Britain’s New Defense Spending Quest Faces Fiscal Constraints

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Or sign-in if you have an account.0jhvodwh821}egsgacpizo2a_media_dl_1.png Office for National Statistics,(Bloomberg) — UK Chancellor of the Exchequer John Healey faces an uphill struggle to find billions more for defense investment, with economists warning that creative financing offers only limited room to increase military spending.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountThe former defense secretary has said he is exploring a combination of using the scope within existing fiscal rules and leveraging off-balance-sheet funding mechanisms. However, experts say these may not be enough to deliver on ambitious defense spending targets in the coming decade, adding to the pressure for further tax rises or public spending cuts. The government needs to raise money both to plug an annual £1.2 billion ($1.6 billion) hole in its defense investment plan and put Britain on a path toward the NATO target of spending 3.5% of economic output by 2035. As defense chief, Healey fought to increase spending to 3% of GDP by 2030, which would cost around £10 billion extra a year.Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againHis options are limited: the £23.6 billion margin the Treasury had against its borrowing rule in March has likely been eroded by the economic impact of the Iran war, the ratio of public debt to GDP is at 95% and UK borrowing costs are the highest among the Group of Seven nations, making markets wary of extra borrowing, whatever form it takes. Eager to keep investors onside, Prime Minister Andy Burnham has denied his government is looking at issuing war bonds.Burnham has, though, hinted at making more use of a 2024 rewrite of the fiscal rules. The shift introduced under his predecessor, Keir Starmer, broadly means that any extra borrowing for investment is offset by the financial assets it creates, so there is no impact on the measured level of government debt.The Resolution Foundation has urged Healey to seize the chance to channel money into the public institutions that provide loans, equity investments and guarantees to the private sector, with a £16 billion injection into the National Wealth Fund over the next five years. As such financial transactions are usually classed as capital spending, they also have no effect on a separate fiscal rule — that day-to-day spending and tax revenue are in balance in the medium term. Only the cost of servicing the extra borrowing required would have a bearing.However, the claims on these financial institutions, nicknamed PuFins, are already growing with Healey planning billions more for infrastructure and housing. The growing share of public investment being channeled into defense — £2.46 in every £10 of capital spending by 2030 — is placing pressure on the investment budgets of other departments, according to Resolution.The NWF and the National Security Strategic Investment Fund, which is part of the British Business Bank, all have remits to invest in the research and development of defense technologies. With the UK allocating just 5% of its defense budget to research and development spending, less than a third of the proportion the US spends, the government has scope to do more, said Paolo Surico, economics professor at the London Business School. This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.He said steps should include taking more equity stakes in promising defense or dual-use start-ups, which offer positive returns, draw in private investment and can help prevent firms relocating to the US. The Ministry of Defence has been looking to do this and the British Business Bank is showing more interest in defense or defense-linked technology firms, taking equity stakes in Kraken Technology, Hadean and SatVu in recent months. But government investment in the three firms amounts to less than £35 million of around £600 million in total across more than 50 UK firms. Although a much bigger economy, America’s Defense Advanced Research Projects Agency has a budget of $4.9 billion this year alone. “The scale is just too small,” said Surico. The constraint is that the financial transaction model is mainly limited to start-ups, and most PuFins are expected to achieve a return on their investments.It’s harder to make a case for using them for more traditional capabilities like tanks, jets and warships, which tend to be manufactured by defense primes with the government often the primary or only customer.“If you try to do it that way, that would just be a mirage and would not genuinely be an alternative way of financing this that didn’t ultimately rely on government borrowing,” said Thomas Pope, chief economist at the Institute for Government.The fiscal rules also cannot be bent for everyday spending such as military salaries, training and exercises, which military chiefs have said face the biggest pressures. That’s unless the government follows the advice of former chancellor and prime minister Gordon Brown, who last year called for “exceptional” defense spending to be exempted from the fiscal rules. Brown is now advising the government on using international finance partnerships to boost national security.As Defense Secretary Healey pushed Starmer to look for creative funding options, including pointing to how almost 20 European Union nations activated an escape clause to temporarily deviate from budgetary requirements to fund defense. Economists and markets are wary though.“It makes sense to borrow in the short term for something you expect to be temporary,” for example if the UK was at war, said Pope. “But everything around the defence investment plan and the Strategic Defence Review is saying that we need to permanently have this different posture.”Savings through welfare reform is a more viable option, he said, but the government is yet to publish its plans and Starmer proved how difficult it was to push through policies involving cuts after many of his own Labour lawmakers rebelled. “Even if that ends up funding some of the gap, I’d be very surprised if it found close to all of it,” said Pope.Burnham’s government has indicated it would like to join Canada’s defense bank, allowing the UK to provide capital for the defense industry alongside allies. That’s alongside a multilateral mechanism Healey’s predecessor Rachel Reeves set up to stockpile and procure off-balance sheet, which she said would save the UK as much as 20% on procurement. Economists say these offer promising ways to lower costs and reassure markets with the fire-power of multiple nations, but both are yet to be operationalized, little economic research has been done so far and it’s not clear if funding through these mechanisms would be counted as government spending.“Most likely you will need a combination of the three and it would be strange not to,” said Surico, pointing to the prospect of tax rises, increased borrowing and spending cuts. —With assistance from Tom Rees.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.