War Economy: What is it, and why we will not transition to it?

May 28, 2024

A week or so ago, Aleksandar Djokic sent me some questions about transition to a war economy for an article he was writing (you can read it here). I wrote a reply that was way too long to make it in any reasonable form, so I decided to replicate it here.

When it comes to a “war economy”, the thing to bear in mind is that the last Western experience with war economies was really WW2. Back then, it was the Axis powers and the USSR that began mobilizing their resources before war broke out, aware that it would be unlikely that they would be able to secure a decisive victory quickly. In contrast, the Allies began mobilizing only after they concluded that war is inevitable. In general, the side that expects fighting – usually the aggressor who intends to start it – will have to start making preparations earlier, and will tend to mask them with plausibly sounding cover, like “modernization” or “reform” of the armed forces. The militaries are, of course, constantly trying to upgrade whenever they can, so one must be watching for signs that the investment is outstripping any reasonable modernization needs and eating into the consumption side too much. Since we cannot divine intent, all of these estimates are shaky and contested, which is why aggressors often do manage to get their readiness well underway before realization that a response is needed sets in.

We see something quite similar playing out with Russia and China over the past decade or so. Both began rapid modernization of their armed forces, and – in the Chinese case – made enormous investments in the defense sector (current estimates claim that when hidden spending is taken into account, not just the official figures, China might be spending as much as the US on defense, an astonishing development, if true). In Russia’s case, the changes were more modest owing to the inherent weakness of the economy and the much smaller capacity. The Russians changed Soviet doctrine and began relying on the strategic nuclear forces to deter NATO while reformatting their ground forces for rapid deployments in the near-abroad, suggesting that their intent was to perform operations like the ones they had done in Chechnya, Georgia, and attempted to do in Ukraine.

Until 2022, intent was unclear (and in the Chinese case, it remains opaque), which has hindered the organization of any response that would require massive economic dislocations. This is exactly as it happened in WW2 as well.

The second factor that determines the decision to mobilize resources and how much effort to dedicate to doing that is proximity to the conflict. The further out, the less urgency to change policies in ways that would be costly without producing for consumption. While governments feel there is little threat to them, their desire to intervene in the economy for mobilization purposes or to cooperate with others on such measures is going to be very weak. This is understandable: these policies tend to be unpopular with the citizens, and unless they are convinced that the policies are necessary, changes in that regard are going to result in political turmoil.

We see all of this play out in the West today: European governments who are far from the theater of war or who feel secure for other reasons (e.g, Austria) tend to be lukewarm at best about making costly policy changes while those in the near-abroad who are really worried tend to invest a lot (Poland) and even upend decades of foreign policy (Finland, Sweden). This is not a hard-and-fast rule though because the degree of mobilization is affected by many other things, the structure of the economy (dependence on foreign trade, for example, especially for strategic resources), level of development (especially technology vs manpower, and quality over quantity), the domestic politics, and the quality of the administrative apparatus, among them. Moreover, continuing with mobilization over the medium and long run also requires sufficient domestic control or cohesion. The issue of quality vs quantity is very important because countries that can produce higher quality weaponry can get a lot more bang for the buck, meaning that they can afford to strain their economies less than countries that have to rely on quantity. Analogously, countries that can rely more on technological sophistication and machinery as opposed to manpower can also mobilize a lot fewer soldiers – thereby putting less stress on their economy – than a country that is forced to rely on numbers.

Now onto your questions. To put the main point bluntly, I do not believe that any transitioning to a “war economy” is in the cards for Europe or the United States until they get directly involved in hostilities. What we are seeing now is mostly attempts – and not very good ones – to rebuild capacities lost at the end of the Cold War. To give you an example, the US is now making 72k 155mm shells per month, after opening two new facilities. These took 2 years to bring online, and the increase from under 20k shells per month, and the planned expansion to 102k/month by end of 2025 sound impressive until one realizes that the US had capacity to make 500k/month in the 1990s, and 250k/month in the 2000s. The situation with the European defense industry is even more dire. So, a lot of the current “mobilization” is just trying to go to some fraction what the West used to have in peacetime 30 years ago.

A war economy means government intervention to coordinate the relevant industries to produce for the needs of the front, and to finance and organize adequate and timely supply for their functioning. Since this introduces severe dislocation in the allocation of resources, it means subordinating the market. As military production takes precedence – companies are required to fulfill orders from the defense sector with priority irrespective of other orders; companies that make dual-use products are required to switch to making the single-use product for the military; factories move to 24/7 operations with multiple shifts – consumption is squeezed, which means prices for various products and services rise. This might necessitate price controls, wage freezes, and increasingly violent control of labor that might not be willing to do work “all for the front, all for victory.” This encourages the emergence of black markets, which means corruption of law enforcement, as part of the economy shifts into the gray zone. The governments become increasingly devoted to propaganda as they attempt to manufacture a consensus for policies that cause privation to many citizens. If the mobilization also involves conscription, the situation becomes even more difficult because not only must the government forcibly take men to send them to front but because the men it takes (and it’s almost invariably men) tend to be of the most productive age, so their absence from the economy will be quickly felt. There’s a reason the largest expansion of women’s suffrage in the West tended to come after women became more involved in the economy when the men got mobilized. Moreover, mobilizing large masses of men can create serious postwar problems if the economy is in shambles: one has tens of thousands of armed and train men who can’t find employment. Governments might have to continue intervening in the economy to keep them from going rogue with state employment and more state-run programs (unemployment insurance, health care, etc) or it can try to use them to acquire more resources (Saddam’s decision to invade Kuwait had a lot to do with his inability to demobilize properly due to lack of resources after the war with Iran). Thus, the difference between peacetime and wartime economy is that the latter has the government impose certain kinds of production with all attending political and social consequences.

