Personal Context: For this one, it is mainly my curiosity. Keen to get an objective understanding of the sector. My personal experience with this sector has been quite brief. I happened to come across this sector while working in PE. I was evaluating an engineering company which was doing part of the work for a big defence project. Although major global defence/arms suppliers are companies based in the US and Western Europe, (and Russia until recently), more and more developing countries have the desire of self-dependence on matters of defence giving rise to offset policies etc which complicate the overall picture a bit. Trying to untangle my understanding here.
Understanding the numbers
To begin with the big numbers. Annually, the world carves out US$1.74 trillion on defence (2017 numbers). That number accounts for almost 2.2% of the global GDP.
As a proportion of GDP, this 2.2% is a steady decline from the last high in 1982, during cold war, 36 years ago, when 4.2% of the world’s GDP was earmarked for defence, or in 1962 when it was over 6%. However, the current spend is the highest proportion since the end of cold war, and is increasing year by year.
In absolute terms, in 2001, the global defence spend was $839 billion (against current $1.74 trillion).
A big portion of this spend on defence is incurred by the United States (35%). The US has by far the largest defence budget in the world ($610 billion), followed by China ($228 billion), then Saudi Arabia with around $70 billion. Followed by Russia ($66 billion) and India ($64 billion). These are the broad-brush numbers from 2017. The US budget is much more than the total of defence budget for next 13 countries after skipping China (so if you were to total from country number 3 to 15, you’ll still not be able to add up to the US budget).
To get a better grasp of these numbers, understand that the US defence budget is bigger than the GDP of most countries in this world. (Except perhaps the top 20). And much more than twice the GDP of many countries (except perhaps the top 40 in the world). Or put it another way, if US military budget were a country, it will rank around No. 22. And if China budget were a country, it will rank around No. 46.
As I looked at these numbers, what stood out or surprised me was Saudi Arabia up there at the third place. It has around a tenth of the US population. And the defence budget forms more than 10% of Saudi Arabia’s GDP. I am also surprised to not see Russia with a higher number. But that’s what perceptions do to you. Good to get the facts checked. Russia however has a big GDP load, around 5.3% of GDP on defence. I am also wondering where North Korea comes in. But then, not all data is available. And some of the numbers may be extrapolated as not everything is shared by all countries on defence. In terms of regions, Africa has the lowest spend ($42 billion), and almost a quarter of it is incurred by Algeria.
As a portion of GDP, Saudi Arabia is the one of the highest spender, only Oman (with population of 4.4 million) surpasses that, by spending 16.7% of its GDP on defence. Israel spends $17.8 billion or 5.8% of its GDP. Amongst the big budgets, US is at 3.3% of GDP, India 2.5% of GDP and China 1.9% of GDP. And under Trump’s leadership, US plans to increase the number in 2019, which would be equivalent to adding the budget of Saudi Arabia to US’s existing defence budget.
The country where I live, Australia, spends USD 26 billion on defence. And this is 2% of the Australian GDP. And Australia plans to broadly double the annual defence budget number by 2025.
In terms of forces, there are 27 million people around the world in military jobs. China has the highest number with around 2.2 million. Apart from China, only US, India, Russia and North Korea have more than 1 million military personnel.
If we were to look at historic war and peace around the world, and how and where it has evolved, we can perhaps say that since 1946, after the end of world war 2, the nature of conflicts has changed. Where earlier there were colonial conflicts, and conflicts between countries or groups of countries, since 1946, the main conflicts have been civil, and the affected parties have been civilians (not as many military personnel). Some have had foreign intervention, but the nature of conflict is increasingly intra-state rather than inter-state.
With this context, it is interesting to note that the absolute spends on defence over the years still keep going up, although the overall number of conflicts has gone down. It is currently at highest level since the Cold War. Defence is still one of the cornerstones of government budgets. Be it a high-income or low-income country, it stays a big number in national accounts.
Why spend on defence?
The obvious reason of the spend is to maintain sovereignty, liberty and existential security of a nation; to guard against any potential threats. And then, to build up enough for counter attack. If the neighbour or potential threats spend it, you cannot afford not to. And hence, sometimes even at the cost of other critical needs of the nation, countries end up spending a lot on maintaining and constantly upgrading their defence. It is a fine balance, a literal arms race, spending and maintaining on the latest armaments and war forces to ensure the fine equilibrium of peace.
For example, consider Saudi Arabia. Amongst the top defence spending countries, Saudi Arabia stands out. It spends a large portion of its GDP on defence. And the increase is recent, since the new leader/prince came in power in 2015. It faces threats from several quarters, including being located in the generally unstable Middle East, but part of the reason is Iran. Iran’s spend on upgrading and advancing its weaponry leads to powers in Saudi to upgrade their systems and outlay more towards defence. It spends more on defence than what it spends combined on health, social development, infrastructure and transport. And given the potential civil instability (the population has grown over 7 times since 1950), high reliance on petroleum and unprecedented levels of arms import, there are criticisms of the approach. Still, a country’s security stays a primary priority for any leader, and hence, despite criticism and debate, the number is where it is.
