What lies ahead? defence, budgets and the financial crisis

At the June 2009 Paris Airshow, defence orders exceeded those in the commercial sector

How will tighter belts affect the way military budgets are spent? And when will defence feel the pinch? Dr Derek Braddon examines the impacts for suppliers, customers - and alliances.

‘Economists are pessimists: they’ve predicted eight of the last three recessions’ once quipped Dr Barry Asmus, Senior Economist at the National Center for Policy Analysis. Pessimists or not, for those of us who have spent a lifetime studying economics, the recent global ‘credit crunch’ and its policy aftermath have stretched our understanding of the subject to its limits.

Such has been the urgency to address the current global financial crisis that both fiscal and monetary policy in many countries have been taken in directions and to levels of intervention which earlier would have been thought unsustainable - perhaps even irresponsible. The G20 agreement in April 2009 to jointly reflate the global economy with $1.1 trillion (including a remarkable $809billion fiscal stimulus plan in the US alone) was unprecedented.

In many ways, we are now in uncharted economic waters. The extremely uncertain future economic outcomes leave policy-makers, not least in the defence sector, in something of a dilemma.

If current expansionary economic policies do succeed, deep and prolonged recession may be avoided. However, the unprecedented fiscal and monetary stimuli adopted (especially in the US and UK) to avert total economic collapse may rapidly lead to an inflation crisis. This would then require draconian public expenditure cuts. Defence spending would inevitably be a prime target.

On the other hand, if the recent ‘green shoots’ prove to be illusory and economic policies fail to stop a global economic depression, the outlook for public spending will be equally serious. Again, defence expenditure will be a relatively easy target for stringent cuts.

Reuters

Sitting target? Defence spending may feel a squeeze in some countries

The impact on employment of defence cuts has historically been felt more at a regional level rather than national level. This makes spending reductions easier to implement than in other public sectors.

Also, inflation in defence goods tends to be higher than the normal inflation rate. This makes the defence sector appear less cost-conscious than others and consequently perhaps more deserving of budget cuts.

Finally, while defence tends to be a positive factor for the trade of countries like the US and UK, the ‘arms trade’ remains highly unpopular and a powerful lobby in both countries would support deep defence cuts.

In the short term, however, it is unlikely that the defence sector will face major cuts in expenditure.

Most defence spending involves long term commitments from government which are difficult and often expensive to reverse. President Obama’s recent $634billion defence budget proposal does represent a cut in terms of his predecessor’s plans but still amounts to a 4% increase overall. Similarly, in the UK, despite talk of a ‘black hole’ in the defence budget, immediate cuts are unlikely.

The danger for defence spending will come in the longer term - after 2010 - as the real cost of dealing with the financial crisis emerges. Without an explosion of economic growth in the global economy, public sector budgets will come under unprecedented pressure as governments are forced to repay massive borrowing. It is here that major defence projects will be at their most vulnerable and cost savings will have to be made.

Already a number of major defence projects are being cut or are under serious threat in the US including the F-22, new helicopters, next-generation armoured vehicles and high-technology naval vessels.

In the UK and Europe, analysts suggest that the A400M transport aircraft remains at risk and that the Trident replacement is once again under threat. Additionally, many smaller European NATO members, already struggling to maintain a real commitment to more equitable burden-sharing within the organisation, will inevitably see their defence budgets devastated by severe budget cuts in the longer term.

Lockheed Martin

The Joint Strike Fighter F-35 Jet, a top of the range - and highly expensive - project

A new report on UK defence spending by the Institute for Public Policy Research (IPPR) reinforces the view that swingeing future defence cuts cannot be avoided. The report, researched and written by a group of leading UK military figures, makes clear the divide already perceived between what defence goods the UK wishes to acquire and what the country can actually afford.

The IPPR recommends:

• scaling back planned UK military spending by some £24billion;
• reviewing alternatives to the Trident replacement;
• encouraging much wider trans-European defence equipment procurement cooperation and
• encouraging greater specialisation in the UK armed forces.

The message for the military sector across NATO could hardly be clearer.

Budget contraction in the major NATO nations may ultimately weaken NATO defensive capabilities for the future. At the same time, strategists need to come to terms with three additional challenges

First, some countries outside NATO – notably China and India - have recently been increasing their defence expenditure, a trend which looks set to continue once global economic recovery is apparent. Asia’s share of world military spending is expected to increase sharply from 24% in 2007 to over 32% by 2016. China’s defence budget, which some analysts suggest in reality is double the official figure is considered to be the largest in Asia and China’s military are undergoing a major modernisation programme as a result.

In India, the recent surge in defence spending has been on a massive scale, (a 24% increase in the budget for 2009-2010 alone), making them the world’s third largest spender on defence in terms of the purchasing power of their currency.

Secondly, the so-called ‘revolution in military affairs’ (RMA). This focuses on harnessing leading-edge information and communications technologies to deliver superior ‘network warfare’ capabilities. It is an extremely expensive process. The RMA is already placing the defence budgets of the major players under great strain, yet without it, NATO cannot expect to retain its global advantage in this area of operations for long.

Already there are problems across NATO in terms of the quality and availability of certain types of military equipment. Some European forces complain about their sub-standard radios, weapons and armoured personnel carriers, among others, compared with their US counterparts. While an attempt is being made within NATO to eliminate these differences, the solution requires enormous expense and the ‘NATO Gap’ and its strategic implications can only be exacerbated further by severe contraction in future defence budgets.

The third challenge relates to the changing nature of the threats we face. The Cold War at least had the advantage that we knew with some certainty who, what and where the enemy was. Today, the enemy is more often than not a terrorist organisation or a ‘rogue nation’ and NATO forces are just as likely to be drafted in to a conflict zone to act as peace-makers on humanitarian missions as they are to be called upon to fight in a conventional war.

The recent terrorist attacks in Mumbai and elsewhere make very clear how the nature of warfare has changed, requiring a different approach to training and equipment. Although training and properly equipping rapid deployment forces has been a recent NATO priority, the bulk of our troops are still equipped and trained largely for the conventional war theatre. The readjustment process required here – both in terms of strategy and budget deployment – will again prove expensive, squeezing further the limited funds available to finance NATO’s military operations.

To an economist studying the provision of defence at a time of extreme financial contraction, these challenges can mean only one thing – a concept right at the heart of economic science – choice. Something – indeed, perhaps many things – will have to give.

Major military programmes will have their long term economic viability questioned; choices will have to be made between forces recruitment and, perhaps, purchasing some new equipment; the military advantage from RMA technical breakthroughs may have to be sacrificed to pay for humanitarian operations; and so on.

In discussing choice, economists often refer to one of the most fundamental concepts of all – opportunity cost; essentially, what we have to sacrifice in order to have something else that we want. As decision-makers in the defence sector struggle in the future to minimise the opportunity costs arising from the budgetary axe, it may be that the real price to be paid for the recent global financial crisis will be measured in terms of reduced security, greater threat and, in some parts of the world, possibly more serious civil disorder which we will be less able to counter effectively.

Those who would challenge this conclusion would argue that strategic defence reviews have come and gone in the past and little has actually changed. On this occasion, however, unprecedented economic forces are at work with unknown outcomes. And what lies ahead for the defence sector looks increasingly like radical surgery.

Dr Derek Braddon is Professor of Economics and Director, Defence Economics Research Group, University of the West of England, Bristol, UK