Benjamin Tal, CIBC’s Deputy Chief Economist, and Katherine Judge, CIBC Senior Economist, provide insight into the trajectory of defence spending in Canada and the potential boost to economic activity associated with it.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Katherine Judge: Welcome to another episode of Eyes on the Economy. I’m your host, Katherine Judge, and I’m joined today by CIBC’s Deputy Chief Economist, Benjamin Tal. Today we’re going to talk about defense spending, which is a theme that’s gaining a lot of traction globally right now. So Benjamin, what are some of the trends we’re seeing in defense spending?
Benjamin Tal: Yes, it’s up period. It’s up very fast. Listen, we all know that the Trump is wrong on many things, but he’s not wrong on defense. You know, for years, the US has been subsidizing NATO in a big way with let’s face it, many free riders, including let’s call it as it is Canada. Now global defense spending was roughly what about 6 % of GDP.
in the (0s and now it’s about 2%. So it went down dramatically over the past few decades. Average net defense spending outside the US is about 2 % of GDP. Now listen to this, the US accounts for no less than 40 % of global military spending. That’s 3.4 % of the GDP. So Trump definitely has a point here. Canada clearly does not have a point.
We all know that Canada’s spending is subpar. We’re talking about roughly 1.4 % of GDP, which is way below the 2 % target. And the size of the Canadian arms forces is now 40 % smaller than it was during the 70s. So clearly a much smaller military. What is less known is that NATO has another requirement. This has to do with the distribution of spending. More specifically, we are talking about the requirement that at least
20 % of new spending will be on equipment. Canada is not even close to that. So if you look at the combination of actual spending and the distribution of spending, Canada is the second worst in NATO, Belgium is the worst. That cannot last. And in fact, it’s not lasting. We have this fog of uncertainty. Let’s face it, nobody really has a clue what’s going on, including Trump. But in this fog of uncertainty, there is one ray of clarity.
defense spending will be rising. They’re rising very fast and the trend is clearly reversing. It seems that Europe has entered the period of high and increasing military spending. Just a few examples. The UK is now committed to increase spending to 2.7 % of GDP in 20( France is aiming even higher. The Germany military spending over the past year was $(5 billion. This is… 28 % increase on a year-over-year basis. The EU Readiness (0 package introduced much more flexibility when it comes to the budget and defense spending. That’s huge. The US defense spending budget is about 15 % higher than it was a decade ago. So things are moving. Even Japan is on a move. The latest budget is seeing a close to 10 % increase in the defense spending to a record high of 9 trillion yen.
This is huge and the stock market is noticing it big time. We are seeing huge increase in the global defense tech ETF is up basically 44 % year to date and the aerospace and defense subindex is up by about 14-15%. So the stock market is already smelling blood here. Now the question is, is it a good thing or a bad thing?
because clearly, listen, we’re talking about defense spending. It would be better to spend on health and education. But if it’s a given, if it’s a given and we have this commitment and requirement to increase defense spending and it’s happening as we talk, is it a good thing or a bad thing? That’s something that I will ask you, Katherine.
Katherine Judge: Thanks Benjamin. So there’s a lot to talk about in terms of the economic multipliers associated with defense spending. First of all, for less developed countries, there’s empirical evidence that shows the multiplier for GDP is actually negative associated with defense spending. So essentially there’s lower government quality in these countries and there’s higher degrees of corruption and you can get some rent seeking.
behaviour. So that combined with these inefficient operations essentially means that you’d be getting less GDP for every dollar invested in defence in less developed economies. Now obviously Canada is a developed country and for developed economies, defence spending does have a very positive impact on the economy. It varies by the type of spending.
and by how much you’re importing in terms of spending. So first of all, the US and Russia account for 55 % of global arms exports and 80 % of arms exports come from seven countries combined. And Canada, of course, is not one of those. So to the degree that Canada’s importing arms, it does erode the multiplier. So Canada’s would be less than the US, but the multipliers,
generally range from about 1.5 to slightly over two. The impact is higher when the spending is capital related. When it’s operational, you get a lower multiplier. if we look at what the Liberals are planning in terms of new spending for defense, there’s about 31 billion on a cash basis that’s being planned into fiscal 28 and ( So 55 % of that is operational.
When you account for the size of these multipliers, it can be a one and a half to two times impact on GDP. it’s very significant. And the fact that Canada’s economy is starting right now from a position of substantial economic slack means that there should not be very much crowding out. Obviously, it depends on how the type of spending is financed. Like if you finance it through higher taxes. That obviously erodes the multiplier versus debt financing, even though, I mean, there is a limit on debt issuance too as well. But essentially you get all these positive impacts, not just in the public military sector, but also through private innovation. There’s a lot of R &D that goes into developing technologies for the military.
The US leads the world in terms of military investment in R &D. About 15 % of their defence budget is in R &D and that compares to something like the EU where there’s only 5 % of the defence budget going to R &D. the more money that’s spent on R &D, the more you get these broader applications that can produce a positive impact throughout the economy.
as a whole, so you just get a bigger multiplier that way. So in terms of how the multipliers vary, you get a much bigger multiplier associated with research and development investment. So the US leads the world. About 15 % of their defense budget goes into R &D. And a lot of that
spurs innovation and investment in the private sector and has an impact throughout the broader economy. That compares to a country like the or an economic region like the EU where you only get about 5 % of the defense budget going to R &D. So these multipliers vary a lot, but essentially the 31 billion that the Liberals have earmarked for additional defense spending could ultimately boost Canada’s
economy by 64 billion. And that includes not only the direct and indirect impacts of the spending, but it also includes induced impact. So essentially the further out you get from the time of investment, you get a higher job creation associated with the spending. And then the feedback between production and wages is ultimately funneled back into consumption. So you’re getting a higher multiplier as time goes on. Essentially, so this could be a very good thing for Canada’s economy because we’re operating with a very substantial negative output gap at the moment.
Benjamin Tal: Yeah, that’s very interesting, but we have to emphasize one thing. We have to remember that this money to subsidize and pay for defense is not coming from the sky. It’s not falling from the sky. It’s something that we have to raise either through taxation or debt, or you basically spend less on something else. Regardless, it means that the multiplier will not be as high as perceived because of the fact that it’s replacing something else or financed by debt that might lead to higher interest rates or of course, taxes.
Nevertheless, given the fact that we are committed to it, and it seems that we are committed to it, especially with Trump, the spending on defense as share of GDP will have to rise. It seems that we are stuck with that. If that’s the case, the positive multiplier is actually good news. So that’s a defense spending, a very interesting topic, something that not too many people are talking about. Thank you very much for listening. And until next time, we will have our eyes on the economy and we will be calling it as we see it.
Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.
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