And so goes for other developing countries as well, which have recently reached economic maturity and the annual amount allocated to defence are substantial enough on the world stage comparable to the developed countries.
The developed world (US, Western Europe, and Russia as well) has been incurring a high absolute number over the last few decades since 1946. Most of the spend by the developed world was incurred during cold war. So, a way to consider it, is that every year the developed world has been setting aside and accumulating arms and ammunition, the cumulative number of which is sky high compared to where the new developed world begins. The developing countries are yet to create enough base of arms as they envisage might be right for their countries. So they spend a big chunk towards new acquisitions. They are now entering the phase of stockpile build up which saw most of the Western world accumulate weapons over the cold war period.
If one were to compare the stock piles across the world, although personnel may be highest in China, US has the highest number of helicopters, aircrafts (around 13.7k to Russia’s 3.8k) and aircraft carriers (19 to China’s 1 or Japan’s 4), Russia has the highest number of tanks (20.2k to China’s 6.5k or US’s 5.9k) and nuclear warheads. By far, US is the best war-equipped country in the world.
Finally, apart from the reasons of maintaining security, and arms race, the reason the amount spent on defence by a nation starts to grow over time is the non-discretionary spend on continued maintenance of the forces and the assets. As countries develop and the defence systems mature, a larger portion of the defence budget goes towards maintenance of the infrastructure.
Nature of Defence Spend: Expense or Assets?
There are three main categories where the defence budget flows in. The first is the operations – maintaining the forces, the personnel costs, the bases etc. Next is procurement and build – new arms, and new construction, systems. The third is R&D.
Given that defence is a big spend, how it is incurred, and the increase in these budgets are quite keen debate and discussions on the national level in any country. In developed countries which already boast of a substantial stock pile, the spend is mainly ongoing operations and maintenance related. And a small portion is towards new acquisitions and upgrades. Although, in US’s case, even a small percentage (less than 10%) of its military budget translates to a huge absolute spend.
A large portion of the global defence spend is on personnel. There are 27 million people employed by defence around the world. Spend on and around them constitutes a big portion of the annual defence budgets. In addition, for countries like US, there are around 600+ (?) US military bases around the world with land area equivalent to Switzerland (?) What this means is that majority of budget goes towards infrastructure – maintaining these bases and caring for the personnel stationed there. The other military powers with bases around the world are Russia, France, UK and China.
However, in the new developing world, mainly China, and then India, and other developing countries, a large portion of budget is towards buying new and upgrading existing systems.
For example, consider India’s defence budget. India divides its defence budget in two categories, revenue and capital. Revenue spend is almost two-thirds of total budget and should include heads such as salaries and the ongoing running expenditure. The capital portion is towards asset acquisition. Part of it is capital acquisition: weapon systems etc. And the rest is towards land, infrastructure and R&D. Over the next decade or so, India plans to spend $150 billion to modernise and upgrade its military equipment.
The Arms industry
So, we have a sense of how much the countries spend and broadly where the spend goes. For the portion that goes towards new and upgrade of equipment, there are several private sector players constituting a big arms and defence industry.
The way procurement is structured differs from country to country. In the US, where the largest defence budget is, it is individual armed services (army, navy, air force) that procure per their respective needs. In the countries of UK, Australia, France and India, the defence procurement is organised and controlled by a department of the Central Government. And in Sweden, Switzerland, and South Africa, it is independent civilian corporations owned by the state that control the procurement.
Now a number worth considering to get a sense of the arms industry is the combined arms sale by the total top 100 defence companies in 2016. This was around $400 billion. To note that the $400 billion is a relatively lower number than the approx. $450 billion of arms annually sold by the top 100 arms vendors in recent history (from 2008 to 2014). Perhaps I’ll add another interesting number here. The top 100 arms vendors have sold $5.8 trillion worth of arms since 2002, until 2016 (in 15 years).
It is also worth noting that the top 10 companies account for around $200 billion annual arms sales, and even the smallest amongst the 100 sells $700 million worth of arms annually. A note here that this data excludes China, and hence is underrepresented to that extent. Out of the top 10 companies, 7 are American, one British, one Italian, and one trans-European.
Lockheed Martin leads the pack (US, Arms sale of $41 billion, 86% of its business, employing 97k people), followed by Boeing (US, Arms sale of $29.5 billion, 31% of its total business), and Raytheon (US, Arms Sale of $23 billion, 95% of its total business, employing 63k people). Others are BAE Systems (UK), Northrop Grumman (US), General Dynamics(US), Airbus (Europe), BAE Systems (US).
