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Weapons exports: The bogus moral dilemma Samuel Brittan: World Economics April-June 2003 The article draws freely on a lecture published in the Royal Society of Arts Journal, August 2001 and, like the author’s earlier work, has benefited from indispensable help by Paul Ingram of the Oxford Research Group. Introduction After Saddam Hussein invaded Kuwait in 1990, the arms exporting governments belatedly realised that their weapons sales to his regime had been an enormous mistake. British equipment was used by Iraqi forces in 1991; and the French were unable to fly because Iraq’s Mirage 2000 jets could not be easily distinguished from the French ones on radar screens. Indeed, ever since the Matrix Churchill Arms for Iraq scandal and the subsequent Scott Report of 1996 [1], the attitude of Western governments to arms exports has come under the microscope. After 1991 there was indeed an international embargo on arms exports to Saddam’s regime. Nevertheless, rumours spread earlier this year that a French company was supplying Iraq with spares for its Mirage jets and Gazelle helicopters. Fears that French troops would face forces using their own equipment may well have contributed to the French government’s decision not to take part in the invasion, although other considerations were of course also involved. The belief of most heads of government, diplomats and business spokesmen is that it may be desirable to stop exports to dubious regimes; but that jobs and exports are at stake and that a practical compromise has to be drawn between supporting a major industry and doing the right thing in foreign policy. There are indeed many occasions when an ethical policy is costly. We cannot all be heroes and a frequent human response is to strike some compromise between doing what is right and what is personally beneficial. Tragedy arises when the costs of an ethical approach are small or even negative, but we refuse to carry them out of a mistaken belief that they are horrendous. Official support for arms sales in the main Western industrial economies is a prime example. The circular flow To understand the issue, it helps to stand back from the subject of arms and examine the basic fallacy of the commonsense politician or businessman. This is to ignore the circular flow of income: a fundamental concept which many economists find too obvious to explain. The main idea is that there is a continuing flow of spending between final purchasers, the products which they buy and the incomes thereby generated, which in turn lead to still further purchases. The process can be seen in the very first two tables of, for instance, the UK National Income Blue Book. This shows expenditure on consumption, government services, investment, exports and so on as one ‘approach’ to estimating Gross Domestic Product. The second approach looks at the output produced. The third looks at the income generated in the process which is overwhelmingly wages and salaries, but also includes profits and numerous miscellaneous items. These three approaches should all lead to the same total; and statistical discrepancies apart, they do. In the case of the UK, the result is a Gross Domestic Product of around £1,000bn per annum. There is a similar flow across the foreign exchanges. There is an outflow of spending on imports and on direct overseas investment as well as on portfolio purchases. There is an inflow from exports and inward investment. Under a floating exchange rate these two flows automatically balance. Ignorance of the circular flow of income is probably the most important single source of perverse economic policies today. For instance, many alarmist writers worry about what will happen once China or India are able to produce cheaply vast quantities of products which are now made in the West. But few people go on to ask what the Chinese and Indians will do with their export earnings. Presumably they are selling these cheap goods to make a living and not to line their bank vaults with sterling, dollar or euro notes. (Even if they did, international payments would still balance, but by a more complicated route.) ‘Lump of labour’ fallacy Similarly, it is frequently assumed that if Britain or France lose arms orders in pursuit of an ‘ethical foreign policy’ that the workers in the arms industries would simply waste away in idleness. It is not asked whether there will be other purchases at home or abroad to make up the difference. Here is an extreme example of the widespread ‘lump of labour’ fallacy, which assumes that there is a fixed amount of work to be done in each industry and workers displaced by technological progress, or by a shift in demand away from their product, are doomed to the unemployment scrapheap. The circular flow of income can be helped by sensible ‘macroeconomic’ policies, such as efforts to maintain an adequate, but not excessive, flow of total spending. There are plenty of arguments about the relative role of monetary and fiscal policy in providing this support and the form they should take. But the interested citizen