UK risks shooting itself in the foot on defence

In the early 20th century, as the UK’s naval arms race with Germany ramped up, the public decided that building six dreadnought battleships wasn’t enough – “we want eight and we won’t wait” was the popular cry. There was widespread support for higher spending on the military.

In the 2020s, it’s difficult to detect any such clamour. The government has promised to increase defence spending to 3.5% of GDP by 2035, and I’m yet to hear chants of “we want 4% and we’ll brook no dissent” (or any catchier alternative). Public priorities appear to lie elsewhere. But the pressure for the UK to spend more on defence is steadily growing as the US draws back from its role as guarantor of European security. The implications of this can’t be avoided for ever.

In 2024-25, the UK spent roughly 2.3% of GDP on defence. This is set to rise to 2.6% next year and stay there, as the government seeks efficiency gains and procurement improvements to make the budget stretch further. The big question is how, and how quickly, spending on defence will increase towards the new Nato target of 3.5%, agreed at a summit in June. While the UK and numerous other countries drag their feet, Poland has already delivered a rapid increase.

This new commitment is a big deal: the UK hasn’t spent 3.5% of GDP on defence since the late 1980s. It raises some clear challenges. An extra 1% of GDP is about £30bn that the cash-strapped Treasury would need to find – and devoting an extra 1% of our national resources to defence means doing less of something else.

The fiscal challenge is relatively simple, if no less daunting for that. If the UK now needs to spend tens of billions more on defence, not as a one-off but as the new normal, that will eventually mean higher taxes and/or lower spending on other things. We could borrow a bit more to ease the transition – especially if spending needs to be rapidly increased in a crisis – but that isn’t a sustainable long-term solution. Germany is borrowing to fund its rearmament, true, but from a considerably stronger starting point in fiscal terms: at about 60% of GDP, German government debt is much lower than the UK’s, which stands at 96%.

While there may be some growth opportunities from higher military spending, these are unlikely to be large enough to justify borrowing to pay for it (especially when compared with what we might otherwise have invested in).

That means tough choices on tax and spend. The first tranche of additional funding for defence (ostensibly) came from an offsetting cut to the overseas aid budget, but that approach has limits: there is only so much aid spending left to cut. Other financing options will need to be considered.

The lesser discussed and, in my view, more interesting, question is where the “real” resources will come from. Unemployment has ticked up recently, but the UK economy is operating at pretty close to full capacity. If more people are employed in the army, they’re not working in pubs or estate agencies. If our brightest engineers are building military drones, they’re not building new kitchen gadgets. Or, in the classic example, if we’re buying more guns, we’re not buying butter.

Put another way, devoting more of our national resources to defence would almost certainly mean having to lower levels of consumption – either of public services (like healthcare) or private goods and services. Higher taxes would be one means of achieving the latter. But not the only one. If the government sold war bonds (as recently floated by the Liberal Democrats) and households cut back their spending to enthusiastically pile in, that could achieve a similar result.

Consumption represents a bigger fraction of the UK economy than it does in most comparable countries (in the G7, we’re second only to the US). We’re a nation of spenders, not savers. This is the corollary of our low levels of investment. In some sense, then, starting from a higher base, we may be pretty well positioned to pare back our consumption a bit.

But there’s some important policy context. In making the case for the UK to shift towards being a higher-investment economy, this government is already implicitly arguing that household consumption should be lower (even if it doesn’t tend to say that bit out loud). After all, if more people are building houses or tunnels, they’re not working in cafes or shops. Making the shift to a higher-investment model will be hard enough. Doing it alongside a major rearmament programme would mean a double hit to household consumption: a very tough ask after an extended period of near-stagnant living standards.

Ben Zaranko is associate director of the Institute for Financial Studies

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