Transatlantic Defense Partnership at Stake?
Geostrategic Changes,
Economic Trends,
and Mutual Defense

Panel One: Why Do We Invest in Military Expenditures?

Thomas Valasek:

For the past four years until April, I was the permanent representative of the Slovak Republic to NATO. There are many thankless, unrewarding, impossible-tosucceed- at things you’re asked to do as an ambassador—seating arrangements at dinner tables, the schedule for visiting ministers or prime ministers; but few were as impossible and unrewarding as explaining to prime ministers and finance ministers why we need to invest in defense.

I’ve developed quite a good pitch because I’ve had to deliver it over and over. In the next few minutes I’m going to lay out essentially what I used to tell my bosses about the need for investing in defense and holding onto the 2 percent target, imperfect as it is:

We as allies—EU member states and any NATO ally—have set out for ourselves certain ambitions for military capability: one major regional conflict, or two major regional conflicts plus six smaller ones, etc. These ambitions were not pulled out of a hat. They’re neither frivolous nor over-ambitious. We spent considerable time debating them. They have to do with defending our own borders and managing our immediate neighbors.

We know that we don’t have what it takes actually to fulfill those ambitions. We know that because of the way things work at NATO. We asked the defense partners and the military commanders what capabilities they actually need to fulfill those ambitions. They told us, and when we compared what they told us to what we had, we found quite a long list of capability shortfalls. These are not cheap kit sets, but things like transport aircraft, precision munitions, electronic warfare jammers, and so forth. To put it simply, over the past couple of decades we 29 allies have not resourced the ambitions that collectively we have set up for ourselves.

This may prove the need to invest more in defense, but it doesn’t prove the need to invest 2 percent of our GDP in defense; that’s quite a different thing. In one sense 2 percent—let’s be honest—is a somewhat arbitrary figure. As the Americans like to say, it’s a ballpark estimate. The cost of acquiring the capabilities we know we need and we haven’t currently got could be more, could be less. This of course depends hugely on how we invest and how efficiently we spend our investment.

But the fact that we do not know accurately whether 2 percent is the right number should not be an argument against investing in defense capabilities. The reality is that, even at home, in national procurement, the cost estimates for weapons purchases are ballpark ranges at best. Think of how much the cost of the J-35 has fluctuated in both directions. We accept a high level of price uncertainty as a fact of life in defense procurement, and it doesn’t keep us from investing in defense; nor should the question mark attached to the accuracy of 2 percent keep us from aspiring to that figure.

I sometimes hear that better spending negates the need for more spending. In other words, there’s so much efficiency waiting to be unlocked in procurement in Europe that if we only did everything right, no additional money would be needed, much less 2 percent of GDP. This is at best partly true. I contributed to the original European Parliament’s 2013 Study on the Cost of Non-European Defense, which came up with 26 billion a year in potential savings. That amount would, I suspect, be more than enough to acquire all of the capabilities we need. But between us, the study is based on outdated assumptions. It was written in 2013 and assumes no collective defense tasks, only Petersburg tasks1, which, after the war in Ukraine, are simply inconsistent and incompatible with NATO ambitions. It also assumes an integration of the European armies, which may be an admirable and desirable goal in the long run, but one that, I think we’ll agree, is unlikely to happen in the next one or two planning cycles.

A more realistic estimate came from a McKinsey study prepared for the Munich Security Conference last year. It produced an $11-billion-a-year figure of potential efficiencies and savings if we pooled procurement, storage, and maintenance costs —much more politically achievable goals in the medium run. But even the McKinsey figure assumes that we can consolidate all procurement in Europe roughly to the extent that the United States does; and therefore the average size of any batch of defense equipment ordered would increase 570 percent, nearly six-fold. I leave it to you to gauge how realistic that is in the next one or two planning cycles.

I’m not arguing against seeking efficiencies. I used to write extensively on the need to pool and share, and on the right approaches to pooling and sharing. But the savings are
probably going to be more limited than the most optimistic estimates assume and, most importantly, they’ll be achievable only in the medium to long run; whereas the ambitions we have set up for ourselves are applicable now, and the shortfalls are immediate. Therefore we’ll need to spend both better and more at the same time.

For my last point, let’s get into the politics. Let me acknowledge here that the manner in which the US president makes the argument for higher defense spending is at best only partly helpful. The 2 percent is not debt. It is not owed to the United States. This is European money for European militaries to boost the security of Europe. And every time the president says otherwise, frankly, more Europeans turn against increases in defense spending. There has been some Trump effect, I concede. The recent defense spending increases in Canada and Denmark can be attributed to President Trump being so insistent that it became impossible not to increase defense spending. But a vast majority of increases that have occurred predate his taking office and are the result of a Russia effect rather than a Trump effect.

If anything, there has been an emotional reaction to Trump in Europe, particularly in Germany. Germany spent the least on defense and has the largest economy in Europe, and therefore has the most potential to contribute to an increase in collective European defense capabilities. If I were advising President Trump on the most effective way to get more out of Europe as a whole, I would start with Germany; it holds the most potential to make a meaningful difference in collective European defense capabilities.

