A new report from Oxford Analytica and WTW firm Willis shows demand from the defense industry is surging amid an increasingly volatile geopolitical landscape, but is constrained by lagging production, economic nationalism, fiscal vulnerabilities and supply chain risks.
The report draws on in-depth interviews with senior executives across the defense industry. It outlines the structural challenges the industry faces, driven by an unexpected surge in demand, while also facing multiple risks.
The report identifies five economic risks currently facing the defense sector, including struggles with the scale/sovereignty trade-off as countries need to balance focusing defense resources to increase efficiency while maintaining national control.
It also highlighted the risks of a tariff war, with escalating trade barriers disrupting supply chains and raising costs, as well as the industry’s continued dependence on China due to its dependence on Chinese materials and components such as rare earths and electronics.
Another risk is phantom spending, whereby political commitments to increase defense budgets may not translate into actual investment in the future.
The report also points to the failure of reindustrialization, as Western countries rediscovered the need for industrial capacity but faced difficulties in rebuilding it.
In addition to these current concerns, respondents highlighted two new threats related to fiscal stress: social backlash against defense spending and a looming fiscal crisis.
With debt-to-GDP ratios exceeding 100% in much of Europe, North America, and Japan, governments face the risk of “soft defaults” caused by inflation or financial repression. Increases in the defense budget could cause political discontent if they lead to higher taxes or cuts to social programs, especially at a time when economic growth is uncertain. These pressures could undermine long-term defense commitments and create political instability.
“In the late 1990s and early 2000s, the threat of terrorism dominated the national security agenda,” said Sam Wilkin, director of political risk analysis at Willis. “In retrospect, this concern was born out of an era of extraordinary geopolitical stability, when conflicts involving states had declined to historic lows.
“Today, that stability has disappeared. Non-state actors remain disruptive, but the past few years have been affected by a resurgence of state-sponsored violence. These threats are occurring on a much larger scale, thus driving a surge in defense procurement and the reshaping of global defense supply chains. For companies active in this space, this shift in the risk landscape has significant implications for operations and future planning.”
