Hello and welcome you are listening to Patrick Boyle on
Finance, a podcast exploring ideas from quantitative finance,
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of finance. To learn more about the podcast,
visit on finance.org. The peace dividend was an idea
popularized by George Bush senior and Margaret Thatcher in
the wake of the collapse of the Soviet Union.
The term was used to describe the economic benefits of reduced
defence spending. It meant different things to
different people. To summit meant lower taxes, but
the most common interpretation was the government spending on
social needs would increase as defence spending was cut.
After the fall of the Berlin Wall, Western countries did
indeed spend a lower and lower share of their GDP on defence,
which you can see in this chart. And if we look at defence
spending as a multiple of healthcare spending, we can see
that in both the United States and the UK, the peace dividend
helped fund other popular spending priorities, the
trillions of dollars that had been spent on Cold War armies
and weapons systems. We're slowly being diverted to
things like healthcare, housing and schools.
In the 30 years since the fall of the Iron Curtain, Western
democracies came to believe that the era of global confrontation
was in the past. The new era when security took a
backseat to trade and economic growth ended abruptly with
Russia's invasion of Ukraine last year.
Of course, it's not just Russia. The US National Defense Strategy
released last year bluntly stated that China represents the
most comprehensive and serious challenge to US National
Security. On top of that, the recent
events in Israel and Gaza have the potential of turning into a
larger regional conflict. The threat of nuclear armed Iran
and North Korea continue to grow and instability in West Africa
has reached a six year high. The peace dividend may well be a
thing of the past. It's not the first time that
we've taught that we were in a new era of peace, either.
In 1910, the British journalist Norman Angel published an
extremely influential book, The Great Illusion.
It sold more than a million copies and was translated into
22 languages. It was discussed by the leading
statesman and diplomats of the day.
Even Kaiser Wilhelm was said to have expressed some interest in
its theories. The book argued that new
economic factors meant that we had reached the point in history
where there would be no more wars.
The book didn't focus on the cruelty of war, but on its
economic futility, which made it unacceptable as an instrument of
state. The core argument was that in
the new, interconnected global economy that had recently
developed, commercial and financial linkages between
countries had become so extensive that no rational
leader could contemplate starting a war, as the economic
chaos that would result from a conflict would harm all sides
and the victor would lose as much as the vanquished.
The British Committee of Imperial Defence had hearings on
trade in the time of war. In 1912, the Chairman of Lloyd's
testified to the committee that much of Germany's merchant
marine was insured through Lloyd's of London and that in
the event of war, were German ships to be sunk by the Royal
Navy, Lloyd's would be both honour bound and, according to
its lawyers, legally obliged to cover the losses.
Conflicts between modern nations were all cost and there was no
benefit. According to Angel, the economic
interdependence between industrial countries would be
the real guarantor of the good behavior of 1 state to another.
Angel was right about the meager benefits and high costs of war,
but was wrong about the rationality of nations.
The years that followed saw the worst conflicts in human
history. A new edition of the Great
Illusion, which is today known as the Interwar edition, was
published in 1933, the year Angel was awarded the Nobel
Peace Prize. Military spending by European
NATO members and Canada reached a low point in 2014 as the
demand for military hardware plummeted.
After Russia annexed Crimea that year, defense budgets started to
rise, but most countries still fell well below NATO's target of
2% of national output. Last year, we saw the largest
increase in military spending in Europe in 30 years.
These defense demands, which are likely to last well beyond an
end to the war in Ukraine. Come at a time when many
countries are facing huge spending needs for rapidly aging
populations, as well as having made large financial commitments
to green policies. Once the Cold War had ended,
there was an idea that we were living in a unipolar world where
the United States had no pure military rival.
In the 1990s, political leaders around the world believed that
China would move towards liberalization over time.
This was already happening economically and was expected to
happen politically too. There was a similar expectation
of Russia. The more countries traded with
each other, the less likely conflict seemed to be.
This point of view made perfect sense, just like angels
arguments had in 1910. But just because something makes
sense doesn't mean it is what will happen.
In the early 2000s, Germany spent as little as 1% of GDP on
defence because, as the thinking went, why maintain a large
Defence Force when all our neighbours appear to be friends?
A German finance ministry assessment this summer showed
that the nation only had a stock of 20,155 millimetre artillery
shells in stock, enough for less than three days fighting.