But it is particularly in Germany that you have seen an emotional reaction to the rhetoric that the US president has chosen, which has made it less likely that we will see the pace of defense increases that we would like. While it is emotionally understandable why not meeting President Trump’s demands might be popular, on a rational level it amounts to cutting off the nose to spite the face. We only hurt ourselves in Europe by not investing in defense. It’s the scenarios involving Europe and its neighbors that are chronically under-resourced. It’s the precision bombs, the transporter aircraft to reinforce the Eastern border. At the end of the day, the 2 percent is not a favor to the United
States, but an investment in our ability, our stability, and security. And I suspect, if anything, because of the decreased reliability and predictability of the US reaction in relation to NATO’s Article 5, addressing common defense, the need for investing in those capabilities has only increased. I think any rational security analysis would tell you the same thing.

1 Petersburg tasks are the military tasks of a
humanitarian, disarming, peacekeeping, and
peacemaking nature that the European Union
(EU) is, and the Western European Union
(WEU) was, empowered to perform by the
Petersberg Declaration of 19 June 1992

Edward Hunter Christie:

I work with the international staff at the NATO offices here in Brussels. My activities are essentially to produce analyses, reports, and briefings on economic questions that are relevant to either defense policy of the states or international security more broadly, and that are of interest to the Allies. The unit I work for does not create policy; we basically try to raise awareness. A lot of the work is focused on Russia, the Russian economy, and Russian defense spending, answering questions such as, Is Russian defense spending sustainable given their economic trajectory?

There are two main forces that have been driving European defense spending levels in the last seven, eight, nine years. One is what I call physical capacity available to European governments in the aftermath of the 2008 crisis. The other is the new security environment since 2014 and Russia’s aggression against the Ukraine.

Lithuania has made the biggest change in defense spending as a share of GDP between 2014 and 2016, from 0.1 to 0.5 to 1.5 in the space of just two years. Estonia,
Poland, and Hungary have had similar growth. So you can already deduce one point: Those countries that are very rapidly increasing their defense spending are close to Russia.

In a number of cases defense spending fell between 2007 and 2014, clearly as a result of the financial crisis. Of course the US has remained at consistently high though also decreasing levels in recent years, until a very small uptick from 2015 to 2016.

So what are the facts we want to extract from that? I looked at 24 EU States, excluding Ireland, Malta, Cyprus, and Croatia. The standing effort was below 2 percent of GDP
in all but four of these countries, the exceptions being Bulgaria, France, Greece, and the UK. In 2016, the spending effort is still below 2 percent in all but four, the exceptions now being Estonia, Greece, Poland, and the UK. Spending efforts fell in all but three between 2007 and 2014. The three where they didn’t fall: Estonia, Poland, and Finland.
These falls are largely driven by macroeconomic and fiscal conditions, and there are multiple lines of evidence for this, including statements by policymakers themselves.

We see a trend reversal starting in 2015. The strongest increases, as mentioned, are in the Baltic states and Poland. Further strong increases as a share of GDP are expected in Lithuania, Latvia, and Romania for 2017; whereas, in Western Europe, it’s a little bit more mixed and the increases are more moderate.

Now about fiscal capacity: Public debt as a share of GDP increased very significantly in the aftermath of the financial crisis. We see large increases in most cases, with a number of countries coming in above 60 percent. Bear in mind that the United States is legally obligated to keep its public debt ratios below 16 percent.

At the same time as all these fiscal pressures, the security environment has changed. The crises in Crimea and the Ukraine were relatively brutal awakenings for governments that still had a number of unresolved economic and fiscal problems.

In early 2014, Russia deployed a relatively substantial conventional force to the border between Russia and Ukraine. It was feared at the time that the Russian Federation would actually carry out a conventional invasion, at least of Eastern Ukraine and possibly more than that. This deployment of Russian forces to the border region was extremely rapid and created enormous stress and fear among government allies.

Russian defense procurements from 2011 to 2016 equaled the estimated equivalent of 404 billion international dollars; whereas NATO Europe, including Turkey, spent 291 billion. Russia’s defense procurements in the last five years have been larger than those of all Europe put together.

But it’s not just about buying equipment or annexing Crimea. Russia’s exercises have been increasingly massive, with a steady rise in both size and scope, including simulating aspects of interstate warfare. Also we’re very impressed with logistics. I have two quotes from an article by Keir Giles. In “Assessing Russia’s Reorganized and Rearmed Military,” Giles writes: “A significant proportion of Russia’s ground forces and air forces have now been exposed to operational conditions over an extended period, if not to actual combat.” This is due to the fact that Russians deliberately rotate their international forces in Ukraine and Syria so that they get more exposure to operational combat conditions. They’re really trying to become good at combat.

