Done Right, Increased Defence Spending Could Boost the Canadian Economy

Heightened geopolitical tensions have created a pressing need to raise Canadian defence spending from 1.4% to at least 2% of GDP. That would involve increasing spending by an average of 15% each year if this target is to be reached by 2030 (graph). This initiative would go much further than merely expanding Canada’s defence capabilities. It could serve as a real industrial policy that affects industry, employment, innovation and public finances. The real question is how to increase spending in a way that’s economically sustainable and strategically relevant.

Defence spending presents an opportunity for a Canadian economy struggling with poor productivity. In 2022, the defence industry generated $10B in GDP and employed 62,000 people. Ramping up government defence orders could have several multiplier effects. First, it would reduce Canada’s dependence on imported military equipment, which represents 45% of supply chain costs. Second, it could help usefully reallocate manufacturing capacity that may end up redundant if trade tensions with the United States continue. Finally, another potential benefit could be boosting military exports, which currently amount to less than $7B (less than 1% of Canada’s total goods exports).

Historically, defence spending has helped drive technological innovation that can indirectly benefit other sectors. The internet, night-vision devices, drones and even our handy duct tape were developed for the military before finding civilian applications. In the US, the Defense Advanced Research Projects Agency (DARPA) has often been credited with much of this innovation, whereas in Israel, two thirds of startups are in cybersecurity. An empirical study External link. of OECD countries shows that a 10% increase in defence R&D spending leads to a 5.6% increase in private R&D in the following year, resulting in productivity gains. What’s important is to allocate those funds intelligently by expanding applied research capacity, focusing on dual-use technologies, and creating synergies with technological ecosystems, especially for cybersecurity and surveillance.

While promising, there isn’t a guarantee that higher defence spending will have a positive impact. The Canadian defence industry has yet to prove that it has the capacity to handle an influx of new orders and level up technologically. And it’s an even bigger challenge when considering that Canada is competing in a market with well-established players. The US defence sector alone has cornered 40% of the global market, while the European industry is dominated by leading national champions. Without a strategic vision or sovereign procurement policy, increasing the defence budget may very well result in massive outflows to foreign suppliers.

Meanwhile, the budgetary impact will be considerable and has to be carefully calibrated. Expanding the defence budget by 76% within five years would put additional, albeit manageable External link., pressure on public finances. It would also require trade-offs on other national priorities such as infrastructure (unless it’s dual use), including in the areas of public transit, education, healthcare or the climate transition. A gradual approach would help prevent public-sector spending from crowding out private-sector spending in these critical sectors, although the trade-off would probably be a lengthening of the timeline for reaching the defence spending target.

Canada’s approach must be grounded in some key principles. Certain strategic segments need to be prioritized, especially Arctic surveillance, cyber defence and dual-use technologies with high domestic added value. Strengthening international cooperation and making certain joint purchases with allies, thereby lowering unit costs, would also be a step in the right direction. Finally, climate transition goals should be integrated by focusing, where feasible, on technologies that reduce the carbon footprint of military operations. This could also pave the way for carbon-neutral breakthroughs with civilian applications.

The increase in military spending could represent a major shift for the Canadian economy. If poorly designed, it could squander taxpayer dollars and deepen Canada’s dependence on foreign suppliers. The Auditor General’s reports External link. on this subject are full of examples of such mismanagement. But if well structured, this initiative could drive industrialization, innovation and even climate sustainability. The question isn’t whether Canada should expand its defence budget, but how the country can execute in a way that maximizes the benefits of such a shift.