Last year, the Center for Strategic and International
Studies conducted a war game involving a Chinese invasion of
Taiwan. The exercises revealed how
quickly the United States would run through its current supply
of weapons defending Taiwan. Certain critical supplies like
long range precision guided munitions would likely run out
in less than a week. The United States is not set up
to quickly replenish those stocks.
The urgent need to fortify defenses in Europe against
Russia has now forced European leaders to make extremely
difficult budgetary decisions that can be expected to affect
people's everyday lives in the coming years.
Will the increased military spending come at the cost of
reduced public services? And if not, how will it be paid
for? Through higher taxes, more
borrowing, or both? There appears to be public
support for at least some of this renewed defence spending in
Europe, as illustrated by Finland and Sweden's new desire
to join NATO. In most of Europe, however, the
painful budgetary trade-offs that would be required to
significantly increase defence spending have not yet trickled
down to daily life. Much of the belt tightening last
year that affected households was the result of rising energy
prices and inflation, a senior NATO official was quoted in the
FT recently as saying. Leaders have signed up to a
generational shift in defence policy, but I wonder if they
fully understand the costs or have told their finance
ministers. Governments around the world, on
both sides of any conflict, are realizing that the technological
sophistication of modern weaponry can make defence
spending cripplingly expensive. Russia's war on Ukraine has
shown that modern conflicts are not all about high tech
weaponry. Tanks, artillery and ground
troops are still as necessary as they've ever been.
Being fully prepared in this day and age means having both modern
sophisticated weaponry, along with traditional weaponry and
the industrial base to support them.
Western governments have not yet communicated to their citizens
the costs or the implications of this new military expansion.
Boris Pistorius, the German defence minister, told his
counterparts in Europe this summer that convincing
electorates of the need to spend more on defence requires a
totally changed mindset. Defence specialists argue that
investing in deterrence is less expensive than dealing with the
costs of conflict, and that by preparing for war, peace can be
preserved. Of course, one of the risks of
rearming is that opponents might see increased military spending
as a provocation. While all NATO members have
committed to spend 2% of GDP on defence, currently only 11 of
the 31 members do. But that might be already in the
process of changing. President Emmanuel Macron of
France promised to increase French military spending by 40%
through 2030 and to transform France's nuclear armed military.
France has entered into a war economy that I believe we will
be in for a long time, Macron said in a speech shortly after
announcing his spending plans. In France, government spending
as a percentage of GDP is already the highest in Europe,
and almost half of that spending went on the nation's social
safety net, which includes unemployment benefits and
pensions. Debt has rapidly increased in
the wake of the pandemic, yet Makran has promised not to
increase what is already one of the highest tax levels in Europe
for fear of scaring off investors.
There's no way that the French will not feel a pinch with this
increased military spending. The British Prime Minister,
Rishi Senak, pledged in March to increase military funding by $6
billion over the next two years in response to Russia's invasion
of Ukraine and the epoch defining challenge posed by
China. This increase was only half of
what its Defense Secretary reportedly wanted.
Britain is one of the few NATO members that actually meet
NATO's guideline of spending at least 2% of GDP on defence.
On the same day that the British government announced this
additional spending, teachers, doctors and transport workers
went on strike over pay and working conditions.
The budget did include a $4 billion increase for the NHS
over the same two year period. But as you can see, there are
difficult trade-offs to be made and lots of people will be
unhappy no matter what decision is made.
The USUK and Australia have also unveiled plans for an expensive
fleet of nuclear powered submarines in the Pacific as
part of their Aucus alliance. Germany, the largest and most
powerful economy in Europe, has consistently spent less on
defence as a percentage of GDP than either France or Britain
did since the reunification of Germany.
Now, at times in the more distant past, they've been quite
big military spenders, but not recently.
Germany shift in spending is possibly the most dramatic in
Western Europe, with the German Chancellor Olaf Schultz having
announced a special $112 billion defence fund last year.
The German defence minister asked for an additional $11
billion for next year. And this pot of money does not
include any spending for ammunition, which as I mentioned
earlier, they are quite low on. When this fund is depleted,
Germany will need to find an additional $38 billion to level
up with its NATO partners. Japan's defence ministry asked
in August for a record $53 billion for the 2024 fiscal
year, seeking to double defence spending to 2% of GDP by 2027.
