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The War Economy After the Economic War

Time to read: 10 min

Experts in geopolitics have been saying for more than 20 years that in the northern hemisphere military wars have been replaced by economic rivalries. The most frequently cited examples in this context were Germany and Japan, two countries whose imperialism of war was replaced by aggressively conquering markets for domestic products and services. In this logic, arms expenditure seemed superfluous and even inadvisable, as it involved resources that could be successfully allocated to stimulating domestic consumption or supporting the foreign expansion of domestic enterprises. In the popular consciousness, the heroes were the creators of companies whose products and services are used by the entire world, not the brave defenders of the homeland.

The Russian Federation’s aggression in Ukraine has dramatically changed attitudes towards security. Today, the willingness to undergo military training has increased significantly, and the need to increase expenditure on national defence has become apparent. The change of attitude has not entailed changes in the laws of economics. In static terms, spending on armaments is a “waste of resources”. In dynamic or evolutionary terms, the case is quite different. A prerequisite for doing business is external and internal security. National defence spending can therefore be compared to insurance. The probability of an insurance pay-out is low, but if the insured event materialises, the consequences are so severe that we are prepared to insure ourselves. Every insured and citizens of the countries incurring the arms expenditure should be glad that this expenditure turned out to be unnecessary and the event we feared did not materialise. 
The differences between insurance and national defence expenditure are as follows: (1) the greater the expenditure we incur, the less likely a hostile attack is; (2) defence expenditure can generate “positive externalities” (economic benefits) if properly conducted.

The vast majority of countries with high expenditure on armaments in relation to their Gross Domestic Product (GDP) are poor. The exceptions are two relatively small countries, Israel and Taiwan. The defence spending of these countries is covered by strict secrecy, but it can be assumed to be around 15% of GDP. Despite such substantial military budgets, both countries are among the wealthiest and most competitive in the world.

There is no single and straightforward recipe for combining prosperity and security. Indeed, Israel has achieved a positive feedback loop between defence spending and economic development by fostering dual-use innovation. Technological solutions, information systems, and organisational techniques designed for the military have found civilian applications, increasing the competitiveness of Israeli businesses and the efficiency of state operations. The emergence of analogous feedback loops requires the prevalence of military service, particularly among those with technical and science backgrounds, and a willingness to experiment with technological/IT/organisational innovations by the Israeli armed forces. Without a genuine openness to external innovation, it will be difficult for the Polish army to stimulate innovation through arms expenditure. A natural “transmission belt” of defence innovation to civilian applications is the demobbing of people with technological competence.

A second channel for stimulating the economy through armament spending is to pose technological challenges to state and private research institutions and technology companies. The challenges should concern the development of so-called advanced prototypes of solutions needed by the Polish armed forces, which also have export potential. A challenge can be undertaken by more than one unit or a consortium of units. There is usually more than one way to meet a given challenge, and in addition, healthy competition between those taking on the challenge leads to a reduced risk that an advanced prototype will not be developed. In addition, research, development, and engineering work will likely be carried out faster. The disadvantage of such an arrangement is the need to bear the costs of more than one research team. Allowing a situation where part of the funds will be “wasted” requires a revolution in thinking about public procurements.

The authors of the best-advanced prototype must hand over all material copyrights and documentation to a serial manufacturer, e.g. the Polish Armaments Group. At the same time, the authors receive a small share of the revenue from export sales. A private sector incentive system has been set up in an analogous way in Israel. This approach requires policymakers and large arms companies to trust (smaller) private players. Developing their technological competence based on military challenges contributes to raising productivity in many related civilian fields, which translates into increased competitiveness of the economy as a whole.

The third pillar of “pro-economic defence” is the domestication of imported solutions. Israel is doing this to a vast extent. In Polish terms, replacing software embedded in imported equipment with domestic solutions is the most promising. A number of Polish companies produce world-class systems for controlling industrial robots. Commissioning them to develop software for defence solutions is within the scope of their competence and, simultaneously, creates uniqueness and the effect of surprising possible aggressors. In the civilian aspect, this will enable robotics companies to move to the next level of development and achieve economies of scale and economies of scope.

