PRO Business MS

Accounting and Finance

How Military Spending Affects the Economy

The Why of Military Spending

Military spending is one area where there is no private solution. No single corporation or group of citizens is motivated and trustworthy enough to take financial responsibility for maintaining a nation’s military.

Adam Smith, a father of free-market economics, identified the defense of society as one of the primary functions of government and a justification for reasonable taxation.3 4 The government is acting on behalf of the public to ensure that the military is capable of defending the nation.

In practice, defending the nation expands to defending a nation’s strategic interests. And, the whole concept of “sufficient” is up for debate in any democracy.

Guns-and-Butter Curve

The guns-and-butter curve is the classic economic example of the production possibility curve, which demonstrates the idea of opportunity cost. In a theoretical economy with only two goods, a choice must be made between how much of each good to produce. As an economy produces more guns (military spending) it must reduce its production of butter (food), and vice versa.

The Hole That Debt Built

Capital is finite, and capital going into one spending category means less money for something else.

This fact becomes more urgent when we consider that any government spending that exceeds revenues results in a deficit, adding to the national debt. A ballooning national debt has an economic impact on everyone. As the debt grows, the interest expense of the debt grows and the cost of borrowing increases due to the risk that increased debt represents. In theory, the increased debt will eventually drag on economic growth and drive taxes higher.

Spending in war time

 

 

 

 

 

 

The Cost of Borrowing

The U.S. has historically enjoyed generous debt terms from domestic and international lenders. That tends to reduce political pressure to cut military spending in order to reduce the deficit. 5 6

Some advocates for decreased military spending might tie it to a real or potential increase in the mortgage rates people pay, given the relationship between Treasury yields and commercial lending.7 This reasoning holds and military spending does sit as a large percentage of discretionary spending.

In other nations, particularly ones that are still developing economically, a focus on military spending often means foregoing other important priorities. Many nations have a standing military but an unreliable public infrastructure, from hospitals to roads to schools. North Korea is an extreme example of what an unrelenting focus on military spending can do to the standard of living for the general population.

The generous debt terms that the U.S. enjoys are far from universal, so the trade-off between military spending and public infrastructure is more painful for many nations.