging. Any increase would probably have to come from higher Income Taxes or higher VAT, potentially breaching the Labour Party幼女视频檚 election manifesto.
Increasing borrowing
At face value, borrowing more is tricky. Lower immigration forecasts mean the Chancellor has already likely lost some of the headroom she built up in the last Autumn Budget. In any case, headroom of just 拢22bn would be too small to absorb much of the required increase in spending. Admittedly, more of the defence budget now counts as capital, which will help under the new fiscal rules. But, the chancellor only had 拢24bn of headroom against the supplementary target of public sector net financial liabilities should be falling as a share of GDP in 2029鈭30. A significant and sustained increase in borrowing would therefore need a change to the fiscal rules. One option would be to follow Germany幼女视频檚 lead and exempt defence and security spending from the fiscal rules altogether. However, it幼女视频檚 doubtful that all the increase could, or should, be funded through additional debt. Financial markets are already wary of UK public borrowing. Any rule-tweaking could lead to higher gilt yields.
Defence spending and the UK economic impact
The economic effect beyond a buoyed manufacturing sector depends in part on how the increase in spending is funded and how it幼女视频檚 spent. Spending on domestic procurement will have a bigger impact than importing goods, for example. Yet, shifting spending from other government departments to defence is unlikely to have a significant impact on the overall economy. Higher taxes take money out of the economy. Defence spending puts money in. The question is which effect dominates.
This would primarily depend on what taxes were raised. But, even in a best-case scenario, the positive impact would be small. The biggest impact would come from higher borrowing, which would represent a direct stimulus to the economy, although at the cost of even higher interest rates.
Aside from the direct impact of a fiscal stimulus and increasing manufacturing output, there could also be an impact on productivity in the whole economy if there were spillover effects from defence R&D spending into the civilian economy. There幼女视频檚 some evidence of this happening in countries like the US and Isreal, but the evidence is mixed and inconclusive. What幼女视频檚 more, only a tiny proportion of the increase in defence spending is allocated to R&D, limiting the potential gains for wider productivity.
Either way, the direction of travel is clear. Europe and the UK will be spending hundreds of billions of euros more on defence over the next few years. But, to generate the technological gains and spillover effects to other industries that can boost productivity as well as to capture the growth impact of higher spending, governments will need to focus on increasing domestic supply chains. Simply importing arms from abroad will not provide any economic benefits. That represents a golden opportunity to revive a withering manufacturing industry in the UK and on the continent.