Abandon Old Assumptions About Defense Spending

In 2010, then-Chairman of the Joint Chiefs of Staff Adm. Mike Mullen said, “The most significant threat to our national security is our debt.” At the time the national debt was climbing fast. In 2008 it was about 68 percent of GDP, but due to the financial crisis it jumped to 82 percent the next year. Fast forward a decade to December 2020, when the debt was estimated at 108 percent of GDP, and Chairman of the Joint Chiefs of Staff Gen. Mark Milley told an audience at the Brookings Institution, “I suspect that, at best, the Pentagon’s budgets will start flattening out. There’s a reasonable prospect that they could actually decline significantly, depending on what happens in the environment.”

Owing to the country’s deteriorating fiscal situation — which was already bad before the COVID-19 pandemic hit — the need for resources to combat the pandemic itself, and the economic downturn caused by the pandemic, virtually all observers (with some exceptions) and the reigning conventional wisdom foresee a squeeze on the defense budget in the coming years to keep the government’s books from getting even further out of balance.

This isn’t just speeches — it’s the basis of the Department of Defense’s current spending plans. Although former Secretary of Defense Mark Esper said in October 2020 that he “would like to see 3-5 percent annual real growth for the Defense Department to stay ahead of the challenges we face,” the Future Years Defense Plan in the department’s Fiscal Year 2021 budget request shows a projected decline in real (inflation-adjusted) terms from FY2021 through FY2025. The incoming Biden administration could change that when it submits the next budget request for FY2022 in the spring, though a significant increase seems highly unlikely. But this obsession with the debt and the limits that it places on defense spending is actually a bad idea.

As it turns out, just about everybody has the math all wrong. Historically low interest rates have vastly decreased the debt burden on the U.S. government and allow for significant increases in both defense and non-defense spending without endangering the economy or forcing cuts to other programs or increases in taxes. Even with the possibility of another $1.9 trillion in COVID-19-related stimulus, there may be room for more. The U.S. government could take this path and make needed investments across the board with minimal risk to the long-term health of the economy. This is not to say that the United States should spend more on defense — only that the current debate about defense spending doesn’t take into account that it can.

It’s Just Common Sense

There are three reasons to fear massive government debt. Increased borrowing has the potential to crowd out other forms of spending. Whether the country thinks its priority should be national defense or national parks, it can’t spend money on those things if it first has to pay off debt for stuff it bought in the past. Another problem is the potential loss of the government’s ability to make its own economic decisions. Because of debt problems, elected leaders in many countries have had to answer to officials at the World Bank and the International Monetary Fund rather than to the people who voted for them. In theory, Congress and the president could find themselves having to consider the wishes of international creditors when making policy choices, not just the desires of American voters.

James Fallows posited the third (albeit improbable) problem, the nightmare crisis scenario. Some fear that at some point lenders would lose faith in the United States, and there would be a run on the dollar as people simply refused to loan the U.S. government money. The Federal Reserve would have to jack up interest rates so high to get people to loan the government money again that the economy would all but “melt down” as nobody could afford to borrow money to buy a house or a car, pay for school, or invest in their business. This has never occurred in U.S. history, and the likelihood of it happening in the future is very remote since the dollar remains the global reserve currency.

Despite the rising federal debt since the global financial crisis — and contrary to conventional wisdom — interest rates have stayed low. Instead, the cost of borrowing has dropped — in fact, it has dropped so much that today the United States can borrow money essentially for free.

Something’s Different

In the recent paper “A Reconsideration of Fiscal Policy in the Era of Low Interest Rates” authored by prominent economists Jason Furman and Larry Summers, they state:

Debt-to-GDP ratios are a misleading metric of fiscal sustainability that do not reflect the fact that both the present value of GDP has risen and debt service costs have fallen as interest rates have fallen. Instead we propose that it is more appropriate to compare debt stocks to the present value of GDP or interest rate flows with GDP flows.

What Furman and Summers are saying is that while annual interest payments are not rising too fast, and do not consume a large percentage of overall spending, significantly more debt is sustainable. As long as the economy can grow at a reasonable rate, the government should be able to pay its bills without too much trouble.

Furman and Summers show this table:

A negative real interest rate means that those lending the United States money are in effect paying the country to take it. Worried about the full faith and credit of the United States? The country’s creditors aren’t losing sleep.

In a December 2020 paper the Congressional Budget Office offered a variety of reasons found in the economic literature to try to explain why rates have dropped so much, but came to no definitive conclusions. For our purposes, though, the why isn’t so important, only that it is happening. Government forecasts in recent years about where interest rates have been going have generally been too high. The Congressional Budget Office states that it “expects interest rates to rise over the coming decade but to remain below the historical average levels.”

What Does All This Mean For Defense?

What this all means for defense is that there is room — in fact, a lot of room — for the U.S. government to spend a lot more money on lots of things, and one of those things is national defense. Of course, resources are not unlimited, but they are a lot less limited than many believe.