Giles continues: “Russia has developed its equipment base for high-end war fighting, whilst some western allies have focused instead on low-intensity and counter-insurgency warfare, allowing their capability for high-intensity conflict to atrophy.” So that’s a warning. The Russians are becoming good at things that we’ve been doing less of, and they’ve been spending a lot, and they are quite formidable..


Binyam Salomon:

We know that world military expenditures are not trivial. In 2016, the countries of the world spent $1.68 billion on their militaries. Did you know that’s equal to the sum of the
GDP of at least 114 countries?

But what we do know about the demand for military expenditures? Theoretically we know what the reasons behind the demand for military expenditures are; but what do
economic theory and actual empirical data tell us? They alone should guide us in this debate.

A basic demand model of economics tells us that a (hopefully benevolent) unitary agent will optimize. Certain competing demands will add constraints. The standard of living is usually expressed as GDP as a proportion of the population, but it includes three ingredients: the number of people that are employed, or employment divided by population; the level of effort or hours per employed people; and productivity, which is GDP per hours.

The first two components of the standard of living have natural constraints. To create a larger population and a larger number of employable people, you could encourage immigration; but it’s not going to solve your problem, because your population is aging, etc. You also can’t push people to work many more hours. Last time I checked, people get cranky after working 10 hours or so, and after that their productivity declines. So all you’re left with really is enhancing your productivity.

eeking to enhance growth will sometimes use defense expenditures as a way of dealing with economic malaise, rather than actually worrying about the threats that should be the drivers of defense spending.

Of course, nations also face budget constraints., and they must take more than income or GDP into account. The price of items to be procured, providing security, various bilateral and multilateral security arrangements, how much your allies are spending on defense, and the actual threat must also be taken into account.

Let’s look at Canada as an example. It has been mentioned that the liberal government changed its tune to say that they’re now going to spend more money on defense. Canada cannot be a neutral nation considering that we have nine million square kilometers of space and 30 million people spread out to cover that area. Neutrality is not an option. We need to be part of bilateral and multilateral arrangements. We must also appease our number one trade partner to preserve the billion or a billion-and-a-half dollars in trade happening every day between the United States and Canada; so in fact, political parties don’t have much actual influence on demand for military expenditure. We expect the liberals to be less defense-oriented in their rhetoric; but, whether you’re conservative or liberal in Canada, defense expenditure is not the main issue. Mainly what’s driving spending levels are our alliances.

Let’s look at the threat variables. After the end of the Cold War, some NATO member nations basically stopped looking at what credible threats we’re facing. After watching a lot of Viking shows on the History Channel, Canada might be a bit worried about the Danish invading them. Beyond that, though, we don’t really have much of a threat to worry about. Our current threats are really spillover effects, such as transnational terrorist activities.

Then you have to ask, why was it very important for Canada to go to Afghanistan when they don’t have foreign direct investment or trade there? So we come to this interesting economic principle that Canada is a member of an alliance, or has perhaps a compulsory club membership. That understanding will actually tell us a whole lot more about transatlantic defense expenditures and where we can or should go with them.

Alliance-based defense can be seen as a joint product, which I think has very beautiful implications. The joint product model is one of the best things to come out of defense
economics; it can really enlighten us in terms of burden sharing. So pure deterrence and strategic weapons are pure public good; conventional weapons are partially excludable, like conventional ones; and search and rescue, or aid to civil power, could be private. This model points out that incentives matter. If there are some positive benefits for them, nations are more than willing to share the burden of costs. And this is not just a theoretical curiosity. This actually started within NATO in 1968; and in 1975, it really ramped up, burden sharing improved, and free ridership diminished.

It remained balanced until about 1999. What happened in 1999? Well, NATO decided to stop singing “Kumbaya” and start worrying about regions outside of its NATO collective. They basically moved the public characteristics of defense expenditure very close to the pure public good. And when you are generating more pure public good, there is an incentive for other nations to follow. And the larger forces, the ones that actually do force projection, are going to take a disproportionate amount of the burden.

That’s an insight that comes out of economic theory. If we‘re worried about transatlantic burden-sharing issues, we should go back to the old stuff that we studied in economics. We find there ample evidence of how to structure policies.

We tend to assume that marginal costs are equal for all countries. Eventually more marginal costs would be equal in NATO once we have our doctrine and everything sorted out. The last few countries that have joined are still ramping up to be fully participating members of the defense alliance. The only way that free ridership actually exists is if we make the assumption that marginal costs are equal. But of course they’re not; some nations are able to produce defense much more cheaply than others. If, eventually, we start moving into a weighted sum type of aggregation, then the free ridership problem should diminish.

Other recent studies have shown that a driver of defense expenditure is that essentially defense expenditure can be a positional good, a status good for some nations; so it
has both positive and negative implications.

So we have these pressing questions: What is the underlying game and strategy? Is Trump credible? Is this threat credible? Is this threat credible given the amount of defense expenditure that’s going on in the United States? Economic theory tells us that if they’re going to be spending more of the public good types of expenditures, the free ridership problem will not disappear. These are very interesting insights that come out of alliance theory and that we should discuss further.