‘Starmer and Reeves must break with Treasury orthodoxy to fund Britain’s security’

Compared with July 2024 when Keir Starmer won power, the world has changed dramatically, and his government must do so as well to finance extra UK defence spending. 

Donald Trump’s unreliability and military adventurism, together with Vladimir Putin’s imperialist attacks, have left Britain and our European NATO allies desperately playing catch-up.

Europe now faces its biggest threat to peace since the Cold War without being able to count on US backing, and with Britain’s defence capability badly weakened by fourteen years of Tory austerity. 

But how to finance the country’s national security properly? Surely not by repeating Conservative cuts in health, education or policing? Or by Tory leader Kemi Badenoch’s airy demand to ‘cut welfare’?

After Liz Truss’ financial incontinence, Keir Starmer and Rachel Reeves were right to pledge iron fiscal discipline at the 2024 election. But they now need to think laterally. 

READ MORE: ‘Britain isn’t talking honestly about how geopolitics is driving the cost-of-living crisis’

Germany has radically reformed her fiscal rules to fund higher defence in part by increased borrowing. The European Union has pledged €800 billion to boost military spending by permitting member states to take out loans without being penalised for breaking stringent EU fiscal rules.

Labour has raised defence spending, whilst cutting overseas aid. But that only gets spending to 2.5 percent on defence by 2027, compared with the pledged 3.5 percent by 2035, requiring an extra £36 billion according to the IFS.

Kemi Badenoch says to pay for that by ‘cutting welfare’. But the longer people are out of work, the more costly it is to prepare them for work, as I witnessed when I was Cabinet Minister for Work and Pensions.

Helping millions into jobs will mean extra short-term costs, yet promises a big long-term payoff, both in the dignity and better health of paid work, and the rise in national income produced by a bigger active work force. 

So, unless it is intended to be punitive, slashing spending on welfare is no answer to paying for increases in defence. 

If the alternative is not yet more public service cuts, it is essential that the financial markets finance extra borrowing without imposing higher interest rates on UK government debt – in other words without jacking up yields on bonds.

World War Two provides a useful precedent because fiscal rules were modified then for exceptional, and exceptionally dangerous, times.

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Like today, Britain’s initial hesitancy in the 1930s over the rising Nazi threat was partly because of the extra spending and borrowing that meeting it would entail.Formal commitments to rearm were only adopted in 1936 and ran well ahead of actual military preparations, like many NATO members’ recent promises to raise the share of GDP they devote to defence.

The 1936 UK rearmament programme saw annual defence spending more than double from £186 million in 1936-37 to £400 million in 1938-39 (more than £35 billion in today’s money), of which £272 million came from tax revenue and £128 million from public borrowing under the 1937 Defence Loans Act.

That Act authorised government borrowing to meet defence spending up to a limit of £400 million, extended to £800 million in 1939 as the Second World War began. 

Similarly in 1935 the Cabinet agreed to create a British Army field force of 17 divisions of which five would be regular army soldiers. But by 1938 only two were available to serve on the Continent. 

So true preparations came slowly, but, thankfully, just in time. Otherwise, Hitler would have won and if we don’t do something similar now, Putin could win, maybe with Trump nodding him by and Farage in tow.

The government should promote extra borrowing solely for defence purposes by issuing a special purpose vehicle (SPV) in the form of a defence bond up to set limits. I have spoken to former Treasury chiefs about this, and they cannot see a problem.

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Rachel Reeves and Keir Starmer need to break free from current Treasury orthodoxy – and finance their pledged extra £36 billion of defence spending by going directly to the financial markets to ask for their backing.

Surely, those markets would have no alternative but to say yes for the country’s future security?  

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