needs to know mainly that there is, or can be, such a circular flow and there need be no fear of one country being undercut in everything by its competitors. But suppose that there is a breakdown in this circular flow, whether on a large scale as in the Great Depression of the 1930s or on a modest scale such as the occasional recessions since World War Two? Surely the remedy lies in general measures to boost total spending (in the jargon “maintain aggregate demand”) rather than to pump money into a few chosen industries whose leaders make most noise. The root of the matter is the belief throughout the political and business establishments that exports are worthwhile for their own sake, irrespective of the terms on which they are sold and how much they have to be subsidised. It is for this reason that British Prime Ministers, whether Thatcher, Major or Blair, time and again come down against the Treasury in favour of controversial arms deals or dubious overseas capital projects. Mercantilism The balance of payments preoccupation goes back many centuries. Mercantilist writers in the 16th, 17th and 18th centuries campaigned for a favourable balance of trade and for an inflow of gold and silver. These writers were refuted as conclusively as anything can be in political economy by 18th century members of the Scottish Enlightenment such as David Hume and Adam Smith. During the subsequent period of rapid world economic growth towards the end of the 19th century, huge current account surpluses and deficits built up, far greater than any of the imbalances which commentators have bemoaned in recent decades. The origin of both the export drive and the reinvention of the so-called balance of payments problem was in the immediate post-war years when sterling, like many other currencies, was on a pegged exchange rate and also inconvertible. The financial policy regime was then one of suppressed inflation, which tended to spill over into the balance of payments, and which was held down by a mixture of controls and exchange rate overvaluation. It was, moreover, a world with strict restrictions over capital flows. These controls could not be severe enough to protect determined speculators from launching an attack on a suspect currency, but they were a deterrent to the regular flows of capital across borders which normally finance imbalances on current account. The post-World War Two generation of political and economic leaders was brought up on slogans and posters such as “export or die”, “the dollar drive”, and even on one occasion “exporting is fun”. By contrast, we are now back in a world of relatively free capital flows. There are bound to be large imbalances between countries with high savings ratios and relatively few investment outlets and other countries, such as the United States, which have had low savings but many investment opportunities. Moreover, we now have floating exchange rates. And advanced industrial countries with floating exchange rates need never have balance of payments problems. They may suffer from unwelcome downward pressure on their exchange rate due to financial markets’ distrust of their policies or of fears about domestic inflation. If so, such fears should be tackled directly. In today’s circumstances, export drives really amount to the diversion of public resources towards special interest groups under the guise of patriotic slogans. The basic political and business fallacy is not to realise that exports, like investment, are a cost and not a benefit. If we could finance the imports that British citizens want to buy without any exports—say by interest-free loans from overseas on indefinite repayment terms—we would be better off. Of course, this would require a period of adjustment. But such adjustments are necessary after any kind of economic or industrial change. In the world as it is, exports are a waste of resources and serve no purpose if they are not paid for, or are paid for very late and on a heavily subsidised credit basis and with a strong political risk factor. This is not the place for a long discussion of the euro. But even if the UK were to join, there would still be no balance of payments constraint. There would be no sterling parity to protect, as the pound would have been abolished; and so long as the European Central Bank and the Ecofin Council have the sense not to attempt to fix the euro exchange rate against other leading currencies like the dollar or the yen, the automatic balancing would take place at the euro level. The ‘York Report’ Does size make a difference? Of course it does. If a country is highly specialised in one class of products — say Hong Kong in textiles in the 1950s — then indeed a sudden closure of the market for this product would come as a shock and it would take time for workers and their supporting capital equipment to be relocated to their next best activities. This is the relevance of the empirical inquiries which have been made into the importance of arms sales for particular economies. This article concentrates on the UK, on which I have more detailed information and which is one of the