Transcript – Making Defence Spending Pay

John Van Reenen interviewed by Tim Phillips

John Van Reenen 00:02

Given we have to increase spending on defence, we should be really thinking about strategies to do that in a way which can be supportive of growth.

Tim Phillips  00:13

Call it the curse of VoxTalks economics. Last week I visited the London School of Economics to talk to John Van Reenen about defence spending, and literally, as we were recording the interview, John Healey, the UK’s Minister of Defence, announced his resignation, saying that the UK’s defence investment plan falls well short of what is required for defence and the country at this dangerous time.

Audio Clip – John Healey  00:40

This is the age of hard power and rising threat. This is not the moment for calibration or incremental change. This means bigger politics, bolder priorities, harder choices. I see the current defence investment plans falling well short of what is required.

Tim Phillips  01:02

And then even before I had got back to the office, Al Carns, the UK’s Armed Forces Minister, had also resigned, saying that the UK’s defence investment is not built for the threat we face.

Audio Clip – Al Carns 01:15

I no longer believe the defence investment plan was preparing for the wars we are most likely to fight the character of warfare is changing at an exceptional speed.

Tim Phillips  01:26

Clearly, the way in which governments spend money on the military and what the return is on that spending has never been more controversial. So, today on VoxTalks Economics, defence spending is going up, whether we like it or not. But what will the return on that investment be. Welcome to VoxTalks Economics from the Center for Economic Policy Research. I’m Tim Phillips. There are plenty of contradictory anecdotes of how defence spending can boost R&D or be a spectacular waste of money, but John Van Reenen is an expert on innovation, and he recently spoke to the LSE-Kiel-CEPR Defence Economics Conference on this topic. So, when we met on that fateful day last week, this is how the conversation went. So, John, welcome back to VoxTalks Economics.

John Van Reenen 02:30

Hi Tim. Great to be back.

Tim Phillips  02:31

John, we’re talking about defence spending, something that a lot of people are talking about now, not just in economics. At a very simple level, why do we need to spend more on defence.

John Van Reenen 02:42

Well, I think everybody realizes that the world has fundamentally changed from that which I grew up with, and many of us grew up with. The invasion of Ukraine by Putin was a massive wake-up call to us all here. As we’re speaking today the war has lasted longer than the First World War, and so that just shows you the human cost and the longevity of that invasion. And of course in Europe we’re concerned that it may not stop at Ukraine, it may go further. And the other background fact is that general geopolitical tensions around the world, Middle East, it’s clear that United States under Donald Trump is distancing itself from Europe, and that requires us all as Europeans to step up and increase our national defence spending in order to reduce some of those threats that we face around the world.

Tim Phillips  03:36

When we talk about government spending, we’re used to talking about big numbers. How big are the numbers that we’re talking about here?

John Van Reenen 03:44

Yeah, so the background is that over the post-war period the share of our national income, which went to defence, which was very high after the Second World War, fell quite dramatically. So, by 2019 it was down to about 2% of national income. It was about 7% if we went back 30 or 40 years, and of course, that’s due to things like the peace dividends, the fall of the Berlin Wall. Now, the government has committed, and, as you know, delivered funding to increase this share of national income up to 2.5% of GDP. It was about 2.3% – 2.2% when the current government got in power, but there is also an ambition to increase that to something like 3.5% percent of national income over the course of the next decade at least. And that is an attempt to get up to the aim that Mark Rutte said for the NATO levels. So that is a significant increase from where we are now to where we want to be. If that was an initial, say, percentage point of GDP, that’s I think something of the order of 30 billion pounds per annum, so that is a very large amount of money.

Tim Phillips  05:03

And the argument, political argument everywhere, is that has to be paid for by something. Kemi Badenoch, the leader of the opposition, pointed this out in the British Parliament recently…

Audio Clip – Kemi Badenoch  05:19

“The military is waiting, the bond markets are watching. He has only three options: cutting spending, more borrowing, or higher taxes.” 

Tim Phillips  05:28

You were in a position previously, not anymore, where you were advising the UK government on its fiscal policy. Is it inevitable? Do you think that we’re going to have to raise taxes to pay for this.

John Van Reenen 05:42

I think that that is the hard trade off we face. It’s always the case that if you want to raise spending, there’s three ways to do it: one is through raising taxes, the other is by reducing other parts of non-defence spending, and the third is by borrowing more money. Given where we are with the level of borrowing, the level of interest rates for countries like the UK, it’s unsustainable to finance that increase of defence spending by increasing borrowing. Other countries like Germany have more fiscal space to do that. I think that’s not the case for a country like the UK. So, we are back to the hard question of is that going to be through increased taxes or reducing other parts of spending. The increase from 2.3% to 2.5% that we did when I was working for Rachel Reeves as the Chancellor, we did that through reducing overseas aid spending. It was a tough choice to do, but that’s how we did it. I think going forward, either you have to think of other cuts back spending or increase the tax, I think reality, you probably have to do both of those. So, I think we are looking at both tougher on some other parts of non-defence spending and also on increasing taxation. We might be that’s a political and social choice, I think, for the nation. There’s no ducking that.

