Economic effects of higher defence spending

Approximate read time: 5 minutes

The UK government committed in June 2025 to spend 5% of gross domestic product (GDP) on national security by 2035.^[1] This would consist of a projected split of 3.5% of GDP on ‘core’ defence and 1.5% of GDP on resilience and security. This higher level of defence spending would represent an uplift on the 2.3% of GDP spent on defence in 2024 and would involve, in today’s terms, spending an additional £35bn.^[2]

Spending 3.5% of national income on defence would not be unprecedented. As figure 1 shows, the UK last spent 3.5% of GDP on defence at the end of the 1980s, and in previous decades spent a much larger share of national income on defence.

Figure 1. UK defence spending as a percentage of GDP

1. Higher defence spending could deliver some positives to the economy in the short and long run

1.1 Short-run effects

All else equal, increased defence spending should cause the economy to expand. This effect is captured in estimates of the so-called ‘fiscal multiplier’, which measures the impact of a change in government spending (or taxation) on the overall economy. These multipliers capture the indirect effects of fiscal changes on activity over and above their immediate effect on demand and through raising private incomes and spending.

The Office for Budget Responsibility (OBR) judges that different types of spending policies have different multiplier effects from one another.^[3] A £1 rise in investment spending is assumed to increase GDP by £1 in the short run, while a £1 increase in current, or day-to-day, public spending boosts GDP by an estimated 65p. Since defence spending is a mixture of current and capital spending, the multiplier from spending in this area is likely to sit somewhere between these estimates.

1.2 Longer-run effects

If some of the extra defence spending is focused on research and development (R&D), higher spending could deliver long-run productivity gains, including spillover benefits to the private sector. Defence-led R&D has paved the way for many groundbreaking technologies—from radar to the internet—that have spilled over into civilian activities. One piece of research estimated that a 10% increase in government-funded military R&D encourages more than a 4% rise in private-sector R&D.^[4]

There is also evidence of government-induced ‘learning by doing’, where higher government spending on defence enhances industrial efficiency and builds technological expertise. Shipbuilders and aircraft manufacturers saw significant declines in costs over the course of the second world war as production ramped up, and this appeared to be correlated with their experience.^[5] More recent work estimates that a temporary 1% increase in military spending relative to GDP raises total factor productivity (TFP) by 0.3% through enhancing skills and industrial know-how.^[6]

2. The size of any economic gains will be limited by several factors

However, there are numerous factors which will constrain any boost to economic growth from higher defence spending. One is that the UK’s defence industry accounts for only a small part of the economy. In 2023, the sector is estimated to have contributed around 0.4% to 0.5% to total UK economic output, or gross value added (GVA).^[7] Therefore, if higher defence spending were to stimulate a significant rise in defence output, this would probably correspond to only a relatively small rise in overall GVA.

A second limiting factor is the import share of defence spending. Defence spending comprises spending on personnel, premises and equipment, such as tanks, fighter planes and ammunition. It is estimated that equipment accounted for around 36% of UK defence spending in 2024, the ninth highest share among the 31 NATO countries assessed.^[8] Data on defence imports is less timely, but in 2019 the UK imported $7bn of defence equipment, or £5.5bn based on the then pound/dollar exchange rate.^[9] In the same year, UK spending on defence equipment and support was £15.9bn, meaning imports accounted for almost a third of this spending.^[10] If higher defence spending is orientated towards equipment, a sizeable share may benefit the industrial bases of other countries rather than the UK.

A third potential obstacle to higher defence spending stimulating the wider economy relates to spare capacity in the economy. The OBR thinks the economy presently has a modest degree of spare capacity (the difference between actual GDP and the level of GDP consistent with stable inflation), and predicts that margin to disappear by 2027.^[11] Some experts have queried how meaningful the concept of ‘spare capacity’ is and noted that it is an extremely elastic concept.^[12] However, if the OBR’s forecast proves correct, a significant expansion in the defence sector could cause a degree of overheating in the economy, with the Bank of England responding by keeping interest rates higher than otherwise. In this case, higher output and employment in defence would be offset by lower output and employment in other (particularly interest-rate sensitive) parts of the economy.

Meanwhile, on the question of longer-term economic gains from higher defence spending, there are some qualifications to claims of spillover benefits. One is that advancements in military know-how that could have civilian benefits are unlikely to be disseminated quickly due to national security considerations. Also, defence spending reallocates production across firms, with potential implications for aggregate economic efficiency. Some have argued that military spending may harm the productive capacity of an economy because it misallocates expenditure to less productive firms.^[13]

3. How higher defence spending is financed matters

Any positive economic effect from higher defence spending is likely to be bigger if the additional spending is financed by higher debt, rather than higher taxes or lower government spending elsewhere.

However, if the intention is for defence spending to settle at a permanently higher level, financing that spending by borrowing could raise concerns about the sustainability of the public finances. It could therefore be assumed that permanently higher defence spending may be financed by some combination of spending a smaller share of GDP in areas such as health, education and welfare, or by increasing the tax burden (leaving households with a smaller share of income available to be spent on goods and services). This would cause costs to fall onto individuals and may reduce any positive effect on GDP.

4. Read more

• Delphine Strauss, ‘How big is the economic dividend from extra defence spending?’, Financial Times (£), 4 June 2025
• Ethan Ilzetzki, ‘Guns and growth: The economic consequences of defense buildups’, Kiel Institute for the World Economy, February 2025

---

Cover image by Defence Imagery on Flickr.