half dozen largest weapons exporters in the world; but similar arguments will certainly apply to other European countries such as France. The USA is more complicated. Its arms exports may indeed be the largest in the world, but it has a more flexible economy and a greater tradition of workers changing jobs or even moving geographically when the composition of demand changes. It is difficult to come by reliable figures on Russian weapons exports. The problem here is not necessarily their size, but the fact that the ‘oligarchs’ are more heavily involved than in most other sectors of the Russian economy. The greatest danger of an excessive concentration on arms exports, a reduction of which could lead to an adjustment burden, probably lies in the smaller former Soviet republics. The magnitude of the British economy’s dependence on the weapons business was recently investigated in some detail by a specialist group, including the chief economist of the Ministry of Defence. Its report was published in 2001 by the Centre for Defence Economics of York University [2]. Beforehand, the Ministry of Defence (MoD) was touting the report, which it expected would vindicate official support for British arms sales. Yet, despite a methodology which probably underestimated the subsidy provided by the Export Credits Guarantee Department (ECGD), the group concluded that the economic effects of halving UK arms sales would be negligible. The cost of reducing arms exports, it stated, would be relatively small and largely one-off. According to the York Report, total defence export sales averaged at the end of the last century £6bn per annum in constant 1999 prices, or 2.6 per cent of all exports of goods and services. It also estimated that these had an average import content of 40 per cent. Defence exports also accounted for about 98,000 jobs or less than 0.4 per cent of total employment. For comparison, the study cited the net increase in total nationwide employment in the year 1999 alone as 284,000. The estimated number of engagements (that is, the gross number of people moving into jobs) during 1999 was nearly six million—sixty times defence export jobs. The Report investigated a hypothetical 50 per cent halving of “defence export jobs” as a proxy for a major policy change in this area. A halving of defence exports from recent levels would, it estimated, result in the loss of nearly 49,000 jobs in the defence sector and their replacement over a five year period by around 67,000 new jobs, at somewhat lower wages, in civilian employment. The job loss is much less than the earlier loss of 150,000 jobs in this sector in the period from just before the end of the Cold War in 1985–86 to 1993–94. For comparison, 70,000 jobs were lost in metal manufacturing, and 180,000 in the coal industry between 1985 and 1993. I would add that the skills of coalminers are surely much more industry-specific than those used in weapons manufacture. Moreover, coalminers were surely much more heavily concentrated in specific districts. The Report suggested that the balance of argument about defence exports should “depend mainly on non-economic considerations”. The biggest quantitative difference of opinion was on the extent of government support and subsidies. A report by the Oxford Research Group and Saferworld estimated that there was a net subsidy to defence exports of £420m a year [3]. The York Report, on the other hand, estimated support in a range around £80bn per annum, which it believed was slightly more than offset by items such as the contribution to the overhead costs of British weapons manufacture to provide a net benefit to the economy of around £140m or 0.16 per cent of GDP. 
One bone of contention was the size of the offsetting benefits; but a much bigger difference was in the estimate for ECGD support (see Appendix). The main point, however, is that whether the direct cost of arms support slightly exceeds the benefits or slightly falls short of them, the amount is trivial in relation to a UK GDP of around £1,000bn per annum, and supports the York conclusion that policy should be decided mainly on foreign policy and defence grounds. When it saw how the report was shaping, the MoD ran a mile away from it. In the end it was published as a research paper by the University of York. The government left its response to the Defence Exports Services Organisation — the part of the ministry that exists to sell arms — which cherry picked among the findings to find reasons for continuing arms promotion as usual. For instance, it highlighted the total adjustment costs of around £1bn from the relocation of workers and the loss of shareholder capital in the arms industry. In fact, this sum was the cost spread over five years. As an annual average it amounted to 0.02 per cent of GDP. It is interesting that much of the pressure to support and subsidise British industry overseas comes from the Foreign Office and the Department of Trade and Industry — and does so from similar departments from other Western countries. Yet it is the Treasury which has to take a view of the overall health of the economy