Intermission  06:59

After you finish this episode, follow us wherever you get your podcasts to listen to our conversation with Moritz Schularick on the European side of defence spending. The episode is called ‘Can Europe Defend Itself’ from January 2026.

Tim Phillips  07:25

What we’re discussing today is whether there is some kind of payback for this, whether there might be some dividend for this, in terms of increased innovation from investing in defence spending. Is it appropriate for us to think about that as something that we can plan, that we can create, or is this always just a happy accident when it happens?

John Van Reenen 07:48

I think it is something we can plan for. So, I mean, just stepping back, the reason that we need to invest in defence is because if we don’t, the cost to us, in terms of our survival and, of course, our economy would be awful. So, it’s a protective spending in the same way you know adaptation to climate change is a protective spending. However, given we have to increase spending on defence, we should be really thinking about strategies to do that in a way which can be supportive of growth. And I believe that one of those ways that we can do that is to think about the way that defence spending could be pro-growth, and that’s through thinking about the way it can help generate more innovation. I mean, history has taught us that many of the ideas, which were originally for military protection, have spun off to create a major civilian innovation. So, we think about nuclear power, we think about GPS, think about the internet, and you can go back historically at the core of Archimedes, that Archimedes invented to fend off the Romans and Syracuse in the fourth century is another example of that. So, there’s lots of examples of where there can be these spin-offs, so the question is, can we do that in a very systematic way, and I think we can.

Tim Phillips  09:03

Okay, so if we’re thinking about being systematic as economists, a lot of this discussion is conducted through anecdotes, anecdotes of wasted money, anecdotes of money well spent. Why is there not more systematic evidence already?

John Van Reenen 09:19

There is some systematic evidence, some of the work, and I published last year with Enrico Moretti from Berkeley and Claudia Steinwender at Munich, looked at the history of all industries in 23 major economies over two or three decades. And we showed that when there was increases of spending on research and development for defence that stimulated more public R&D, obviously, but also crowded in more private research and developments, and there are several papers which have looked at that and found that to be positive. We also found that that had a knock-on effect. For productivity growth in the following decades, so there is some evidence. I think there needs to be more of it, and one of the challenges to that, of course, is the secrecy around the information to do with defence. It takes a bit more entrepreneurial excavation of data in order to look at those things in more detail. That’s increasingly possible to do with the data sets and tools we have, especially if you can form partnerships with people in the defence community to try and do that.

Tim Phillips  10:31

As you say, your work implies that rather than crowding out civilian R&D, it crowds it in. But can we go further than that, and can we say that defence R&D delivers bigger long run gains than civilian R&D? Is the money better spent in this area or better spent in civilian projects?

John Van Reenen 10:54

Yeah, so that’s a great question, and it’s a subject of a lot of controversy. Different papers show somewhat different results. I think there’s a consensus, as I said, that defence R&D does really crowd in private sector R&D and create more growth. But if your question is, if you had one pound to spend, should you spend it on defence or non-defence R&D? Some papers suggest that in the short run defence R&D can have a bigger effect, but in the long run, civilian R&D — say on health or on other areas — can have a larger impact. But there is some difference of opinion. I kind of think it’s the wrong question, in a way, because it’s not like the R&D budget is a fixed R&D budget, that’s not kind of not how it works. In the world we live in, defence spending is going to rise, and the question is: How can you make that the most pro-growth that’s possible? The way you make that, in my view, the most pro-growth as possible is to make that innovation rich. So, increasing the fraction of overall spending that we invest in research and development as a way to make them more pro-growth. If you were in a different world and you had a fixed R&D budget, which is actually not the world we live in, you might say, well, the spillovers you get from defence may not be as great as the spillovers that you get from non-defence, because it’s more secretive, there’s less interaction with the civilian sector. Other people argue the opposite. They say that, well, one thing the military has is a kind of mission-oriented sense of doing things that actually can be a good galvanizing way of getting things done in the way that often things aren’t done with such intensity in the private sector. As I said, empirical papers show somewhat different things. I’d say the latest view is that non-defence may have some benefits over defence.

Tim Phillips  12:46

One of the arguments as to why military R&D does not produce better innovation results is not more pro-growth is the way in which procurement is done here in the UK, also in Europe, also in the US. People are arguing, can we spend this money in a way that would have more benefits. What are the problems with how the money is spent now? If we want to think about this as a pro-growth, pro-R&D way to spend the money.

