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Sector Profiles

Defense Industry


Major Industry Trends

Defense Spending and the Global Economic Downturn

Defense spending is clearly the key determinant of the health of the defense industry. It is sensitive to the economic cycle, with democratically elected governments preferring to focus their resources on politically sensitive areas, such as healthcare and welfare spending, or on measures to boost employment, when their revenues come under pressure during an economic slowdown. Plainly, however, when a country is at war it has little option but to maintain defense spending, regardless of the economic circumstances, and no country is willing to sacrifice its long-term security for the sake of short-term savings.

Military budgets have proven buoyant over the past few years, driven by the wars in Iraq and Afghanistan, and higher spending by developing countries. According to a report in April 2012 from the Stockholm International Peace Research Institute (SIPRI), world military expenditure in 2011 totaled US$1.74 trillion, almost unchanged from 2010 in real terms. The small rise of just 0.3%, SIPRI says, marks the end of a continuous series of increases in military spending running from 1998 to 2010, with the average annual increase over the last decade being around 4.5%.

The cutback during 2011 was largely the result of six of the world’s top military spenders, Brazil, France, Germany, India, the United Kingdom, and the United States, cutting military budgets in 2011, mostly as an attempt to find savings as part of the “austerity” debt reduction programs in those countries. “The after-effects of the global economic crisis, especially deficit-reduction measures in the USA and Europe, have finally brought the decade-long rise in military spending to a halt, at least for now,” commented Dr. Sam Perlo-Freeman, head of SIPRI’s Military Expenditure Project.

Military expenditure in the United States fell by 1.2% in real terms, and this was expected to continue during 2012 and 2013. The withdrawal from Iraq and the drawdown of US forces from Afghanistan will lead to additional falls in spending, to go along with further budget cuts in 2013, now being argued over between Republicans and Democrats in the US Congress and Senate.

According to SIPRI, the deepest cuts in Europe in military spending have been made by France, with its defense budget falling by 4% since 2008. By comparison, cuts in the United Kingdom and Germany have been more modest, being just 1.4% for the latter and only 0.6% for the United Kingdom. One of the biggest increases has come from Russia, where military spending was increased by 9.3% in 2011, reaching a total of US$71.9 billion, making the country the world’s third-largest military spender, ahead of both the United Kingdom and France. Russia has embarked on a decade-long program to replace the majority of its Soviet-era weaponry and military equipment with modern equivalents by 2020.

Military spending in Asia and Oceania rose by 2.4%, mostly as a result of a 6.7% increase by China (US$8.2 billion). India’s military budget, by way of contrast, fell by 3.9%, or US$1.9 billion in real terms, with high inflation in the country canceling out a nominal budget increase. In Africa, most of the region’s increase of 8.6% came from a massive increase of 44% in the Algerian military budget to counter concerns over the conflict in Libya. SIPRI has little data on military spending in Iran and the United Arab Emirates, but says that there is a clear pattern across the Middle East of an increasing spend on military budgets. Latin America, on the other hand, saw a decline in military spending of 3.3% during 2011. This was almost entirely due to the fact that the region’s biggest spender on military budgets, Brazil, cut its 2011 military budget by 8.2% as part of efforts to cool its overheating economy and to reduce inflationary pressures.

In general, countries have difficulty cutting their defense spending by significant amounts in the short term. Defense programs can last for decades, and, if a project is already underway, it is often difficult for a government to cancel its order. Defense spending can also be politically sensitive. Cutting back on equipment orders may simply add to unemployment during a recession.

The United States is by far the largest market for defense equipment, and is likely to remain so for the foreseeable future. Even with a built-in assumption that the wars in Iraq and Afghanistan will be concluded before 2015, US defense spending in that year is still projected to be at a higher level, adjusted for inflation, than in any year in the entire post-World War II period prior to 2005. The United States spends almost as much on defense as every other country in the world combined. In 2015, spending on defense and other “security” activities will take up close to 20% of the federal budget. However, the United States has been taking the axe to many programs as the Obama administration curbs defense spending, which doubled during the Bush years. Among them are the costly F-22 fighter plane, a new communications satellite, shipbuilding programs, and missile development.

The need to cut its massive deficit has prompted swingeing cuts in the United Kingdom’s defense budget. However, analysts are warning that the United Kingdom is going to have to choose between continuing a high-profile military and diplomatic role, and winding back its military expenditure. In December 2012, the Treasury confirmed that the Ministry of Defence (MoD) will be looking at some £735 million of cuts to its core budget for the period 2013–15. The MoD will also be expected to absorb around one-fifth of all new spending department reductions. Spending on military operations in Afghanistan is also falling by a further £650 million as British troops prepare to return home. However, the Treasury also announced that in future it would be giving the MoD the power to carry over unspent budget from prior years.