Unlike Israel, Taiwan is not building a competitive economy and a strong army based on synergies between civilian and military innovation but instead sees its security in the development and implementation of key technologies and the centralisation of military procurement in state-owned institutions. The general perception is that Taiwan is simply a significant customer of the US defence industry. In fact, companies and technologies emanating from the Industrial Technology Research Institute (ITRI), founded in 1973, have become key suppliers to the US economy, including the defence industry. ITRI operates in a similar way to the Lukasiewicz Research Network - it focuses on application work for the economy. Creating technologies that can become elements of advanced defence systems produced by other countries requires time and concentration of financial support on technology implementation. If Poland were to follow a similar path to Taiwan, it would probably be necessary to radically reduce public spending on basic research and the social sciences and humanities. Increased funding for implementation work must be followed by a change in the system of economic incentives for researchers (differentiation of salaries) and career advancement paths (preferring implementation success over publishing).

In the last few years, there has been a shift in the approach to weapons development in Taiwan. The Ministry of Defence has decided to refine and equip with local technological solutions to enhance the combat capabilities of the equipment it buys. For this, consortia were built with foreign companies (USA, Israel, France, etc.) in selected areas and licences and technical documentation were purchased. This model of cooperation allowed production to be relocated to the island. Initially, manufacturing potential was located in state-owned entities, e.g. shipyards. Privatisation and the development of the private arms business have meant that private manufacturers now dominate. They are supervised by separate departments of the Ministry of Defence.

Transferring institutional solutions from one country to another is fraught with risk. Especially if the institutional solutions have worked in smaller countries – Israel’s population is under 10 million and Taiwan’s under 25 million. Although today’s economic parameters do not indicate it, Turkey (population over 80 million) is on a very good path to building a competitive economy based on defence innovation. More than 20 years ago, it started attracting high-level armament design specialists (mainly from Ukraine) and establishing research and production facilities. Revenues from arms sales increased from USD 1 billion in 2002 to USD 10 billion in 2020, of which one-third were exports. The Turkish Republic’s armed forces already procure 70% of their equipment from domestic production (up from 30% just ten years ago). The Turkish government aims to become completely independent from foreign military technology. In my opinion, this is an unnecessary and over-ambitious goal. Military technologies have been developed for decades and becoming competent in all types of weaponry is beyond the strength of a single country, except for the largest ones. Nevertheless, successfully entering market niches related to changes in how wars are fought is undoubtedly a success for Turkey - militarily and, in the long term, economically as well.
The following conclusions for Poland emerge from this general and simplified analysis, among others:

1. The expansion of military capabilities need not be a “zero-sum game” - financial resources for civilian needs are taken away and allocated to national defence. If arms expenditure raises the level of technical and manufacturing sophistication, it can stimulate economic growth and development (“positive-sum game”). 
2. The achievement of synergies between the strengthening of defence and the economy’s competitiveness requires that government expenditure on research and development be directed towards implementing dual-use technologies and strictly defence-related solutions. The beneficiaries of this funding should, to a large extent, be domestic private entities - without trust in these companies, the impossibility will not be overcome. Any solutions should have export potential, although the first reference customer should be the Polish Army.
3. Development works should be coordinated by the Ministry of Defence. Three priority areas: (1) creation of components that can be used in defence solutions of global corporations whose products Poland buys; (2) search for improvements to defence systems that the Polish Army acquires or plans to acquire; (3) identification of niches for new products based on Polish technical thought in the global market. Openness to building international consortia at the research, development and implementation level is essential. 
4. All activities must be calculated over decades and implemented systematically and consistently. Probably the fastest effects will be seen in light technologies, e.g. information technology.
5. The above actions can be accelerated by acquiring foreign companies creating dual-use technologies or acquiring experts with unique competencies. Such an approach will result in the internationalisation of Polish state and private enterprises. Are we ready for this?

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