John Van Reenen 13:16

It’s a complex question, but I’m going to make it, to answer in a simple way, with one example. I published a paper last year with some colleagues, Jason Rathje, who’s actually in the US Air Force, Sabrina Howell at NYU, and Yun Wong, who is a student in Chicago. What we tried to address — and this was in the US context, but I think it’s also true in the UK and many other countries around the world — is that the way that the Department of Defence tries to procure Research and Development tends to be very centralised and top down. That’s not true of every aspect, so everybody thinks of DARPA in the US as a counter example, but that’s not the general way that things are done. So we looked at a big programme in the US Air Force, where they try and procure Research Development, and the way they do that, they have these competitions, but they’re very specific, so there might be the Department of Defence, or the US Air Force, in this case, will say we’re interested in trying to find a type of silver paint you can put on drones to deflect radar, right. Tell us how to do that. That’s pretty specific. And the programme, this is called the SBIR programme, it’s been running for many, many decades. People were thinking, is there a way we can kind of reform this? There was an awareness in the US that if you look at military R&D, and people have this view of it, the US being very innovative in defence, actually had been declining relative to other parts of the private sector over the last 20 or 30 years. We document that it was the case. It seems to be creating less new technologies relative to other parts of the economy. And when people looked at what was happening, this is policymakers in the US, it was dominated by increasingly small. Number of firms winning the contracts over and over again, so what they did in this programme as a pilot, they said, well, let’s try it in addition to the standard competitions we have, the conventional competitions, let’s try a new approach, and instead of us saying what we want, we ask the private sector firms, universities to tell us in the US Air Force, what they think we need has to be relevant for the US Air Force, but tell us what’s the kind of innovations that you could come up with that we think would be most useful for us. They started running this in 2018, three times a year, and they continued running it till today. And they were amazed about the reaction that this programme had. So, a whole number of firms who had never applied for this programme before — lot of startup firms, smaller firms from Silicon Valley, other high-tech hubs, like around Boston — started applying to be part of this programme. And we got all the applications from this programme and the conventional programme going back 20 years, and we got the scores. It was done like in any research proposal. There were evaluators who gave a score to the different proposals. And we looked at the difference between the people who just won versus those who just lost. And that’s in economics; this is kind of called a Regression Discontinuity Design. And the good thing about doing it, by the just winners, just losers, they should be very similar to each other. The only difference is somebody lost, somebody won. So, then you can follow them and see actually what happened, you know? You can see how well the winners did relative to the losers. So, we did that, and we were really stunned, because we found that the ones who won in this new open programme, they called it, the Open Innovation Programme, were very successful in translating the research to new technologies that the military used. So, it wasn’t just an idea. It eventually became a prototype, and eventually became a new missile, or a new drone, or a new idea for defence. It was successful in new technology; it was also successful in generating more original patents and also created more civilian spillovers by things like venture capital funding. We compared it to the old programme, the conventional programme, which did not have those effects.

John Van Reenen 17:12

The only thing that the conventional programme seemed to be successful, if you won one, you’re much more likely to win another one. So, it kind of created this kind of lock-in effect, which is why you had these firms winning over and over again. We published that paper last year, and the US Air Force and other parts of the Department of Defence, indeed the federal government, have actually expanded this open programme. I think that that attitude towards defence R&D procurements is potentially a much more successful way of crowding in ideas.

Tim Phillips  17:40

I suppose that also gets away from that process of gold plating, where the procurement gets loaded with more and more features.

John Van Reenen 17:47

Yes, exactly, that’s exactly right. And in the UK, we have this thing called DASA Defence Accelerator Security Agency, which is also trying to incorporate some of those ideas, and some other countries. I think that could be scaled up and could be a way of reinvigorating defence space. In Ukraine, interestingly, they had a much less sophisticated military than we did. They’ve also tried to take that more decentralised, bottom-up approach, create platforms, and get people to create new ideas and new military innovations to help support them, particularly in drone technology, and it’s been very successful. So, I think there’s a lot of lessons to be learned from that model of innovation from Ukraine and other countries as well.

Tim Phillips  18:33

So, as this is public money being spent, is it inevitable then when it comes to thinking about defence spending — particularly if we want to make it pro-growth — that there has to be some kind of industrial policy behind it, that the government has to come up with a strategy to do it?

John Van Reenen 18:48

It’s government money, you know, defence is primarily funded by the government, so we have an implicit industrial strategy in making those decisions. It would be much better to make that explicit and think more strategically about how that interrelates with the economy. So, you know I very much welcome the idea that the government is trying to come up with the defence strategy as one of the key sectors in the industrial strategy. And think how that is going to link with the rest of the economy in order to think about systematically how you know the spending we do will affect not just innovation, which we talked about, but also the skills that we need, housing that you actually need for people who are in the military, and how that interrelates with the rest of the economy.