which includes growth and employment; and the Treasury is against most of these projects. Indeed, it would have happily closed down the ECGD altogether. Unfortunately, it is all too often overruled in favour of departments that push specific interests. There is only one respectable economic argument for trade intervention. This is to use a country’s limited monopoly power as the sole seller of its own goods to improve the terms of trade on which its goods can exchange for imports. The exports of any one industrial country are now too small a proportion of world trade for this to have much force. In any case, UK arms exports are such a small proportion of total UK exports that the terms of trade effects are tiny. The York Committee was prepared to contemplate adding another £1bn to its five year adjustment cost bill to cover a temporary terms of trade loss due to the possible sterling depreciation and associated terms of trade loss required to replace lost arms exports. But it emphasised so much the “speculative” and “uncertain” nature of this effect that it looked as if it was divided over its existence. There is, however, one other category of exports which has some similarities to arms. This is heavy capital projects, many of them involving schemes of a highly controversial nature and of dubious development value, but which are promoted by construction industries of Western countries. They are illustrated by the Pergau Dam in Malaysia in the mid 1990s when the Conservative Government overturned a publicly minuted reservation by the Permanent Secretary of the Department for Overseas Development and insisted on supporting credits for this dam. Over the last three years well over half of ECGD’s total support has gone to defence exports and Airbus which accounted respectively for 37 per cent and 25 per cent of its guarantees. An additional 18 per cent went to large power projects. 
One of the unstated arguments for going ahead with Pergau was that this would act as a sweetener to persuade the Malaysian government to buy other goods, including arms, from Britain. On the other hand, arms sales are justified because they are supposed to persuade governments that buy them to use British equipment in their capital projects. Thus one bad consequence is called in aid to support another; and Third World despots are encouraged to devote still more resources to military spending or prestige projects of dubious value. The main contention There are some who oppose all arms sales. But this is not a position open to anyone who supports Nato or any successor Western defence organisation. It would be absurd for each member of an alliance to try to make a full range of weapons, simply out of amour propre, when specialisation would pay far better. In fact, the crying need is for more arms specialisation among allied countries rather than less. In 1998–99 the Ministry of Defence spent 13 per cent of its equipment budget on 64 co-operative equipment programmes involving 19 partner nations. The most important of these, by far, were France, Germany, the USA, Italy, and the Netherlands [4]. The Oxford Research Group study, drawing on the work of Keith Hartley the defence economist, looked at a variety of ways in which the UK could maintain its alliances at lower cost. The key was to treat weapons, on the production and import side, like any other industry and to buy arms in the cheapest market. The greatest saving might come from a single European procurement agency. But I would not place too many hopes in this direction in view of the EU’s disarray on foreign and defence policy. The most interesting option discussed by the ORG was simply buying ‘off the shelf’ which it estimated would save nearly £4bn per annum. What I do wish to argue is that, even before tackling the more general wastes of the export drive, we should make a start with overseas arms sales. These should not be subsidised or officially promoted in any way. Even where there are no subsidies, governments should be much stricter in enforcing bans on sales to dubious regimes. It should have been obvious even in the 1980s and in the context of the Iran-Iraq war, that the Saddam Hussein regime came under this category. What I have in mind is a more effective ban on the sale of arms to dubious regimes and an end to subsidies for arms sales to any part of the world. There are strong arguments against export subsidies of any kind; but those for arms and heavy capital projects—which are often related—are a good place to start. Those who accept my thesis do not have to agree on which regimes are the most dubious. There is a pretty clear basic list of regimes that commit aggression, support terrorism or oppress large bodies of their own citizens; we can argue about how far the list should extend. Subsidised credit for exports of arms or major capital goods have far worse effects than just the economic ones. Western nations are undoubtedly rich enough to waste some resources. As Adam Smith said, “There is an awful lot of ruin in a nation”. We cannot leave out of account the enormous part that bribery plays in this