E-Notes

The Economics of Defense Spending

by Murray Weidenbaum

February 14, 2006

Murray Weidenbaum, former chairman of the Council of Economic Advisers, is the Honorary Chairman of the Weidenbaum Center on the Economy, Government, and Public Policy at the Washington University, where he is also the Mallinckrodt Distinguished University Professor.

The expanding array of threats to U.S. national security contrasts dramatically with the declining share of national resources being devoted to our armed forces.

Introduction

Challenges to the United States and its friends and allies are constantly in the news and receive great attention in the national public policy arena. The most obvious examples include the danger of organized terrorism posed by the Al Qaeda network, the conflict in Iraq and the continued violence in Afghanistan, the nuclear dangers posed by the buildups in Iran and North Korea, and the bitter struggles involving Israel, the Palestinians, and others in the Middle East. In addition, the rising economic and military strength of China underscores the possible dangers of hostilities arising in such areas as the Taiwan straits either by design or even accident.

Simultaneously, however, a virtually silent long-term decline has been occurring in the portion of American national resources allocated to national defenses. A straightforward examination of publicly available economic and fiscal data demonstrates this quite clearly. Nevertheless, this downward trend has escaped serious public attention.

Yet, when we use a variety of statistical measurements, it becomes readily clear that the United States is increasingly devoting its economic, fiscal, technological, and manpower resources to civilian purposes. However, this statistical analysis, by itself, does not constitute a case for altering the allocation between military and civilian purposes.

Similarly, this report does not attempt to evaluate the military strategy being followed by the Department of Defense. Neither does it judge the worthiness of the specific weapon systems, physical facilities, or manpower allocations that currently comprise the force structure of the U.S. military establishment.

Rather, the author’s personal analysis of the ongoing debates on national security policy leads to the uneasy conclusion that the strategic shift in resources identified here has been made by default rather than by deliberate design. Thus, the purpose is to focus some attention to an unappreciated aspect of national security decisionmaking.

The Statistical Analysis

During each conflict since the end of World War II, the military establishment has used a smaller share of the nation’s resources than during the preceding engagement. Although the absolute level of military resource utilization has been rising during the engagement in Iraq, this general pattern continues to hold.

In every way that it can be measured, the military’s take of economic activity is a smaller fraction than during the Gulf War — or Vietnam or Korea. This relationship holds for the military share of the economy (as measured by gross domestic product) as well as for its portion of the Federal budget, capital investment, research and development, and personnel. Consequently, America’s underlying economic strength provides great leeway to Federal government decisionmakers — and to Americans generally — in setting policy on national security.

While there is intense debate concerning the details of the U.S. military role in Iraq, it seems appropriate to step back and raise several larger questions on national security policy: Exactly how much of the nation’s resources are being taken by the military establishment? Is that military share rising? Is it sustainable?

The current data are clear: military expenditures in the U.S. are rising in absolute terms. Total Department of Defense expenditures grew from $281 billion in Fiscal Year 2000 to $471 billion in FY 2005 — significantly faster than the overall rate of inflation. The national defense portion of GDP rose from 3.8 percent in calendar year 2000 to 4.7 percent in 2005. This short-term upward trend is not surprising. The conduct of war invariably exerts increasing pressures on the military budget. That was the experience during the Gulf, Korean, and Vietnam conflicts, and especially during World Wars I and II.

In the long term, however, a number of factors contribute to the smaller share trend, such as the geographically limited nature of the wars during the past half-century. Moreover, the increasingly high-tech orientation of defense spending and operations may be generating a special rise in productivity. However, that point is offered merely as a surmise rather than a finding bolstered by supporting detail.

The record shows that, at its World War II peak, military outlays equaled about 35 percent of GDP; during the Korean War, approximately 15 percent; Vietnam, 10 percent; and the Gulf War, six percent. The current ratio (as of late 2005) is less than 5 percent. None of these numbers provides any solace to the Americans and our allies who have been wounded in Iraq or to the families of the servicemen and women killed. Keep in mind, though, that the purpose of this study is neither to justify nor attack the conduct of the U.S. involvement in Iraq — or Afghanistan or elsewhere. Rather, it is the mere contribution of an economist trying to measure an important and often misunderstood aspect of the American economy.

Thus, it is beyond the scope of this report to state whether devoting 4.7 percent of the national output — or any other number — to military purposes is too much, too little, or just right. As economists have pointed out, military spending generates an important “opportunity cost” since the resources used are not available to meet other needs — and desires — of the nation. Simultaneously, of course, society can receive substantial benefit from military spending in the form of enhanced national security. These are the types of issues that public sector decisionmakers continue to wrestle with.

Much of the resources used by the armed forces are very specialized. Missiles, tanks, helicopters, destroyers, submarines, and Humvees are not part of the typical civilian market basket. Moreover, they generally are not produced by the same companies that make civilian products and services and rarely in the same facilities. Also, military purchases tend to be higher tech and higher quality — and surely far more expensive — than their civilian counterparts. To put the matter bluntly, the less expensive and second-best fighter aircraft may not be a bargain. In contrast, the second-best refrigerator may be much more popular than the far more expensive top-of-the-line model. Moreover, the financial constraints imposed on military spending are quite different from those that face the typical civilian consumer.

As for the key resource — the men and women who serve in the armed forces — they too are special. Compared to the U.S. workforce as a whole, the military establishment recruits younger members of the prime working age groups. It also imposes special qualifications in terms of physical condition and mental ability.