Tim Phillips  19:32

I mean, these are big questions now for 2026 not just for the military spending, but also how we produce growth in the UK economy. What would you say if you were still advising policy? What would you be saying are the priorities for defence procurement strategy?

John Van Reenen 19:50

What I said then, what I say now, is going to think about how you can do this in a pro-growth way. So it’s not simply about standard defence. It is also thinking about how you can use this to strengthen the economy more broadly, and that’s the kind of strategic question. There is a lot of waste, which happens within the military. There’s lots of cost overruns, so I do think, you know, more rigorous way of trying to control costs, project management essentially. There’s a tendency to keep on going with a project, even when it clearly is not delivering good value for money. So, I think there needs to be a more rigorous and careful cost control. I think we need to coordinate with Europe, so as we started this conversation, it’s just a European-wide problem in terms of raising defence, defending ourselves against the threats that we face. I worked with Mario Draghi in his report. The problems we’re describing are not unique to the UK at all. They’re common across European problems. One of the things we need to do is align more on common standards. It’s ridiculous to have different standards for Italian helicopters versus French helicopters versus British helicopters. We need to have much more interoperability between the different standards we have for different systems. We need to have more opportunity and competition to build things in different parts of Europe, where different countries have comparative advantages. So we need to think about ways in which we do this in a much more common European way, and I think that the way that the European Union has to evolve is to have whenever — the jargon is variable geometry — so there’s some aspects where countries cooperate much more closely both within EU and outside the EU, defence, I think, is a key part of that. So, the same way that some countries are more prepared to be in the euro, have very close integration, in some words, we could think about defence on those areas where even a country outside the EU, like the UK, because we have a relatively large defence sector, could be part of that coalition of the willing to help have more coordination and more joint procurement in order to strengthen our collective defences.

Tim Phillips  20:37

I was talking to Moritz Schularick about this a few months ago, and he was making the same argument that European cooperation will be essential if we want to do this efficiently, but does that then start to re-impose a top-down feeling to it. If suddenly, if you have governments cooperating on it, then it gets in the way of that innovative structure that you argued for?

John Van Reenen 20:49

I don’t think so, because it depends on what you mean. If you’re talking about completely new things like R&D and innovation, that I think is an area which requires a lot of new, you know, new thinking to come in. I think when you’re talking about trying to think of a standard, a common launch pad for a helicopter, that’s more about the society.

Tim Phillips  22:11

That is top down, yeah.

John Van Reenen 22:53

Which one we go for, really, so kind of horizontal coordination, probably doesn’t even mean new products, can be existing products. So, I think that for the parts which are less technologically complex and new, I think the kind of interoperability around standards I think is something which goes together. Now you’re right, that will require some more collective decision making, and that’s always a political challenge, but crisis often breeds the ability to do things that we wouldn’t otherwise do, that we can see there is a very urgent need to do things differently in the past, rather than doing things just parochially for our own particular countries. We need to see this as a real collective problem, you know, the threat that we face is going to hopefully galvanize us into acting in that way.

Tim Phillips  23:44

It is a crisis. We do need to act fast. What happens if we do not answer this question quickly and do it effectively?

John Van Reenen 23:55

It’s going to make it even more expensive than it will be if we do things inefficiently. That’s going to mean even bigger increases of taxes or cuts of spending. More existentially, that will weaken our ability to defend ourselves against common enemies, particularly the challenge we face from Russia. That will loom even larger, and the fear is that we’re seeing this all the time, interference with our elections, our security, and in a very physical way, in Eastern Europe, that could actually lead to more incentives for, for, for Putin or his successors to take more of Europe. So, it’s a very existential threat we face. We haven’t really got a choice. I really hope that we realize this socially and politically in order to make that change. Eastern European countries, which are most on the front line, are seeing this threat most decisively and acting, and Western Europe are a little bit away, so the pressure is slightly off us. Western Europeans are the ones who need to change the most to create more dynamism in our societies. The threats are there and growing all the time.

Tim Phillips  25:03

John, thank you very much for talking about it.

John Van Reenen 25:05

Thank you, Tim.

Tim Phillips  25:14

Two papers there to give you the references for. One is ‘The Intellectual Spoils of War? Defence R&D, Productivity, and International Spillovers’. The authors, Enrico Moretti, Claudia Steinwender, and John Van Reenen. It was published in the Review of Economics and Statistics, 107, number one, that’s 2025. Also ‘Opening up Military Innovation: Causal Effects of Reforms to US Defence Research’. Authors Sabrina Howell, Jason Rathje, John Van Reenen, and Jun Wong. It was published in the Journal of Political Economy, 133, number 11, and that was also 2025.

Outro  26:02

VoxTalks Economics is a Talk Normal production. The assistant producer is Megan Bieber, and our editor is Andrei Zagarion. Next week on VoxTalks Economics, the historical success of the embedded state.