The upending of fiscal orthodoxy could open up a range of possibilities for U.S. defense strategists. Suddenly the Navy’s plan for 500 ships or the Air Force’s desire for 386 squadrons, fiscal fantasies according to conventional wisdom, are not so out of reach after all. The Army and the Marine Corps aren’t even talking about expansion right now, but they could.

Here is the “money quote” from Summers and Furman. They suggest that the economy could handle “about $5 trillion of deficit-financed investments over the next decade” with the result that “the debt would stabilize at less than 150 percent of GDP which would be the highest the United States has ever experienced but nominal interest payments would still be only 3.8 percent of GDP.”

Assume that only 20 percent of the proposed $5 trillion in extra spending that Furman and Summers posit over the next decade could be devoted to defense. That’s still an additional $100 billion per year, about 14 percent over the FY2021 defense budget of $696 billion. There are only four years on record when the defense budget increased by a higher percentage than that in one year and they were during the Korean War, the Vietnam War, and in 2003 after 9/11 and in the midst of the Iraq war. That could change, leading to additional investment in research and development and procurement, the retirement of legacy systems at a faster pace, and the faster modernization of the force with up-to-date technology.

Assessing Risk

But isn’t this risky? What if the United States takes on all this debt and something changes? What if interest rates suddenly rise or inflation spikes or growth slows, what does that mean? What if in fact this new conventional wisdom is wrong? This is a risk here, not just with the United States but with the global economy given the country’s outsized role in it. These questions are worth considering.

The United States can lock in current rates for 10, 20, and 30 years with bonds. In fact, it might be possible to lock in rates for even longer. Several countries in the Organization for Economic Co-operation and Development have issued 100-year bonds and investors have scooped them up. Former Treasury Secretary Steve Mnuchin talked about the United States issuing 50 and 100-year bonds last year. A recent paper by economists Peter R. Orszag, Robert E. Rubin, and Joseph E. Stiglitz also recommend 50 and 100-year bonds. So, these rates might not stay low for as long as we think they will, but we can lock them in right now, perhaps for a century.

Paying the World War II Bill

Although all the economists recommending this new spending are focused on civilian needs like infrastructure and healthcare, it’s actually defense spending that provides the best historical example of the country taking on lots of debt for essential needs and not causing long-term harm to the economy.

At the end of World War II the U.S. debt-to-GDP ratio was a bit higher than it is right now, standing at 114.9 percent in 1945. The government paid for the planes, tanks, and ships that won the war with borrowed money. But ten years later the debt-to-GDP ratio was 67.5 percent and after another decade it was 45.4 percent. By 1981, it had fallen to a historic low of 31.8 percent.

And what did all this mean for the U.S. economy? At the end of 1945 U.S. GDP was about $2 trillion in constant 2012 dollars, while at the end of 1981 it was $6.8 trillion. GDP grew at an average annual rate of about 3.1 percent. Some conditions are different today than they were then, but it has still been shown that in a period of low interest rates and moderate inflation, the U.S. economy can weather and even prosper with a large amount of debt.

In addition to a huge increase in civilian spending, putting an additional $100 million a year into building ships, tanks, planes, and other things the military needs also has a stimulative effect — more people are working in shipyards and factories, spending money, and paying taxes. The cumulative growth effects of all the increased spending, both defense and non-defense, should not be discounted, and may in fact be essential. Summers, referring to the lack of civilian investment, stated at Brookings, “The central principle is that in a period of extraordinarily low interest rates that can be locked in for 10 to 30 years provides an unprecedented opportunity … failing to take advantage of that opportunity is putting our children at risk.” It may be putting our national security at risk as well.

America Can Spend More on Defense, But That Doesn’t Mean it Should

None of this should be read as an argument that that a 500-ship Navy or a 386-squadron Air Force or other defense expenditures are what the nation actually needs. Nor is it intended to say that other priorities, from education to healthcare to green infrastructure, are less important than defense. What is clear, though, is that since the passage of the Budget Control Act in 2011 both defense and non-defense spending have been driven not by debate about what the nation needs, but by how much can be squeezed into an artificial cap because of a misapplied and antiquated focus on debt.

Arguments about how big a Navy or an Air Force the United States should have, or how much to spend on defense overall, can be grounded in an assessment of what the nation needs for its security, rather than simply what it can afford, because it may be able to afford much more spending on defense and much else.

The most influential economist in history, John Maynard Keynes, said in 1936: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” Perhaps the United States needs to abandon some old assumptions and listen to other economists who aren’t so defunct.

Robert Levinson is a retired Air Force officer with over 20 years of service. After retirement he worked as a lobbyist, defense contractor, and now works as a defense analyst. In his current role, he advises clients in the defense and government contracting industry. 

Image: U.S. Air Force (Photo by Staff Sgt. Melanie A. Bulow-Gonterman)