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Can the UK economy get more bang from higher defence spending?

by June 2, 2025
June 2, 2025
Can the UK economy get more bang from higher defence spending?

At her spring budget, Chancellor Rachel Reeves outlined an ambitious vision: to make Britain a “defence industrial superpower”.

In doing so, she joined a growing wave of European leaders rethinking their military budgets not just through the lens of national security, but as tools for economic growth. As war returns to Europe and global power balances shift, defence spending is being recast—from fiscal burden to potential economic catalyst.

It’s not just rhetoric. Reeves has earmarked an increase in the UK’s defence budget from 2.3% of GDP to 2.5% by 2027-28, equivalent to £6–8 billion in additional spending. Longer term, she wants to push that figure to 3%, which would mean another £17 billion by the end of the decade. Her stated aim: more UK-made drones, AI defence systems, and military tech incubated in British start-ups. The message is clear—this isn’t just about buying bullets, it’s about building economic momentum.

Across Europe, the same thinking is taking hold. Germany has set up a massive off-balance-sheet defence fund and is exempting military spending from its fiscal rules. The European Commission is letting member states borrow for defence outside of deficit constraints and is finalising a €150 billion loan facility to fund joint security projects. If the EU once championed the welfare state, it is now making peace with the warfare state—ushering in what some have dubbed a new era of “military Keynesianism”.

Traditionally, defence spending has had a limited impact on long-term productivity. Military expenditure in Europe has historically been a poor driver of economic expansion. A European Commission study found no clear growth effects from defence spending across 15 countries over five decades. Even in the UK, while real-terms defence spending has crept up since the 1980s, employment in the sector has halved. Today, only around 0.9% of UK jobs are supported by Ministry of Defence contracts.

Yet proponents argue that how governments spend matters more than how much. Paolo Surico, professor at London Business School and an advisor to the Treasury, believes defence spending can have a significant economic multiplier—if focused on research and innovation. He estimates that traditional military outlays generate a modest return of £0.60–£1.00 per £1 spent over four years. But when targeted at R&D and emerging technologies, that multiplier could rise to 2:1 over the long term.

Examples abound. The internet and GPS both trace their roots to U.S. defence research projects. The hope is that investment in autonomous drones, quantum radar, and cyber capabilities could deliver similar spillovers. Reeves has signalled support for this approach, stating that she wants the benefits of defence spending to be felt “across the whole country”, including in regional tech clusters.

But sceptics say the UK risks falling between two stools. Khem Rogaly of the Common Wealth think tank warns that Labour’s current approach resembles “military austerity”—funding rearmament by cutting back on other industrial investment, such as the National Wealth Fund. Others note that with around 50% of the UK’s defence procurement coming from overseas, and as much as 75% for EU countries, it’s often American firms, not British ones, that benefit most from Europe’s rearmament.

Then there’s the question of financing. Unlike the EU, which is considering joint debt issuance to fund defence, the UK remains bound by strict fiscal rules. That limits the ability to borrow and risks crowding out other public investment.

Still, some economists argue that defence spending could unlock broader EU integration. With 15 member states already planning to use Brussels’ relaxed fiscal rules to boost military budgets, there is growing support for a permanent EU-level fiscal policy to fund shared security needs—potentially marking a “second ‘whatever it takes’ moment”, according to Vanguard economist Shaan Raithatha.

For the UK, though, the path is narrower. If Labour is serious about building an industrial strategy around defence, it must commit to more than just rebalancing budgets. It must create ecosystems of innovation, secure domestic supply chains, and avoid the temptation to simply increase troop numbers or purchase imported kit.

There are big questions about whether defence spending will deliver meaningful economic returns. But with geopolitical pressures rising and growth levers limited, Reeves may feel she has little choice but to try. The stakes, after all, are not just about job creation—but the future of national security, industrial resilience, and Britain’s place in a new global order.

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Can the UK economy get more bang from higher defence spending?

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