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As global tensions mount, governments face tough fiscal choices. These choices have been highlighted this week by Prime Minister Keir Starmer stating his ambitions for the U.K. to increase defense spending to 3% of GDP by 2034.

A new in the Center for Macroeconomics Discussion Paper Series explores this dilemma by analyzing the economic aspects of military deterrence. The study shows that when defense spending helps prevent future conflict, funding it through debt can smooth tax burdens over time and improve overall economic outcomes.

The research, which uses an advanced economic model of endogenous disaster risk, shows that defense investment can reduce the likelihood of future wars. The study finds that spreading the cost of this investment via borrowing—instead of front-loading it through taxation—is often the optimal fiscal strategy. Crucially, it is the investment in defense that deters conflict; the choice to borrow simply allows governments to fund this investment in a more economically sustainable way.

The study uses the Geopolitical Risk Index, a robust measure of tensions and threats worldwide, to calibrate their model. The researchers then assessed how fiscal policy choices—particularly borrowing versus taxation—interact with defense capacity and global stability. They found that while borrowing increases future tax liabilities, the long-term deterrence and insurance roles of defense capital can offset these costs by reducing the frequency and severity of wars.

Dr. Vytautas Valaitis, economics lecturer and lead author of the study from the University of Surrey said, "Our findings challenge the conventional wisdom that defense should be paid for upfront through taxes. Instead, strategic borrowing to invest in defense capital can prevent wars from happening in the first place, which is a far better outcome for society. This form of debt financing allows governments to spread the costs over time, avoiding punishing tax hikes now while still safeguarding the future.

"While Prime Minister Keir Starmer's 3% target remains an aspiration pending fiscal conditions, the government's recent Strategic Defense Review underscores the importance of sustained investment in military capabilities to address evolving global threats."

The study outlines two key benefits of investing in defense: as a deterrent against conflict and as a fiscal insurance tool. Defense assets can meet emergency spending needs during conflict, lessening the need for sudden tax increases. The researchers conclude that, in times of heightened geopolitical risk, governments should consider allowing twice as much fiscal leeway (deficit-wise) for defense investments as they would for other types of public spending.