Unraveling the Ultimate Mystery: How do governments manage to finance their wars?

Next April, for the first time in more than three centuries, the Danes will have to work during the holiday of Great Prayer after the government canceled the religious day in part to pay for extra defense spending.

The decision, approved in March, was deeply unpopular: in a poll, 70% of Danes opposed it. But economists have praised Copenhagen for having a plan in place to meet its rising defense spending, unlike many other governments.

“Nobody wants to pay more taxes. But at the same time, everyone wants better defense and good health services too,” said John Llewellyn, former OECD chief economic forecaster. funds will be raised.”

Japan, worried by the rise of China and the risk of war in the Indo-Pacific, he did not specify how it will fund a projected two-thirds increase in its defense budget by 2027. The UK, spurred by Russia’s war on Ukraine, wants to eventually raise military spending to 2.5% of gross domestic product, but only when “fiscal and economic circumstances permit”.

The Germans, unnerved by Russian aggression, want to increase defense spending, but not if it means missing a public holiday. France has not specified how it will pay for a planned 40% increase in its military budget over the next five years. The same goes for Polandwhich aims to nearly double its spending to 4 percent of GDP.

How to pay for wars is a problem as old as war itself. Cicero, the Roman statesman, said that “the nerves of war are infinite money.” In 1694, the Bank of England was founded to help William III finance the war with France. Today, even as the world appears increasingly chaotic, spending appears more limited in a context of rising interest rates and high public debt burdens.

Europe is in the midst of its largest armed conflict since 1945. Geopolitical tensions between China and Taiwan are on the rise. Iran may soon be able to make a nuclear weapon. Furthermore, global challenges such as climate change and migration can also force governments to spend big.

The Stockholm International Peace Research Institute (SIPRI) estimates that global defense spending increased by 4% to a record $2.24 trillion last year. It is set to continue to rise this year, even as higher rates drive up government borrowing costs.

Economists such as Lawrence Summers, former US Treasury secretary, and Olivier Blanchard, former chief economist of the IMF, have suggested higher defense spending could even help drive up interest rates.

“One scenario is that countries that have already increased defense spending in 2022 continue to do so, while those that have stated that they will start increasing defense spending in 2023 will actually start,” said Diego Lopes Da Silva, researcher senior at SIPRI’s military spending and weapons production program.

Among the world’s five biggest defense spenders, the numbers are staggering.

In the United States, politicians have carved out an exemption in debt ceiling talks to allow for a 3% increase in military spending to $886 billion in 2024. China’s defense budget, which Sipri estimates at $292 billion dollars, this year is on track for its 29th consecutive annual increase.

Russia, which spent about $86 billion on defense last year, has meanwhile said there will be “no funding restrictions” on its war against Ukraine, even if its budget remains classified. India plans to increase its defense budget by 13% next year to $73 billion, while Saudi Arabia, fearful of a nuclear Iran, now spends 7.5% of GDP on defense, according to only to Ukraine.

In NATO, only seven of its 31 members last year met the alliance’s self-imposed defense spending target of 2 percent of GDP. If everyone did it, total spending would rise by more than $150 billion a year, FT research shows.

While warfare was one of the “most costly and least productive human pursuits,” James Grant, financial historian and editor of the Grant’s interest rate observerhe noted that there was “also a penchant for peace which periodically erupts in our faces”.

Grant added, “When that happens, there’s often a confluence of payment promises and money printing.”

As a general rule, “short, hot wars” that require a sudden increase in spending are financed by extra borrowing, while “long, cold wars” that require sustained defense spending are financed by taxes.

The Napoleonic Wars and World War I and World War II were largely financed by debt. Conversely, during the long decades of the Cold War, the West financed its defense spending through higher taxation. In the quarter century that preceded the fall of the Berlin Wall, tax revenue among OECD countries it has risen to more than 32 percent of GDP on average from 25 percent, while debt levels have generally declined.

“For short wars, governments can finance spending by borrowing,” said James Macdonald, author of A free nation deeply in debt, history of public finance and wars. “But if there’s a long war, the longer it goes on, the more you have to use other methods, like taxes.”

Wars are also often accompanied by higher inflation and the suppression of interest rates. During World War II, wholesale prices in the United States increased by an average of 8.2% per year, even though interest rates on long-term debt had been set at 2.5%, a gap which helped Washington inflate the value of US bonds. released.

“All wars are generally associated with some inflation. Politicians don’t like raising taxes [to pay for wars]and inflation is a hidden tax,” said Richard Sylla, co-author of A history of interest rates.

Economists suspect that rebuilding long-term defense spending, which has fallen by a third in OECD countries since the fall of the Berlin Wall, would require a mix of higher taxes and spending cuts elsewhere.

“Politics can’t be avoided,” Llewellyn said. “Societies face a variety of conundrums and some tough choices have to be made.”