It's time to review arms industry's £4bn subsidy

Demand for heavy weapons has fallen since the Cold War ended

There are some fortunate industrial backwaters that the powerfiul tide of free-market forces has passed by in the past 20 years. Some – shipbuilding, steel and mining – completely succumbed, while others, such as energy production and car manufacturing, restructured entirely. And a few have escaped little changed.

There are some fortunate industrial backwaters that the powerfiul tide of free-market forces has passed by in the past 20 years. Some – shipbuilding, steel and mining – completely succumbed, while others, such as energy production and car manufacturing, restructured entirely. And a few have escaped little changed.

They enjoy copious government subsidies and wouldn't have any idea what a free, unregulated market looked like. Yes, farming is one, although it has at last come under much-needed scrutiny. But there's another lame duck left: Britain's defence industry.

A thought-provoking report yesterday by the Oxford Research Group and Saferworld has assembled the available evidence on the size of the subsidy from taxpayers to the arms business. Its headline figure for the cost, including everything from export credits for arms sales overseas to government funding for defence R&D, is £4.25bn, or £12,300 per job in the industry. (To put it in context, this is about half the taxpayer subsidy per farming job but vastly higher than any subsidy a miner or steelworker enjoyed.) The report suggests this is not good value for money, and Britain could maintain its armed forces and an effective national defence without propping up an industry that sells weapons systems to our European allies and to many nations with dreadful human rights records and vicious internal conflicts.

The arms business is by its nature not one for which figures are easily available. But other recent research by economists, published by the Centre for Economic Policy Research and the Royal Economic Society, does indicate that demand for arms (at least, the major weapons systems rather than the light weapons used in all the nasty small-scale conflicts of recent years) has fallen off sharply worldwide since the end of the Cold War. (Remember the "peace dividend"?) Prices appear to have been falling as a result of the over-capacity in the industry, which is bad news in a business characterised by huge economies of scale. For example, a new air-to-air missile has a development cost of about $2bn, an awful lot of sunk cost to have to sink in a competitive market.

There can be little doubt that globally there is a negative net return in the arms business, though public subsidies result in making most of the individual companies concerned highly profitable. So why should the British Government bother continuing to subsidise the industry to such a degree, especially when it has so many other pressing priorities for public funds?

Winding down a redundant industry is never painless, as many a mining or shipbuilding community can testify. Even when unemployment is low and skills in short supply, it is difficult and traumatic to move people to different jobs. But, unlike steel or ships, where the localised unemployment costs of decline added up to a reasonable case for prolonging government subsidies to the industries, the defence business is based mainly in the prosperous south of England, and its workers for the most part have easily transferable engineering and technical skills. The report does not pretend the issue is a no-brainer. Luckily for the companies involved, the arms industry benefits from a lot of helpful strategic and geopolitical baggage. For example, there are only five big arms exporters in the world, the five permanent members of the UN Security Council, which account for 85 per cent of the world market among them. The US, Britain, France, China and Russia produce arms for themselves and sell pretty much all their surplus to middle-income developing countries in unstable regions of the globe.

While the ethics of this are to many of us troubling, it is clear that any of these five governments would hesitate to shrink their arms industry and leave the others even more dominant in arms supply. Would the UK feel comfortable relying on imports from France and the US if it wanted to continue playing as a major world power?

If you believe not – and few non-Americans seem comfortable with the thought of sheltering behind George Bush's new missile defence shield – this is a genuine argument for a taxpayer subsidy.

There is another decent argument for at least a part of the government subsidy for defence, and that is the spending on R&D. America's industrial policy has always been conducted through its defence budget, and the spin-offs, from the internet downwards, have been impressive. The only technologically cutting-edge country that has not used its defence industry in this way is Japan. Unlike America, it has never had a problem with the idea of an up-front industrial policy.

In Britain we are more American about this, being very uneasy about the idea of government having an industrial policy, especially one involving scientific and technological research. The embarrassing failures of the last one we had, the "white heat of technology" drive in the late Sixties, still casts a long shadow. Much easier to fund R&D on the quiet in defence where there is enough secrecy, and enough unthinking political support for things military, to veil the failures.

Governments fail at hi-tech industrial policies, whether military or civilian, when they try to be too prescriptive. Yet despite the dangers, there is a strong case for a taxpayer subsidy to R&D, for pushing at the frontiers of research, which might or might not deliver fast and tangible results.

Britain has a low level of spending on R&D by international standards, and privately funded research is focused on areas likely to deliver short-term commercial returns. Government money is needed to finance the scope for serendipity in research.

If the £4bn earmarked for propping up arms suppliers were redirected instead to an explicit industrial policy, which could benefit very many more British companies and workers than the lucky few in defence, there would be less reason to fret about the use of taxpayers' money.

diane@enlightenmenteconomics.com