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Market Analysis

Arms Race Developing in the Asia-Pacific Region

Many analysts believe that growing friction between the United States and China will define the coming decades. Certainly, China is in the midst of an ambitious bid to modernize its military by the middle of this century. A key part of this effort is to downsize its army—the world’s largest—while beefing up its air force and navy. This will enable China to project military force farther beyond its borders. China’s total spending is second only to that of the United States, but it is low as measured by per capita spending. However, China has expanded its military spending at a double-digit pace in the past decade, and it became the world’s second-largest military power, surpassing France, in 2009. In March 2011, the Chinese government announced that it would be raising its official military budget by 12.7%, to US$91.5 billion. This marks a surge forward in military spending and reverses the government’s 2010 position, when it reined in military spending to a mere 7.5% increase. The 2010 military budget was the first to fall below 10% since 1989. Military experts in the United States and elsewhere have said Beijing’s real military spending is at least double the announced figure. A 2009 Pentagon report estimated China’s total military spending to be between US$105 billion and US$150 billion. While growing rapidly, China’s military spending is still dwarfed by that of the United States.

China clearly now intends to develop a military capability to match its new-found economic status, and is spending more on its navy and air force, and cutting back on its land forces. The idea is to put the country in a better position to project force outside its own borders. China’s insatiable appetite for raw materials and energy has also widened the military’s mission to protect China’s strategic economic interests overseas. The country’s naval and air forces certainly appear determined to impose their dominance in the South China Sea—through which vital oil supplies pass, and where several islands are in dispute—and in the East China Sea, where China and Japan are in dispute over mineral rights, and a number of contested islands. The government says that most of the increased military expenditure is focused on improving the historically poor living conditions of soldiers in the People’s Liberation Army.

In addition, the authorities intend to increase spending on “informatization,” in an attempt to close the gap on the United States’s use of “smart” technology. Defense companies in the West could benefit from China’s attempts to upgrade its military technology, although it is extremely doubtful whether Washington would allow American companies to supply technology to China.

Some analysts contend that if China’s economic growth remains robust, and the country is thus able to continue to expand its defense spending significantly each year, it will pose a threat to the United States’ military dominance of the globe by the mid-21st century, or earlier. In early 2009, Beijing confirmed plans to build aircraft carriers, with the apparent intent of projecting “blue water” naval power eastwards into the Pacific, bringing it into potential conflict with the United States. For its part, Beijing fears that the United States is trying to “encircle” China, by using India, and allies such as Japan and Australia, as proxies to contain China’s increasing military strength. China’s concerns have some validity—military ties between Washington and New Delhi, for example, are growing in a number of areas.

India is also growing into a major purchaser of US military equipment, an about-turn for a country that relied on Soviet weapons during the Cold War. In a groundbreaking deal, India agreed to buy six Lockheed C130J transport planes for around US$1 billion in January 2008—New Delhi had previously procured transport aircraft from the USSR or Russia.

India is expected to spend US$100 billion in the next decade on its military. India’s defense minister, Arackaparambil Kurien Antony, has made it clear that he expects military spending, currently 2.5% of GDP, to increase substantially as the nation’s robust economy continues to grow.

Other Major Trends

The Environment

It might appear surprising, but the US military is arguably doing more to save the planet than any other organization on earth. The US Defense Department is investing huge sums in the search to develop renewable sources of energy, as well as improving energy efficiency. The key drivers behind this trend include: national security—the United States does not want to be dependent upon energy imported from politically unstable regions; cost reasons—even a 5% cut in the fuel bill would save the Department of Defense US$635 million (based on the 2007 figure); and, finally, because it makes sound military sense—many lives are lost transporting fuel to the frontline in vulnerable convoys.

The US military is already one of the largest consumers of renewable energy in the world, and it has set a goal that 25% of its energy should come from renewable sources by 2025. The US Air Force’s goal is that 50% of all the fuels used in domestic training flights will come from synthetic, or non-petroleum, sources by 2016. The US military is also investing heavily in solar and wind power.

Technological Advances

The military is one of the key drivers of technological advances. There are certainly some remarkable developments taking place. The F-35 Joint Strike Fighter, being developed by Lockheed Martin, Northrop Grumman, and BAE Systems, for example, features some extraordinary features. These include technology that allows the pilot to look through the structure of the aircraft. The aircraft also features voice commands that significantly reduce the pilot’s workload.

The military is also investing heavily in information technology on land. Military units constantly transmit huge amounts of data back and forth to report their position, generate situational awareness, and share information on enemy tactics. Soldiers with access to laptops, for example, can provide vital information to military commanders. Real-time management of information enables rapid decision-making, meaning that military operations can proceed quickly, possibly providing a decisive advantage during a battle.

Cyberspace: The New Battlefield

Unsurprisingly, given the new emphasis on information technology, governments around the world are investing heavily in measures to protect their computer networks from attacks, and to launch their own cyber attacks. In 2010, the Guardian reported (January 13, 2010) that the Chinese military has been developing capabilities to spy on, infiltrate, and compromise adversaries’ computer networks for years. “Informatized war” is an integral component of its “three warfares” (san zhong zhanfa) strategic concept, and the achievement of information superiority is viewed as a requirement for battlefield supremacy. Many large defense companies have already branched out into cyber-security and information-technology services.

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Further reading on the Defense industry

Websites:

  • DefenseLINK, official website of the US Department of Defense: www.defenselink.mil
  • Jane’s Defence Weekly, long-established and respected source of information on developments in global defense matters: www.janes-defence-weekly.com
  • Stockholm International Peace Research Institute (SIPRI), which details trends in military spending: www.sipri.org

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