Absent entitlement reform, U.S. government debt will continue to increase in the context of large fiscal deficits, which will limit policy flexibility in terms of medium- and long-term defense spending. The Congressional Budget Office (CBO) projects large fiscal deficits and a continued increase of the debt-to-GDP ratio, driven by increasing (mandatory) entitlement and net interest expenditure. It is highly unlikely that the projected increase in government over the next two decades will cause any financing difficulties, let alone a financial crisis, not least due to the pivotal role of the dollar, the relative attractiveness of U.S. assets and a more favorable growth outlook than in most other advanced economies. However, a combination of more modest economic growth and large fiscal deficits will translate into greater defense spending constraints.
> U.S. federal government is $35 trillion, which translates into more than $100,000 per citizen. U.S. federal government debt has more than tripled since the beginning of the century, increasing from 32% of GDP in 2001 to 96% of GDP in 2023. The CBO currently projects the debt-to-GDP ratio to reach 116% of GDP by 2034 and 166% of GDP in 2054. Federal budget deficits will average around 6% of GDP.
> Mandatory spending will increase from 13.9% of GDP to 15.1% of GDP over the next ten years, while discretionary spending will decrease from 6.4% of GDP to 5.1% of GDP. If the decline in discretionary defense and non-defense spending were to be evenly split, U.S. defense spending would be less than 3% of GDP by the middle of the next decade and close to an all-time post-World War II low.
A significant fiscal adjustment involving a reform of social security is necessary would help create more space for significant defense expenditure increase, but such a reform is highly unlikely to take place in the short or even medium term. Mandatory spending covers spending for entitlement and other programs, such as Social Security, Medicare, Medicaid, and several other health and old-age programs. Discretionary spending is controlled by annual budget process and pays for the operations of most federal agencies and national defense programs. Discretionary spending as a share of GDP has declined gradually over time, mandatory has continued to increase. Reducing, less so limiting the growth of government spending invites a political backlash from those groups that will be negatively affected. Demographic change and the emergence of a “grey majority” is making it even more difficult to substantially reduce entitlement spending, as the affected groups is gaining electoral weight by the year. Psychological biases, such as the endowment effect, further strengthens opposition to reforms. At a minimum, this will require any entitlement reform to phase in a reduction of expenditure (relative to baseline) in a very gradual fashion. But even then, it will be difficult. It is no coincidence that neither party supports a reform of social security and other programs. The last significant entitlement reform that sought to balance the books took place in 1983.
> In FY 2023, the U.S. federal government spent $6.1 trillion dollar. The U.S. federal government spends more than what the Japanese economy, the world’s third-largest, produces.
> Mandatory spending accounts for 60% of federal spending, discretionary spending for 30% and interest on debt 10%. Discretionary spending includes defense and non-defense spending with defense spending account for 13-15% of federal spending (or roughly half of discretionary spending.
The constraints on U.S. defense spending are political, financial and economic, and these constraints and trade-offs will increase over time. Economically, high levels of defense spending are detrimental to long-term growth if spending limits the availability of national savings and investment. In the short run, however, a sharp increase in defense expenditure can help boost economic growth, particularly in the context of an economy with ample spare capacity. Financially, increased defense expenditure needs be financed through higher debt, increased revenues or reduced expenditure. With more resources allocated to consumptive defense spending and no offsets elsewhere, savings and investment will fall or private consumption will fall, or both. If the former, economic growth will suffer over the medium- to long-term. If the latter, political opposition to higher defense spending will increase. The end of the Cold War led most Western countries to reap the so-called peace dividend, meaning reduced military expenditure led to increased savings, investment, lower interest rate and higher economic growth. Faced with increased geopolitical competition, the need for increased defense spending will make for painful economic, financial and political choices, while increased defense spending (as a share of GDP) will weigh on the longer-term growth outlook. While none of this means that the U.S. will not be able to increase defense expenditure, it does mean that the economic, financial and political trade-offs and constraints will become more important.
