The relative decline in Britain's economy, compared with other industrial countries, during the first eight decades of the twentieth century was clearly a factor limiting her ability to compete as a military power. Even so, output per person remained above French and German levels until the 1960s. Since Britain spent a higher proportion of her national income on defence than other Western European countries after 1945, her military expenditure remained greater than France's until 1968 and West Germany's until 1970. The disparity between Britain, on the one hand, and the United States and the Soviet Union, on the other, as regards ability to produce the full range of weapons systems was not obvious until the 1950s. From 1950 to 1969, however, total British defence expenditure averaged about 9.4 per cent of the American level and her attempt to match the superpowers' range of research and development with much more limited numbers of scientific and technological personnel resulted in high unit costs and cancelled projects.18 The connection between arms and wealth was first noted by Thucy-dides, who commented in the fifth century BC that 'war is a matter not so much of arms as of money, which makes arms of use'.19 The money to which Thucydides referred to was gold and silver, which could be used to purchase supplies abroad as well as at home. In fact, what he called money was identical to what we would now call foreign exchange. Britain could supplement her reserves of gold and foreign exchange by exporting goods and services, by selling overseas assets (in which there had been large-scale investment before 1914), or by borrowing from abroad. The availability of loans depended on the credit-worthiness of the British state and on the foreign policies of other countries, of which the most important was the United States. Pounds could be used for

17 Barnett, Collapse of British Power, p. 477.

18 Figure calculated from table in Kennedy, Rise and Fall, p. 495.

19 Thucydides, The History of the Peloponnesian War, ed. and translated by Sir Richard Livingstone (Oxford University Press, 1943), book I, section 83.

purchases only in the United Kingdom and in the sterling area, the latter comprising countries that tied the value of their local currencies to sterling and banked their reserves in London. Insofar as these countries could be persuaded to add to their reserves of sterling, Britain could import from them without increasing exports of goods and services. However, lack of industrial development in the sterling area outside Britain meant that such imports would be largely confined to food and raw materials. Ability to spend pounds on munitions depended upon what British industry could produce, and an attempt to spend more would push up prices, as clearly happened in both world wars, and could happen at other times. What mattered most as regards output of munitions were Britain's natural resources (very limited; mainly coal, prior to the development of North Sea oil in the 1970s), and the productivity of her labour force, the latter being strongly influenced by investment in industrial plant and new technology, as well as by the quality of management and the state of industrial relations.

Economists have put forward a number of reasons why defence expenditure may have an adverse effect on the economy. Malcolm Chalmers lists three: first, it tends to be at the expense of investment, and therefore of capacity for future production; second, it diverts scientific and technical resources away from commercial production; third, it harms the balance of payments by absorbing resources that might otherwise have been used to produce exports.20 The idea that defence expenditure would crowd out investment in the civil sector was accepted by the Ministry of Defence by the 1950s (and much earlier by the Treasury), but international comparisons in the 1980s by Keith Hartley and John Singleton showed that the crowding out effect was felt unequally in different countries.21 This result is not surprising since crowding out is less likely to occur if there are unemployed resources (such as labour with appropriate skills). A fourth possible way in which defence expenditure can harm the economy is the effect of contracts on industry. Mary Kaldor has argued that the defence services were conservative in their requirements, and wanted more powerful versions of existing weapons systems rather than completely new ones. Her thesis is that over-elaboration of existing technologies produced what she called a 'baroque arsenal'. In her view, firms that became accustomed to contracts that had higher specifications than would be required for civil goods, and which neglected costs, became less able to compete in

20 Malcolm Chalmers, Paying for Defence: Military Spending and British Decline (London: Pluto Press, 1985), p. 114.

21 Keith Hartley and John Singleton, 'Defence R and D and crowding out', Science and Public Policy, 17 (1990), 152-6.

markets for commercial products.22 This tendency, although difficult to quantify, may be added to the long list of reasons that have been put forward for Britain's relative economic decline.23

Taxation is another factor that has to be taken into account. Normally chancellors of the exchequer tried to balance their budgets, either because that was what was expected of them in peace, down to 1939, or because the consequence of too great a gap between expenditure and revenue was a tendency for prices to rise, imports to exceed exports, the balance of payments on current account to move into deficit, the gold and foreign exchange reserves to fall, and for sterling to depreciate against other currencies, thereby raising import prices. In war, borrowing and its adverse effects would be accepted, just as a runner in a race will use up his or her reserves of strength in a final sprint, but normally borrowing was limited to what international financial markets would accept as sustainable. Even balanced budgets could have adverse economic effects if high tax rates discouraged enterprise or risk-taking on the part of businessmen, or effort on the part of workers, as may well have happened during and after the Second World War.

It should be emphasised that defence expenditure was only one of many factors that may have tended to hold back the growth of the national economy, and it was probably not one of the major ones, except in wartime. On the other hand, unlike most factors influencing the performance of the private sector, such as the structure of firms and the training of management, industrial relations, the productivity of labour or the design and marketing of products, it was something that government could act on directly. It should also be made clear that defence expenditure can have economic benefits, in the form of scientific and technological advances that may have applications within the civilian economy. Nor is all of the expenditure a net burden on the Exchequer: some of the money will return in the form of taxes paid by contractors

22 Mary Kaldor, The Baroque Arsenal (London: Deutsch, 1982). Seymour Melman, The Permanent War Economy: American Capitalism in Decline, rev. edn (New York: Touchstone, 1985), argues that American experience shows that lack of effective competition results in unnecessarily expensive products.

23 Defence expenditure is not mentioned in Nicholas Crafts' comprehensive analysis in his Britain's Relative Economic Performance 1870-1999 (London: Institute of Economic Affairs, 2002), but may have been a contributory factor to some of the reasons that he does give: cartelisation and poor productivity in firms that were kept going instead of being allowed to fail (defence departments tried to keep contractors going, often peddling out small orders, so that these firms would be available in war) and poor productivity in nationalised industries (which include the royal dockyards and royal ordnance factories, and one major aircraft firm, Short Brothers, taken over in 1943, and kept going on account of the employment it offered in Northern Ireland long after it would have otherwise been closed down).

and their workers, and unemployed or underemployed resources may be activated by the increase in demand originating from the government expenditure.24 Given all the uncertainties about the interaction between defence expenditure and the economy, the best litmus test of whether defence expenditure is too high to be sustained indefinitely is whether the balance of payments on current account is in deficit. However, this test is not infallible as it may be possible to correct the deficit by cutting civil expenditure, both public and private.

A warning about statistics used in the chapters that follow is in order. There was no series of official statistics of British national income before the 1940s, although revenue per penny in the pound of income tax gave chancellors of the exchequer some idea of how the economy was prospering. Earlier figures for national income are estimates by economic historians. There is a bewildering variety of statistics for defence expenditure as a percentage of national income. Data for defence expenditure were compiled by the Central Statistical Office and the North Atlantic Treaty Organisation (NATO) according to different definitions. For national income, or product (which should in theory be equal), there are different data depending upon whether it is measured at market prices or factor cost. Gross domestic product (GDP) excludes net income from abroad; gross national product (GNP) includes that income. Figures in different tables may not be directly comparable, and should be regarded as showing trends rather than precise measurements.

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