The Pressure to Increase Defence Spending: A Delicate Balancing Act for European Allies
At a recent summit in Paris, Sir Keir Starmer, the UK Prime Minister, joined other European leaders to urge their counterparts to take the new U.S. administration’s demands for increased defence spending seriously. With the NATO summit looming in June, the call to action is clear: European allies must make concrete spending commitments to bolster their military capabilities. The UK, under Labour’s leadership, has already pledged to raise its defence spending from 2.3% to 2.5% of GDP. However, the road ahead is fraught with challenges. Critics are quick to point out that while the commitment is there, the timeline for achieving this target remains unclear, and the Treasury is already pushing for delays.
The Fiscal Squeeze: Defence Spending vs. Domestic Priorities
The crux of the issue lies in the difficult trade-offs that come with increasing defence spending. At a time when public services are under strain, diverting funds to defence means making sacrifices elsewhere. The government has vowed to adequately fund the NHS, courts, prisons, and local authorities, but these promises are now at risk of being broken. Ministers are caught between meeting geopolitical obligations and maintaining their domestic agenda. The fiscal ruleIntroduced by the government, which requires tax receipts to cover day-to-day spending, further complicates the situation. Business taxes have been raised to support public services, but this has come at a significant political cost. With little room for manoeuvre, the Chancellor, Rachel Reeves, is under immense pressure to find additional funding without resorting to hikes in VAT, income tax, or national insurance.
Squaring Defence Spending with Fiscal Reality
The UK’s current fiscal framework leaves little flexibility for the kind of defence spending increases being demanded. To reach 2.5% of GDP, an additional £5bn-£6bn in annual defence spending would be required, bringing the total to around £66bn. While this may seem manageable on the surface, it represents a significant portion of the Chancellor’s £9.9bn headroom against her fiscal target. This figure is already set to shrink when the Office for Budget Responsibility (OBR) updates its economic forecasts next month. With growth prospects likely to be downgraded, tax receipts will decline, leaving even less room for manoeuvre. The Treasury is already considering budget cuts across departments to meet its targets, a move that could undermine the government’s political ambitions.
The Broader Context: Defence Spending and the NHS in an Era of Stagnant Growth
The challenge of increasing defence spending is further compounded by the pressures of an ageing population on the NHS. With stagnant growth and elevated interest rates, the UK is facing an "epochal challenge," as described by Ben Zaranko of the Institute for Fiscal Studies. Meeting the demands of defence and healthcare simultaneously would require a level of fiscal flexibility that the current government does not have. Labour’s manifesto commitments are now under severe strain, and it remains to be seen whether the government can reconcile its promises with the harsh realities of the current economic climate.
A Comparison with EU Fiscal Rules: A Potential Way Forward?
While the UK grapples with its own fiscal constraints, the EU has taken a different approach. In response to the heightened geopolitical tensions, Ursula von der Leyen announced a temporary easing of EU fiscal rules to allow member states to increase their defence spending. This move acknowledges the extraordinary circumstances and provides some flexibility for countries to invest in their military capabilities without violating the bloc’s debt and deficit limits. However, the UK, having left the EU, cannot take advantage of this adjustment. Any decision to change its own fiscal rules less than a year after setting them would risk damaging its credibility in financial markets.
The Way Ahead: Tough Decisions and Uncertain Outcomes
As the UK navigates this fiscal and geopolitical landscape, the path forward is anything but clear. Meeting the demands of defence spending while maintaining public services and adhering to fiscal rules will require difficult choices. The government may need to revisit its manifesto commitments and consider exceptions to its current framework. However, with borrowing already on the rise to fund investment, any further exceptions could unsettle investors and undermine confidence in the UK’s economic strategy. The coming months will be pivotal in determining how the government balances its competing priorities and whether it can find a sustainable way to meet the growing demands of defence and domestic spending.
