Defence spending and its economic impact on the UK and Europe

At her last fiscal event in March, Rachel Reeves outlined ambitions to transform the UK into a “defence industrial superpower.” The chancellor’s statement came amidst significant shifts in Europe, where nations like Germany are bypassing traditional fiscal constraints to ramp up defence budgets. Berlin’s announcement of unlimited defence spending outside standard fiscal rules is just one example of the rearmament trend sweeping across the continent.

The European Union (EU) has also introduced measures to support increased military spending. A €150 billion loan facility has been approved, allowing member states to fund investment in weapons, drones, and missile defence systems. Such measures aim to ensure national security and bolster regional defence capabilities. In the UK, the Labour government has committed to increasing its defence budget from 2.3 per cent of GDP to 2.5 per cent by 2027-28, equating to an additional £6 to £8 billion in spending. There is also a pledge to raise this figure to 3 per cent of GDP in the following parliamentary term, which would inject as much as £17.3 billion into the sector by the end of the decade.

According to proponents of military-driven investment, this surge presents opportunities beyond enhancing security. Reeves has linked the defence strategy to industrial development, stating it could fuel innovation in emerging technologies like artificial intelligence and drones, while creating new business opportunities for UK tech firms. Public investment in research and development (R&D) has been highlighted as a crucial aspect of unlocking the long-term economic benefits of defence spending.

Economist Paolo Surico from the London Business School suggests that diverting defence funds towards R&D is a high-risk, high-reward strategy that could yield significant economic returns. Examples of this approach’s success include projects led by the US military, such as the development of the internet and GPS technology. Surico highlights that R&D-focused spending could deliver a fiscal multiplier effect of up to 2 over time; in other words, every £10 billion of investment could ultimately generate £20 billion in GDP. However, such predictions depend on the unlocking of major technological advancements, a hurdle Europe has historically struggled to overcome compared to the United States.

Despite the potential for high returns, other economists express scepticism about the macroeconomic impact of military expenditure. An analysis by the European Commission of 15 countries over the past 50 years found no clear correlation between increased defence budgets and economic growth. Additionally, the UK faces specific challenges, given that more than 50 per cent of its defence equipment is sourced internationally, including 75 per cent from EU member states and the United States. With much of the industry controlled abroad, the immediate economic benefits of spending are unlikely to remain within the country.

The employment implications also raise questions. While defence budgets have seen modest increases since the 1980s, employment in the sector has halved over the same period. Presently, defence-related activities account for only 0.9 per cent of UK jobs, according to research conducted by the Common Wealth think-tank. This makes it challenging to position the expansion of defence spending as a significant driver of job creation or industrial revival.

Critics have also pointed out that redirecting funds from broader industrial initiatives, such as the UK’s National Wealth Fund, contradicts claims that defence spending will deliver a wide-reaching economic boost. Rather than fostering a bold strategy for national reindustrialisation, some argue that the measures represent a form of “military austerity.”

There is some optimism, however, regarding the potential for Europe to approach defence expenditure collectively. Economists argue that joint EU-level procurement and financing could reduce inefficiencies and fragmented decision-making while creating opportunities to standardise European security measures. This trend aligns with calls for broader fiscal federalism within the EU, potentially creating a more cohesive approach to managing military and security priorities across the bloc.

In the coming years, the extent to which defence spending can stimulate economic growth, drive technological innovation, and deliver tangible industrial benefits will remain a central focus of debate. For the UK, the key challenge lies in balancing ambitious defence objectives with prudent fiscal management and measurable economic outcomes.