As I said, Europe will not transition to wartime economy before direct hostilities become imminent – because of all the negative consequences of doing so I enumerated above. The best we can hope for is political will to reinvest in the defense sector so that they could hit the ground running in case it’s necessary to mobilize. In that respect, the war in Ukraine is “good” for the US because for all the talk about the coming confrontation with China, preparations for such an eventuality have been anemic, to say the least. Recall that even here, Congress imposed a sequester on the Pentagon in 2011 in order to reduce the deficit. The packages that go under “aid to Ukraine” moniker are actually mostly designed to rebuild and modernize our stocks, and to invest in future capacity. The actual aid to Ukraine is a lot less than the billions “spent” suggest. The most immediate need for Europe is to begin investing in its own production capacity. One thing that is going to be very different now compared to the Cold War is that the American focus will shift to the Pacific, and it will be up to Europe to contain Russia. Obviously, this would require an US-EU partnership to counter the Russia-China alignment, and some distribution of labor within the NATO framework would be very helpful. If the US could concentrate on developing capabilities to counter China while Europe focuses on what’s needed to counter Russia, everyone in the West would benefit. So this is the second “pillar” of this transition: division of labor within NATO.

Industries affected will be the ones that serve as inputs to the defense sector, and through those, the entire economies will feel it. The reason is that increasing demand for their products/services would naturally drive up the prices, and the governments (which have to place orders or else no private firm would be producing anything out of the goodness of its heart) will have to run larger deficits, increase taxation, reallocate away from social services, or intervene in the market. All of these are very unpopular, and as a result we will see very slow and uncertain moves. The situation gets even more complicated when many components have to be sourced from abroad, where the government is at the mercy of capital flows, international demand, and has little ability to affect prices other than subsidizing them at home.

The public is not going to like public services cut, higher prices, and higher taxes. Moving too fast toward reinvestment in defense risks draining public support before meaningful changes are made, especially if the threat to which the government is supposed to be responding does not seem imminent or realistic. There’s a reason that so much Russian-sponsored propaganda tries to frame the issue as one of spending on useless weapons when there are more pressing needs to worry about (e.g., the crisis with immigration in the US). The public generally does not understand that investing now means production in years. The costs are immediate but the benefits – far off, and perhaps not obvious at all – the best military is the one that’s strong enough to deter a challenge, which gives room to critics to ask why so much is spent on a military that does nothing. Arguing the counterfactual is great in academic circles but makes for poor political slogans. Where the public feels there’s a direct threat (e.g., Poland), support for costly measures will be higher, but even then they might draw the line at government intervention in the economy until absolutely necessary.

It is inevitable that some EU members states will be more willing to adopt a war economy than others. I would just take that as a given because the willingness to do so depends on the level of threat, and not all EU states feel the threat equally. This means the EU will be of limited use to coordinate a EU-wide response, and there will be lot of national decisions that will undermine the Union. We are already seeing some of that in the competition between Czech and German (and French) defense sectors: the initiatives that the Czechs coordinate do not go through EU institutions, and the Czechs have been quite open about not wanting to run their aid to Ukraine through the EU because they wish to privilege their own defense sector and they fear that going through the EU would give the Germans a lot of leverage to shift the benefits to their sector. Competition like this is good for the defense industries but the distrust of EU institutions being able to provide a level playing field is just going to get worse. I do not expect the EU to evolve a common security policy either, and not just because of Trojan horses like Hungary, Slovakia, or Austria.

The risks arise from all the factors I enumerated above. For instance, the UK (and not just the UK) has a serious housing shortage. The obvious solution is to move from Thatcher’s policies and spend money on building more housing. But a government unwilling to raise taxes for ideological reasons that is committing to increasing spending on defense to 2.5% of GDP by 2030 by spending 75 billion pounds over the next six years is going to have to find places to cut spending. Insofar as these cuts mean that problems the public considers important continue to be unaddressed, social and political turmoil is likely.

The biggest challenge to NATO is to transition from its Cold War model of the United States providing the umbrella for everyone else (with the attending distribution of labor within the alliance) to a new framework where the Europeans will become more co-equal partners so that responsibilities can be allocated to both European and Pacific theaters. This has its own challenges as China-firsters in the US want to divest from Europe altogether (and are using this to argue against aid to Ukraine). I think this is deeply problematic because confronting the Russo-Chinese alignment will require a lot more coordination and cooperation than the Cold War, and so much tighter connections between the US and Europe.

• commentary
• economic factors
• Europe
• Russo-Ukrainian War 2022
• US foreign policy
• war arguments