As it faces an increasingly assertive China and an
unpredictable North Korea, the question of how to fund this
increase has divided the nation. Already struggling with
ballooning Social Security costs, Denmark's parliament
voted earlier this year to abolish a springtime public
holiday to boost spending on the military.
The cancellation will provide an additional $400 million to be
used on the defense budget, according to the government.
There were protests, but Denmark's government said the
extra money was needed to raise the defense budget to NATO's
target of 2% of GDP by 2030 instead of 2033 as had been
previously planned. This change of plan was due to
Russia's invasion of Ukraine, according to the Danish
government. Sweden, which has applied for
NATO membership, announced in September that it planned to
raise defense spending by more than 25% to meet the military
alliances target of 2% of GDP. Obviously, the closer you get to
Russia, the more you see countries start to worry.
Poland has pledged to spend 4% of its national output on
defense. Russia's budget for 2024
provides for an increase of 68% for defense compared to the
previous year. This would bring spending to 6%
of GDP. In contrast, spending on
education and health in Russia has been frozen at 2023 levels,
which corresponds to a spending cut when adjusted for inflation.
Due to the high rate of injuries of Russian soldiers, healthcare
expenses and financial aid for relatives of those killed
increased over the year. Taiwan's 2023 defense budget of
around $25 billion represents around 2.6% of GDP and is a 10%
increase from the prior year. Taiwan unveiled its first
domestically built submarine last month, demonstrating its
determination to push back against growing military
pressure from China. Many US defense experts see the
project as a distraction from Taiwan's need to quickly build
stocks of cheap and mobile munitions and strengthen its
defenses against a ground invasion force.
Taiwanese strategists argue that the submarines could greatly
complicate operations by China's Navy in the Straits North and
South of Taiwan. China claims to be spending $300
billion a year on defense. But assessments by U.S.
intelligence agencies and the highly regarded Swedish defense
think tank CIPRI put the number at $700 billion per year.
This is not too far from the US defense budget of $900 billion
per year. North Korea spends 26% of its
GDP on military, the highest proportion of any country in the
world. The rest of the budget is spent
on haircuts and food. For Kim Jong Un.
US spending grew by less than inflation last year, though it's
set to accelerate in 2023. Surveys in the United States
show that only 1% of respondents cite national security as their
main concern. The US is military budget is
already twice that of all other NATO members combined.
US is forecast to run budget deficits of 6% of GDPA year for
the next decade, and by 2053 federal debt will be twice GDP,
according to estimates from the Congressional Budget Office.
The US makes a significant contribution to the defence of
its allies around the world, but if these countries refuse to
shoulder more of the cost as the geopolitical situation heats up.
The US could lose enthusiasm. While the US does have a huge
defense budget, a recent article by Michael Brennes of Yale
University in Foreign Policy magazine argued that the war in
Ukraine revealed serious problems in America's ability to
manufacture weaponry. Following Russia's invasion of
Ukraine, the United States provided the Ukrainian military
with a range of weapons that were critical in helping halt
Russia's invasion. But the rate at which soldiers
are using ammunition in Ukraine strained the US defense
industrial base. This isn't really new, as U.S.
soldiers in Afghanistan and Iraq complained in the past about
being undersupplied. The conflict in Ukraine has so
far been a war of warehouses, where many of the weapons
systems and munitions came directly from US inventories,
depleting the nation's stockpiles.
Brenice argues that the United States needs to have the
industrial base to ramp up production in times of conflict.
The war in Ukraine has demonstrated that great power
wars are industrial conflicts. The effort to deploy arm feed
and supply forces is a huge task, and the consumption and
destruction of military equipment requires a large scale
industrial base for resupply. the US Army plans to increase
production of artillery shells by 500% within two years to
replenish stockpiles sent to Ukraine.
This is the largest production expansion since the Korean War.
A lot of difficult financial trade-offs lie ahead in every
country in the world. Reduced defense spending in
countries around the world helped governments to increase
spending on social programs without big tax or debt
increases. Over the last 30 years,
governments have done little to explain to their populations the
implications of the geopolitical tensions that we see today and
the increased military spending that is happening.
In every large country in the world, Norman Angel was right in
1910 about the futility of war, both from an economic and social
perspective. But one of the flaws in economic
thinking is to assume that people always make rational
decisions. If you found today's podcast
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