> In the short run, government can almost always mobilize massive resources to support defense spending, if flanked by appropriate economic and financial measures, such as capital controls or central bank buying of additional debt issuance. U.S. defense spending (including Department of Energy spending on nuclear weapons) was 3.5% of GDP. In 1953 (Korean war), U.S. defense spending reached 11.3% of GDP. In 1968 (Vietnam war), 8.6% of GDP, In 1999, it fell to a post-1940 low of 2.7% of GDP before it increased again to reach 4.5% of GDP in 2010 (Afghanistan and Iraq wars). Defense spending exceeded 40% of GDP during World War II.
> In the long-term, there are economic limits to excessive defense spending. The reduction of defense spending following the end of the Cold War led to the so-called “peace dividend,” allowing for more productive government spending, higher national savings and lower interest rates. Unsustainable defense spending drove the USSR into economic stagnation, financial failure and ultimately political collapse. The USSR spend a disproportionate amount of its GDP on defense as opposed to private consumption or investment, which led to both economic stagnation and contributed to growing political discontent.
The United States remains the world’s top military spender by a wide margin, but Chinese defense spending has been increasingly rapidly on the back of rapid economic growth, which, in turn, is putting increased pressure on U.S. military spending. The U.S. remains the world’s largest defense spender. If a decade or so ago, it spent more on defense than the rest of the world combined, U.S. expenditure today continues to account for nearly 40% of global spent, while China accounts for less than half of U.S. spending. The size of defense spending matters, but it is not everything. Several caveats apply. First, comparing military spending, even if adjusted for PPP to take capture the effective spending power, is difficult, as different countries include and exclude different defense-related spending categories and items, and some countries’ defense expenditure figures lack transparency altogether. Second, even with a PPP adjustment, it is not obvious one dollar of defense spending buys an equivalent amount of security. Leaving aside that security is a relative concept, using PPP to compare spending is unsatisfactory due to differences in terms of what the money is spent on as well as what adjusted dollars can buy, given that advanced military technology is not traded on international markets and local production costs differ, and sometimes certain defense-related technologies are not available at all to allow for comparisons. Third, it matters not only what the money is spent on but how it is spent, and ultimately what “strategic bang for one’s financial buck” one get. For example, directing funds to procurement and development rather than outdated platforms or personnel, including veterans’ pensions may not translate into increased military effectiveness. Lastly, when comparing U.S. and Chinese defense expenditure, it is important to take into consideration differences in terms of force structure and military posture. The U.S. has world-wide commitments and a costly and extensive global footprint. China does not and its military forces are geographically much more concentrated. Military spending should therefore at best seen as a proxy for defense capabilities. In this sense, the constraints the U.S. the relatively greater and faster increasing constraints the U.S. is facing in terms of increasing defense expenditure is a constraint, but it is a constraint that can be also be alleviated, at least partly, by ways other than spending increases. Over the long term, however, significant differences in spending will matter from a security point of view.
> In current dollars, the United States accounts for almost 40% of global military. China and Russia account for a combined 17%. The big-4 European countries account for 9.5%, compared to Russia’s 3.9%.
> In 2023, U.S. defense expenditure accounted for 3.5% of GDP, China’s official defense expenditure for less than half at 1.6% of GDP. Due to much more rapid underlying economic growth, Chinese defense expenditure as a share of GDP has been growing much more rapidly without translating into higher expenditure.
> In nominal dollar terms, the US spent about $900 billion and China $300 billion on defense. Adjusted for PPP, the difference would be far smaller, but Chinese spending would be only about half of U.S. spent. In 2010, the U.S. spent $740 billion, compared to Chinese spending of $100 billion. In PPP terms, China has been catching up even faster.
> In addition to faster economic growth, China has also greater scope to increase defense spending as a share of GDP without jeopardizing long-term economic outlook, because it has excess savings and limited profitable investment opportunities. This should allow it convert its excess savings into military consumption without unduly undermining the long-term growth outlook. The U.S. is far more constrained in this respect.
> U.S. defense spending currently breaks down into the following spending categories: $182 billion for personnel (25%), $338 billion for operations and maintenance (40%), $168 billion for procurements of weapons and equipment (20%), $143 billion for R&D (15%).