
It's not guns vs growth. Spending on desi defence tech can boost economy
By all accounts, Operation Sindoor has been a success. It has demonstrated the strength of India's air defence system, as well as its offensive capabilities in destroying training and logistical facilities of terror networks deep inside Pakistan. But this success was not achieved overnight. The Indian govt has been proactively investing in procurement and indigenisation of advanced weapons and surveillance capabilities in the past decade. Following the demonstration of the capabilities of indigenous technologies like Aakash, the confidence in indigenous research and development (R&D) is at its peak. This presents an opportunity to significantly increase defence spending, even if it requires loosening the fiscal deficit targets.
This might raise a few eyebrows, especially among monetary hawks and bond vigilantes, but from the Spanish conquest of the Aztecs to the use of the nuclear bomb in World War II, history is replete with examples of epochal, and yet one-sided, battles that turned the page of civilisations due to technological superiority on one side. These tech advancements are often achieved with state backing through speculative R&D investments. A prominent example is the Manhattan Project behind the first nuclear bomb.
Fiscal hawks will ask two questions when they hear suggestions of increased govt spending. First, how would this affect private investment? And second, how should this increased expenditure be financed?
Focus on firepower: It makes sense to fund defence R&D even if it means relaxing fiscal deficit target
The metric to assess the impact of the first question is called the 'fiscal multiplier'. To put it simply, fiscal multiplier tells us how much is the additional output (GDP) created by increasing govt spending by one rupee. A fiscal multiplier of greater than one means a positive spillover effect on the private sector, while less than one indicates otherwise. In her research published in 2019, Prof Valerie A Ramey of the University of California, San Diego, found that most types of govt spending have a multiplier of less than 1, i.e., they crowd out private activity entirely. A simple example would be a policy like free cash transfer to the poor. Such schemes can disincentivise some workers from going to work, thereby making labour more expensive, leading to firms cutting down their investment and production.
But what about defence expenditure? What is its fiscal multiplier? A recent paper in The American Economic Review titled 'The Long Run Effects of Government Spending' by Juan Antolin-Diaz and Paolo Surico of The London Business School argues that by shifting the composition of public spending towards R&D, military spending boosts innovation and private investment in the medium-term, and increases productivity, GDP and consumption at longer horizons. Essentially, defence expenditure is distinct from other types of govt expenditures, including public infrastructure investment, due to its ability to spur R&D in both public and private sectors. Using extremely conservative methods for estimating fiscal multiplier, they show that military spending has a fiscal multiplier of nearly 2. In other words, a rupee spent on military spending creates an additional GDP of another rupee. Most importantly, the additional rupee comes from an increase in productivity that lasts a very long time. These quantitative estimates may vary from country to country, but they are unlikely to be significantly less than 2 even in a country like India.
Moreover, while the quantitative effects may be surprising, the qualitative effects are entirely unsurprising. Increased R&D expenditure is likely to go to the most talented, productive, and ambitious people in the economy. It is entirely expected that allocating capital towards their R&D initiatives will create strong and robust second-order gains. The second question then is how to fund defence expenditure? In India's context (and even otherwise), tax would likely be the worst way to finance this increased defence expenditure. It has one of the lowest fiscal multipliers and will likely have serious repercussions on the GDP. But the govt can raise long-term money at a rate lower than 6.5% per annum. This makes the choice of funding source for defence expenditure clear: long-term govt borrowing. Given the sustainable benefits from defence spending, the govt should not have a problem repaying the debt.
However, this requires a mindset change in the govt, where a certain segment holds a dogmatic view that debt is bad. Not all debt is bad; it is the debt to finance unproductive expenditures that causes trouble. Debt to finance defence R&D expenditure should be sustainable given the strong positive spillover effects. We hope that the govt considers relaxing the fiscal deficit target by 0.5-0.7% of GDP ($20-30 billion), borrowing long-term, and using it to fund defence expenditure that is heavy in R&D. This amount would go a long way in creating deep-tech defence startups making India stronger and, thus, more prosperous. Facing external threats from two neighbours—one reckless and one highly advanced—time is not on our side.
Tantri is a faculty in finance at the Indian School of Business while Kuvalekar teaches economics at the University of Essex, UK
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This piece appeared as an editorial opinion in the print edition of The Times of India.
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