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Sector Profiles

Defense Industry


Major Industry Trends

Defense Spending and the Global Economy

It is an obvious truism that the defense industry globally is reliant on governments placing a high priority on maintaining or extending the capabilities of their armed forces. Since military spending competes directly for the limited resources available to governments to meet their social welfare, health, and pensions promises, there is always a tension between providing benefits to citizens and providing cash for the military. Given this tension, it is no surprise that defense spending is highly sensitive to the economic cycle, and when revenues come under pressure politicians know that there are generally more votes to be had from welfare spending than from increasing the defense budget. 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. Global military expenditure in 2013 (the latest year for which figures are available) amounted to around US$1.75 trillion according to the Stockholm International Peace Research Institute (SIPRI). This is down some 1.9% on the 2012 figure and was driven largely by cuts in the US military budget, which offset rises in most other countries, particularly in Asia, Eastern Europe, the Middle East, and North Africa. The fact that China increased its military budget by 7.8% (US$11.8 billion) and Russia by 16% had a major impact in holding the decrease to just 0.5%. Although emerging countries are spending more on defense, buoyed by strong GDP growth rates, NATO members still account for the largest proportion of the global defense spend, with NATO accounting for around US$1 trillion of that $1.75 trillion global spend.

In 2012 the United States’ share of world military spending went below 40% for the first time since the collapse of the Soviet Union, with its military spending reducing by 6% in real terms to US$682 billion. This was further reduced, according to Sipri, in 2013 by 7.8%.

SIPRI points out that austerity policies have caused significant cutbacks in defense spending in a number of European countries. “Since the 2008 global financial crisis, 18 of the 31 countries in the European Union or European NATO have cut military spending by more than 10% in real terms,” it says. The same effect can be seen in Asia, where the annual rate of increase in military spending has come down from an average of 7% between 2003 and 2009 to just 3.4% between 2009 and 2012. In South Asia, military spending fell by 1.6% in 2012. In Latin America, increased military spending to combat the drug cartels pushed the Mexican defense budget up by 9.7%.

Saudi Arabia and Iraq continue to account for the major increase in military spending in the Middle East, pushing total budgets up by 4.0% on the 2012 figure to an estimated $150 billion. Saudi Arabia increased its military spend by 14% to reach $67 billion (see the previous Sipri link: http://www.sipri.org/media/pressreleases/2014/Milex_April_2014). According to Sipri the desire to maintain a strong and loyal security force in the face of potential “Arab Spring” style protests probably accounted for the sharp increase in both Saudi Arabia’s spend and that of Bahrain, which increased its military spend through 2013 by 26%. Sipri points out that while Iraq increased its spend by 27% as it sought to rebuild its military, there was no data available for 2013 for Syria, Qatar and the United Arab Emirates, making it hard to see the overall total of military spending in the region.

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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 middle 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. Perhaps the most significant move by China in 2013 was the unilateral extension of its air defense identification zone to include a large tract of the East China Sea. The extension brings the disputed Senkaku Islands, the subject of a bitter ongoing dispute between Japan and China, within China’s air defense space. This has ratcheted up tension not only between China and Japan and other neighbors, but also between China and the United States. China has also stepped up its naval ship-building program, and in November 2013 it flew its first stealth drone, called “Sharp Sword”—an eye-catching addition to China’s stealth fighter program, which includes the J-20 and J-31 stealth fighters.

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 marked a significant surge in military spending and reversed the government’s 2010 position, when it reined in military spending to a mere 7.5% increase. 2010 was the first year the growth in the military budget had fallen below 10% since 1989. Military experts in the United States and elsewhere have said that 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. Though growing rapidly, the country’s military spending is still dwarfed by that of the United States.

China now clearly intends to develop a military capability to match its new-found economic status. 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. 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’ 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 US 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, by the mid-21st century or earlier it will pose a threat to the military dominance of the globe by the United States. In early 2009, Beijing confirmed plans to build aircraft carriers, with the apparent intent of projecting “blue water” naval power eastward 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. Chinese concerns have some validity—military ties between Washington and New Delhi, for example, are growing in a number of areas. Military analysts argue that it will take decades for China to build up the experienced sailors and commanders it will need to man its growing naval fleet, and that manpower will continue to be a real drag on China’s blue water capabilities for perhaps the next 30 years.

India is also becoming a major purchaser of US military equipment, representing an about-turn for a country that relied on arms purchases from the Soviet Union during the Cold War. In a groundbreaking deal, India agreed to buy six Lockheed C-130J transport planes for around US$1 billion in January 2008—previously New Delhi had procured transport aircraft from the USSR or Russia.

India is expected to spend US$100 billion in the next decade on its military. The country’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 Department of Defense is investing huge sums in the search to develop renewable sources of energy, as well as to improve energy efficiency. The key drivers behind this trend include: national security—the United States does not want to be dependent on 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 front line 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 nonpetroleum, 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, boasts some extraordinary features. These include technology that allows the pilot to look through the structure of the aircraft. The aircraft also features control by voice commands, which can 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 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 attack, and to launch their own cyber attacks. In January 2010 The Guardian reported 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 China’s “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.

Military Implications of Arctic Oil

Dr Kent Moors, an oil expert and advisor to the Russian Ministry of Energy, has pointed out that toward the end of 2013 Russia sent a fleet of submersibles under the Arctic ice to plant a titanium flag on the seabed over the Lomonosov Ridge. The purpose, Moors says, was to bolster Russia’s claim to large tracts of the ridge, which is sitting on US$43 trillion (his estimate) worth of oil and gas equivalents. Russia, he says, has recently trained up two special Arctic brigades with the specific mission to defend its Arctic interests. However, SIPRI quotes Russian spokesperson Dmitry Afinogenov, from the Apparatus of the Security Council of the Russian Federation, as saying that “Russia does not see the need for military blocs in the Arctic.” He argued that beefing up security around the region’s critical infrastructure, including offshore oil rigs, the newly-built seaports, and other onshore infrastructure is not an example of militarization, but of “ensuring and improving security in the region.”

Emergence of Robotic Warfare

The US army in particular is investing heavily in exploring the potential of robotic warfare, but it is by no means alone. Today unmanned aerial vehicles (known as drones, or UAVs) regularly accompany even small groups of French soldiers on patrol in hostile territory in Afghanistan to act as aerial scouts and to prevent a repetition of the ambush by Taliban fighters that killed 10 of their number in 2008. As The Economist noted in June 2012, “fighting forces and intelligence services worldwide are equipping themselves with all manner of robots that operate on land and sea, and in the air. The conduct of war is being transformed—and largely it seems, to the West’s advantage.”

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Further reading on the Defense industry

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