UK defence spending boost could lift GDP by 0.8% and add £30bn to economy

• EY analysis shows that 69% of UK Ministry of Defence private sector spend goes to UK-based supplies and expenditure is capital and R&D-intensive.
• With significant spend kept within the UK and directed at long-term assets, increased expenditure could yield an additional £30bn in economic activity.
• But scale of the opportunity will depend on overcoming obstacles, including accelerating procurement and maximising UK supply chains.

Proposed increases in defence spending could produce enduring growth and productivity benefits for the UK economy, lifting GDP by 0.8% and generating £30bn a year in additional economic output by 2045, according to EY.

The UK Government has committed to raise defence expenditure to between 3.5% and 5% of GDP by 2035. While these plans are not reflected in current budget allocations, EY analysis – based on OBR forecasts and projections of GDP – estimates that raising expenditure from the existing 2.5% level to the Government’s 3.5% target would require an additional £31bn of real terms spending by 2035.

Meeting the 5% target would require an additional £77bn of real terms spending by 2035.

According to EY analysis, increasing spending to these levels could yield significant long-term benefits for UK growth and productivity, due to the structure of the UK defence industry and the way in which expenditure is typically allocated.

However, the report also highlights that delivering this economic opportunity will require policymakers and the private sector to address a series of potential barriers to growth and ensure expenditure is directed strategically.

Peter Arnold, EY UK Chief Economist, said: “If spent appropriately, increased defence budgets provide a dual opportunity to bolster UK security and generate lasting economic benefits that support the Government’s growth agenda. The UK’s relatively self-sufficient defence sector consists of a number of large ‘prime’ businesses and their interconnected supply chains of contractors, so the bulk of spending remains within the domestic economy. Accelerating industrial production and research and development has the potential to support growth within the UK’s borders and create productivity benefits that resonate far beyond defence companies.

“Defence is more capital-intensive than other areas of government spending, particularly in its support of manufacturing activities that yield long term economic advantages. A considerable proportion of government defence spending is also targeted towards R&D, which can produce dual-use technologies that can be commercially applied, stimulating productivity growth. Maintaining this approach as budgets rise would help galvanise the UK’s manufacturing and industrial base, while defence-driven innovation could create spillover benefits in areas of the civilian economy like aviation or cybersecurity.”

Idris Memon, EY UK Defence Leader, said: “The extent to which extra defence budget translates into real-world security and economic growth will be determined by what the extra money is spent on, as well as how, where and when it is spent. Strategic planning and coordination will be required to strike a balance between plugging immediate equipment gaps through imports and investing in the UK’s own sovereign production capabilities and security readiness.

“Achieving the UK’s defence priorities demands a national effort reminiscent of the pandemic response, involving close collaboration with large and small businesses to drive innovation and reliably scale results. This will require a nimble approach to procurement that can shift to meet emerging needs, as well as recognition that boosting UK exports to international partners strengthens and sustains sovereign production capabilities at home. By reshaping the UK defence ecosystem in this way, higher defence budgets would deliver greater national security and safety, while also providing an enduring boost for the domestic economy."

Structure of UK defence sector offers a growth opportunity

The majority of UK defence expenditure stays within the domestic economy. According to EY analysis, 69% of annual private sector spending by the UK Ministry of Defence goes to UK suppliers, while 31% goes overseas either directly or via the supply chains of UK companies.

EY analysis indicates that maintaining or even increasing this ratio as spending rises would substantially stimulate the UK defence industry and generate economic momentum throughout the supply chain. It could also present significant scale-up opportunities for UK businesses and attract domestic and international institutional capital as spending increases.

UK defence expenditure is also more capital-intensive than most other areas of government spending. Almost one third of the Ministry of Defence budget - around £20bn – is currently allocated to capital expenditure (CDEL) for infrastructure, equipment and technology, rather than routine operational costs (RDEL) such as day-to-day spending on salaries and accommodation, which generate temporary economic stimulus.

Maintaining this focus on capital investment as government spending rises would present economic benefits, including the direct growth gains associated with the UK defence sector’s productive capability. It could also provide indirect gains as defence-led innovation creates positive ‘spillover’ effects for the broader economy, such as aviation advances that have applications for commercial markets.

Challenges to delivery

The report identifies key barriers that must be addressed by government, industry, and investors to ensure that the UK can leverage additional defense spending for sustainable economic growth.

Among these challenges is the need to balance immediate military readiness through off-the-shelf equipment purchases with the long-term investment in domestic manufacturing capabilities that foster self-sufficiency and resilience.

The report also urges the Government to accelerate procurement processes and continue to clarify its equipment priorities for the years ahead. This would help provide UK defence companies with the confidence to invest and swiftly scale up capacity and capability in the appropriate areas.

The report highlights the need to widen the supplier ecosystem to include innovative smaller businesses, noting that currently only 4% of Ministry of Defence expenditure is directed at SMEs. These companies could be engaged and scaled through agreements that facilitate access to capital, such as commitments in principle to defined volumes.