Let us take up each of these different ways of measuring the military utilization of economic resources. For instance, when viewed in the context of total outlays by the Federal government, a category of civilian (not military) spending has become overwhelmingly prominent — the “entitlements” covering Social Security and Medicare (32 percent in FY 2005). In the same fiscal year, the Department of Defense accounted for 22 percent of the Federal budget. This is a substantial relative decline from the more dominating position held by Defense Department spending in previous decades.

There is a special fiscal arrangement, which encourages this shift from guns to butter. The major entitlements — and some other large items, notably interest on the public debt — are shielded from annual budget review. They do not even appear in the appropriation bills voted on by Congress. Rather, these activities are financed by means of “permanent indefinite” appropriations. They are called “permanent” because they remain in effect without yearly action. They are labeled “indefinite” because there is no limit on the level of annual spending for these items. The Treasury pays whatever amounts are necessary to cover the interest on the national debt. Likewise, it also pays out all of the pensions that Social Security recipients qualify for.

In striking contrast, most defense appropriations are voted on by Congress on an annual basis, as is the case for many civilian programs. As a result, some analysts focus on the remainder of the budget — the so-called “controllable” portion, which is subject to detailed annual review by the president and Congress through the appropriations process. Defense spending remains by far the largest single element in controllable Federal outlays, making it especially vulnerable to the pressures for economy in government.

Obtaining statistical information on defense production in the private sector of the economy is a challenge because there is no separate defense industry dedicated solely to producing weapons and equipment for the Pentagon. In practice, the Department of Defense purchases some goods and services from almost every industry in the nation. Desks, chairs, and other office supplies are an example of such common procurements — items that are employed in military and civilian activities. However, relatively few companies are important suppliers of weapons systems and other equipment designed and produced to meet the special needs of the armed forces. These firms tend to cluster in four sectors: aerospace, shipbuilding, ordnance, and communications. Measures of the trends in these industries convey useful information about the larger military market.

For example, the monthly reports on industrial production show that communications equipment manufacturers operated, on average, at 76 percent of capacity in December 2005 — while all manufacturing establishments, on average, reported operating at 80 percent of capacity. In the same month, the category of “aerospace and miscellaneous transportation equipment” (which includes shipbuilding but excludes the motor vehicle industry) operated at 72 percent of capacity. By way of comparison, over an extended period of time, U.S. manufacturing companies operate at approximately 80 percent of capacity. These data indicate the availability of substantial excess productive capacity in the major American manufacturing companies that produce on order for the Defense Department. To put the data in perspective, the Federal Reserve System estimates that defense and space equipment suppliers accounted for only two percent of industrial production in 2004 (the latest period for which such data are available). Clearly, the bulk of American industry is oriented to civilian markets.

Another way of illuminating the military role in the economy is to measure the portion of capital goods devoted to military hardware. Physical investment generally is a key to the future growth of production and employment in the economy. The military accounts for a somewhat larger share of capital formation than of economic output generally. In 2005, the share of fixed investment devoted to defense (mainly in the form of aircraft, missiles, ships, and ordnance) came to approximately six percent.

Let us also examine the more specialized area of research and development (R&D), the sector of the economy essential to the technological progress of the nation. The data show a concentration on military needs that is substantially above the defense share of GDP. In 2003 (the latest period for which statistics are available), 16 percent of all R&D was devoted to military requirements. This ratio represented a rise from the 14 percent reported in 2000, a modern low point. Over a longer period of time, however, the portion of R&D directed to defense has declined dramatically, from a high of 53 percent in 1959. Since the 1980s, private business has become the major source of financing R&D.

As of September 2005, 1,400,000 men and women were serving in the U.S. armed services (including reserves and national guard units on active duty). That represents 1 percent of total U.S. employment. It also is a low point from the four percent of the labor force serving in the military in 1955. However, such aggregate comparisons are of limited utility. Because of its special needs, it is not very useful to compare the number of men and women in the armed services with the total labor force (which includes those who are working or looking for work). For example, of the 143 million people living in the U.S. who were employed at the end of 2005, 48 million belonged to the 18-34 age group, from which the military primarily draws its recruits.

Another way of looking at the workforce implications of military personnel requirements is to examine the data on educational backgrounds. In July 2005, 41 million college graduates (the prime group for recruiting officers) were in the civilian labor force. However, these numbers cover all age groups. Similarly, 73 million high school graduates of all ages were in the civilian labor force — that is the category from which the military primarily draws enlisted personnel.

Clearly, such statistical comparisons are hardly definitive and do not deal with the many considerations that are involved in recruiting and retaining the members of the armed forces, especially in a period of extended combat. Nevertheless, the data reveal that the 1,500,000 currently serving in the military represent a very small portion of the American workforce. Those part-timers who seek full-time jobs bring the unemployment rate up to nine percent.

Important facts about the military role in the U.S. economy are clear. During the last several years, national defense has taken a rising share of the nation’s resources but — a fundamental “but” — that share remains substantially below the portion of the U.S. economy devoted to national defense in most of the period since the end of World War II. These findings by themselves do not provide a justification for increasing — or reducing — the size of the military budget. However, since, in the past, far larger portions of the nation’s resources have been devoted to defense purposes for extended periods of time, it seems clear that the current economic burden of military outlays is sustainable — now and in the foreseeable future. That finding, of course, does not justify any specific military actions that utilize those resources.

Statistics also tend to confirm the dual conclusions of many earlier studies: Within wide limits, the U.S. can afford to spend whatever it believes to be necessary to promote the nation’s security, and economic prosperity does not require any particular level of military outlays.

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