War Bonds Not The Solution To Financing Higher Defence Spending

All questions received thirty-five responses: 21 on behalf of the UK and 14 the Euro Area.

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Panellists answering for the UK preferred to finance short-term defence spending through tax and lower non-defence spending, while those answering for the EU favoured higher borrowing. Two thirds of the UK panel thought that higher taxes and/or lower non-defence spending should finance a lasting increase in defence spending in the short term, compared with one third of the EU panel. Conversely, two thirds of the EU panel preferred higher borrowing, compared with only one third of the UK panel.

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Those favouring higher taxes and/or lower non-defence spending pointed to the UK's elevated debt burden and borrowing costs, as well as the permanence of defence spending. Commenting on the UK, Martin Weale (KCL) said: “The UK already has a large debt and should be reducing it. Defence spending is bound to be recurrent and should not be financed by borrowing even if the debt were low.” Jonathon Hazell (LSE) highlighted the borrowing costs associated with debt-financed spending, stating: “The UK already has a loose fiscal stance and I expect significantly higher interest rates from a percentage point of GDP's worth of higher borrowing.” Commenting on the EU, Volker Wieland (IMFS Frankfurt) summarised increased defence spending as “the post-cold war peace dividend in reverse”, arguing: “In the short run it can be funded by additional borrowing to avoid sharp rises in taxation. Yet as it is a permanent expense, it should be paid out of tax revenue in the medium to longer run.”

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Those favouring higher borrowing emphasised the intergenerational nature of the benefits from defence spending, potential growth multipliers and, among EU panellists, the role of EU debt. Andrea Ferrero (University of Oxford) commented: “In theory, an investment in defence should benefit current and future generations, and thus debt seems the most appropriate mean of funding an increase. However, with the debt to GDP ratio close to 100 per cent, the UK should perhaps also consider cuts to inefficient non-defence spending.” Paolo Surico (London Business School) argued that the case for higher borrowing hinged on the composition of spending: “Higher borrowing is sensible only if it supports defence R&D and innovation more generally. If most of defence spending is on procurements, then defence spending won’t pay for itself because of the much smaller multiplier of defence procurements (as opposed to defence R&D) and therefore borrowing would not be a good idea.”

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Several EU panellists highlighted the role of EU debt issuance for debt-financed defence spending. Jorge Braga de Macedo (Nova School of Business and Economics) commented: “Given that we are raising defence spending at union level it seems appropriate to borrow at the same level. This would make the discussion more transparent and make the new role for the EU more transparent.” Fabrizio Coricelli (Paris School of Economics) argued that debt-financed defence spending was appropriate only if conducted through EU bonds: “If not [through EU debt], reduction of non-defence spending would be better.”

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Question 2: If some of the increase in defence spending is financed by borrowing, issuing specially marketed "defence bonds" (or "war bonds") is likely to be a more cost effective way of borrowing than standard government bonds.  Do you agree?

A large majority of the panel thought specially marketed “war bonds” would be no cheaper than borrowing through standard government bonds. Some 76 per cent of the UK panel and 71 per cent of the EU panel disagreed with the proposition that such instruments would offer a cheaper form of borrowing.

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Question 3a: A sustained increase in defence spending of 1 per cent of GDP is likely to raise the level of GDP after 2 years by:

Panellists anticipated a stronger GDP boost from higher defence spending in the EU than in the UK, though there was a range of answers submitted by both panels. After two years of a sustained 1 per cent increase in defence spending, 43 per cent of EU respondents expected GDP to be higher by between 0.75 per cent and 1 per cent, compared with 29 per cent of UK respondents. Some 14 per cent of EU respondents anticipated a gain in excess of 1 per cent, compared with only 5 per cent of UK respondents. Just under a third of UK respondents expected GDP to rise by less than 0.25 per cent, compared with around one fifth of EU respondents.

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Those with more conservative estimates of the GDP impact of defence spending pointed to crowding-out effects, the relatively short two-year horizon, leakages from imports, and the offsetting effects of tighter monetary policy. On the size of the multiplier and crowding-out effects, Matthias Doepke (LSE) argued: “Debt-financed multipliers may be higher, but as already argued I see little scope for increasing borrowing a lot, so the gains have to be offset against lost spending or higher taxes elsewhere.” Charles Bean (LSE) highlighted the counteracting effects of import leakages and the monetary policy response: “On the premise that perhaps half of the extra spending will be on military capital and is financed by borrowing rather than taxes, then it should boost aggregate demand in the UK. However, it is likely that a significant fraction of that extra spending will be on equipment supplied by foreign rather than UK-based producers, so leaking abroad. In addition, any extra stimulus to domestic demand is likely to lead the MPC to hold Bank Rate at a higher level than would otherwise be the case in order to meet their 2 per cent inflation target.” Robert Kollmann (Université Libre de Bruxelles) drew a distinction between the returns to defence spending in wartime and in peacetime: “In peacetime, defence spending multipliers are likely modest. But if higher defence spending helps avert war, the GDP effect would be much larger relative to a war counterfactual.”

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Several panellists judged the composition of defence spending to be the key determinant of the GDP impact, with those expecting expenditure to be concentrated in personnel and conventional equipment – rather than R&D and high-technology investment – submitting more modest estimates. Commenting on the UK, Jonathan Haskel (Imperial College London) said: “I assume that more defence spending will be concentrated in personnel and cheap hi-tech defence equipment e.g. drones. The effects on GDP are likely to be minimal, unless there are large spillover benefits from software development.” Commenting on the EU in a similar vein, Alessandra Bonfiglioli (Queen Mary University of London) stated: “It depends on where this spending goes: if it's people and traditional equipment, the multiplier is way below one. If it's research and high tech, it may be higher. All in all, I expect most of it to cover the former, hence a pretty small multiplier.”

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Those offering higher estimates of the GDP impact pointed to the conditions under which a larger multiplier could be realised. Jagjit Chadha (University of Cambridge) said: “I am being somewhat conservative here at 0.75-1 per cent but if we can target defence expenditure in R&D and to nurture local pools of higher demand on a sustained and credible basis, one can imagine the impact lying in the neighbourhood of a significant multiplier effect of over 1 per cent, particularly if co-ordinated across Europe.” Juergen von Hagen (University of Bonn) pointed to investment opportunities in the production sector: “Since the bulk of the increase will be for weapons, and production capacities are currently limited in the EU, the weapons industry will have to invest heavily in new capacity. That industry has been able to attract fresh capital recently already.”

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Question 3b: How confident are you in your answer?