Dollars at work: What defense spending means for the U.S. economy

I had the privilege of moderating a discussion Monday with colleagues Ben Bernanke and Mark Muro on the interactions between America’s defense sector and broader national economic prosperity. For me, there were three main takeaways.

First, although less than 3.5 percent of gross domestic product (GDP) today—and headed soon towards 3 percent—U.S. defense spending is still quite significant in many ways. At one level, this goes without saying. It still totals nearly $600 billion annually—which is $100 billion above the inflation-adjusted annual average for the Cold War! And although Ben was surely right to point out the fallacies of making too much of this figure, U.S. military spending still accounts for 35 to 40 percent of the global total of all military spending (with American allies adding in another 30 percent or so). Such figures do count most U.S. intelligence spending and the Department of Energy’s nuclear weapons activities, but according to standard international convention, do not include costs for the Department of Homeland Security or Veterans Affairs.

Also, in a number of ways, U.S. defense spending can be more considerable than the 3.5 percent figure would suggest:

  • In Virginia—the most defense-dependent state in the country economically—defense spending reaches some 13 percent of state output. In Hawaii, the figure is nearly 11 percent. In Washington, D.C. and Maryland, as well as a few other states like Connecticut and Alabama, it’s more like 6 percent.
  • Defense procurement represents around 5 percent of national manufacturing output (not even counting arms sales abroad).
  • Defense-related research and development, depending on how one tallies it, represents perhaps 10 to 20 percent of national research and development from all sources combined.

So clearly, defense is still important to the economy, even if much less so than in earlier periods—like the Reagan era when it was nearly 6 percent of GDP, or the 1950s and 1960s when it averaged 8 to 10 percent of GDP. That’s the first point.

Let defense needs (not just budgets) drive policy

The second point is one that Ben underscored. Defense policy and spending need not be overly influenced by deficit considerations at this juncture. National debt is fairly high now, but deficits have leveled off and are expected to remain at tolerable levels for a decade. So defense budgets do not need to be squeezed unduly.

This is not a call for fiscal complacency, but it does suggest that in determining near-to-medium term defense needs, the country can and should spend what it must to stay secure. Economics cannot determine what that appropriate level of national security spending should be. But it should not be invoked to place excessive constraints on military budgets, either. 

To me, this is a very important point as we start to debate what the next American president should undertake by way of defense strategy and budgeting. In looking back to the great recession period when he was chairman of the Federal Reserve Board, moreover, Bernanke observed that if anything, the defense budget reductions that began in this period worked at some cross-purposes with other efforts to stimulate the economy (though he also noted that in the Vietnam period, defense spending hurt the economy).

Positive spillover

Both Bernanke and Muro developed a final point. In effect, they recognized the many ways in which defense research and development can help the broader economy by promoting innovation and new technology. This was clearly true in the past and remains true, albeit at lower relative levels of overall resourcing, today. This is not to say that the defense sector by itself should be relied upon to create a national research, innovation, or manufacturing strategy. But in effect, it has somewhat stealthily (in Muro’s words) provided one, or at least an approximation to one, in the past. In so doing, this has on balance helped the nation. 

Going forward, we may need to consider complementary efforts on the civilian side of things, rather than relying exclusively on the military sector and on laissez-faire decisionmaking within the private sector. We also need to bear in mind that basic research is generally of greater benefit to the broader economy than applied, mission-specific research and development and testing programs. But defense has nonetheless played an important economic role in the innovation sector as well, and will continue to do so in the future.