International Trade in Arms
Now consider the developing world. There are enough local arms suppliers in most of the developed countries such as US, Western Europe, UK, Russia, Japan, Australia, and now increasingly, China. However, the defence and arms industry is not as advanced or developed in the new spenders. Historically, the key supplier countries have been US and Russia. US has been supplying to NATO countries, Middle Eastern Allies, in total, some 98 countries. And Russia has supplied to China, Algeria, Venezuela, Vietnam and Syria. There are a few countries that buy from both. Other suppliers are UK, France, Germany, Italy.
Amongst the emerging nations, China is one major supplier to several Asian countries, and increasingly African countries. China supplied arms to Pakistan, Bangladesh, Myanmar. And for some of the countries it supplies to, it is the largest arms trade partner. The role that previously US has played for many countries.
Consider the volume of international trade in arms. According to SIPRI (Stockholm International Peace Research Institute, the total value of the international arms trade in 2015 was $91.3 billion (at least, since certain countries like China do not release the exact data).
What makes the international arms trade intriguing is that national security is such an internal and sovereign(?) matter, that if procurement is done internationally, or sold internationally, it is of concern or sensitivity. Add to that the point that historically, as seen during the World Wars, defence industry has been a leading industry pulling and stimulating other industries forward (such as commodities, communications, aerospace). Hence, countries prefer to be self-sufficient in terms of their military needs. In the case of buyer, it needs to have the confidence that it can rely on that country to supply what it needs. And in case of seller, ensuring that sensitive tech is not handed over to potential threats. What this implies is that like other public-sector services, private sector in this space has to deal with a lot of policies, rules and political scrutiny.
For the buyers, what this translates is in policies and perhaps expensive choices, where they prefer not to buy off-the shelf products but tend to close contracts where they can get something long term in return such as, employment for its populace, or technology for the local industrial base, or infrastructure to be set up in the country. Hence the offset policies and the political involvement.
And for the sellers, or the exporters, the sale by the private defence corporations to other governments is a matter to be regulated as well. Hence, although the absolute amount of defence exports is still 1% of total US exports, it is a big involvement for the government. Part of these exports are through Foreign Military Sales (FMS) programme (where government helps in formulating the contracts). Or when it is direct, then there is an upper limit of $14 million on the contract size. For example, under FMS, US sold almost $16 billion worth of equipment in 2016. A large proportion goes to Middle East (Saudi Arabia, Egypt, Israel, Iraq, UAE), and some to Taiwan, Korea in Asia. Not everything is weapons, it can include stuff such as helmets and boots and clothing.
So far, I have just scratched the surface of this topic. Trying to isolate and pull out the thread of defence budget soon makes me realise the number of other debates and issues that it is intertwined with. Which leads to many further questions which can be explored deeper (listed below).
However, one of the take-away is that the annual defence spend is set to be a growing number globally. It is projected that by 2045, China alone would be spending around $1.3 trillion annually, which would still be less than the then US annual military spend. Most of the spend for China will be local. And it will be a big emerging player in the international arms trade space as well. The other key take-away is that when one reads about Saudi princes and American leaders, or the linked massive web of global politics and global economy, perhaps the layers that don’t meet the eye need to be considered too.
Questions yet to explore:
- What are the ongoing main conflicts in the world?
- The changes in the defence tech over the years. The changing nature of conflicts and nature of engagement. Implications on defence budgets. Some of this discussion can be about how the US security priorities are shifting from Middle East to Pacific. And how this has implications on the kind of budget share – more procurement, what kind of procurement?
- Defence tech and developments that have eventually filtered to the civilian world and improved it. We all know about internet and how it originated in US defence labs. What other ways does defence spend translate to civilian lives? Some other are GPS, air travel, nylon, Microwaves, Aviator Sunglasses (of course!), duct tape, weather radar, canned food, EpiPen, blood banks.
- Business models/ decision making/ offset policies in defence
- The history of defence spend over the centuries.
- The proportion of global defence spend across army, navy and air force. Would Airforce be the most expensive? An analysis of defence budget for US and another country perhaps?
- How much do the weapons cost? Battleships can be over $2 billion for each ship. Aircrafts around $350 million for a F-22 Raptor (? Fighter jets). Missiles can be $1.4 million. Submarines? Humvees/ armoured vehicles can be $200k, and artillery around $50k.
- What is the strength of armed forces of different countries? US is strongest, but an analysis of other countries?
- Where and how cyber-security comes in? Around $10b market current.
- Arms Control. A global Arms Trade Treaty recently became law. Implications?
Disclaimer: The objective of the note is to get a perspective on the Defence and Arms sector. I have referred several web-links and data points for this note. The data referred is quite spread out, and I have tried to consider and compare several sources to arrive at the above. Still, the numbers may not be exact, but they are close enough or approximated to get the broad picture. Happy to be corrected if you spot any glaring errors of fact or thinking. And keen to hear more on the open questions.