trade. A forthcoming study by Joe Roeber concludes that: “Because of the structure, complexity and capacity of the market, and above all, because of the secrecy that surrounds every aspect of its activities, the international arms trade is the most corrupt of all legal trades”. He finally asks: “Can we justify bribing people to buy arms they may not need with money their taxpayers cannot afford, simply to inflate the number of jobs in a declining industry?” Financial issues apart, there is surely something demeaning in using members of the Royal Family and Cabinet Ministers to tout for arms sales abroad. In April 2002, Tony Blair squeezed in a lightning trip to Prague between a visit to the US to see President Bush in Texas and the Queen Mother’s funeral. Its ostensible purpose was to discuss EU enlargement; but Downing Street made no attempt to deny that it was also concerned with the sale of 24 JAS-39 fighter planes made by a British-Swedish consortium, including BAE Systems. Unfortunately the public controversy, as in previous cases, concentrated on the nature of the links of the company with the Labour Party rather than on the principle of the Prime Minister making such sales tours. Indeed his spokesman emphasised, Thatcher style, that he made “no apology for promoting Britain and British business”. All these follies are supported by the myth that exports are valuable for their own sake, however small the return the British nation gets from them. Business lobbyists are able to persuade a succession of Prime Ministers, ranging from ultra-dry Conservatives to New Labour, that if the Government does not support them, their overseas rivals will win the contracts instead. We should follow the example of General de Gaulle. When he was told that if the French left Algeria the Russians would take their place, he replied, “I wish them much joy of it”. The same applies to UK or other governments that want to throw away their national resources on projects which not only do not pay domestically, but which are detrimental to genuine Third World development. The UK record The recent UK record is not all bad. In July 1997 the then new British Foreign Secretary Robin Cook stated that the Labour Government would “not permit the sale of arms to regimes that might use them for internal repression”. It is the least he could have said after the Arms for Iraq scandal. The government has fulfilled a 1997 election pledge to publish annual reports on the UK’s strategic export controls. These have gradually improved in quality; and the third one issued in July 2000 was described by Saferworld as “the most transparent report published by any European country and one which offers a potential template for best practice throughout the EU” [5]. But even this latest report was criticised for failure to provide information on ultimate end users, the absence of summary information on licences refused, and lack of detailed information on actual deliveries, as distinct from licences. The Blair Government inherited various international obligations such as membership of the ‘Australia Group’ of 30 countries aiming to discourage the proliferation of chemical and biological weapons. An international convention was reached in December 1997 banning the production and transfer of anti-personnel mines. This came too early to be attributed to the Labour Government elected in the same year. But the new Government indeed took a lead in pressing for a European Union Code of Conduct on Arms Exports which was agreed in June 1998. The Chancellor of the Exchequer, Gordon Brown, began the millennium by adding 22 new poor countries over and above the previous 41 covered by the ban on export credits “for unproductive expenditure”. Indonesia, however, remained off the banned list. And because the Chancellor’s action was in the context of debt relief for poor countries, it did not affect Saudi Arabia, which last year accounted for close on 31 per cent of all ECGD’s business. It is thus fair to say that there is still a long way to go. Amnesty International’s view has been that the Department of Trade and Industry “is not meeting its responsibility to promote trade in a manner which is not harmful to human rights” [6]. It was also worried that this same department is responsible both for the licensing of arms sales and for their promotion. A joint report of four House of Commons committees reiterated that a serious error of judgment was made in late 1998 and early 1999 in granting several open export licences for military equipment to the government of Zimbabwe, despite that government’s heavy involvement in the fighting in the Congo and its domestic infringements of human rights. The same report urged considering a stricter interpretation of the arms embargo on China and also raised issues about licences for arms to other countries [7]. At the height of the East Timor crisis in early 1999 there appeared a telling Times cartoon. On one side of the cartoon a buoyant Tony Blair was shown exclaiming: “We need a hawk” — meaning a more determined military effort to put pressure on the Government of Indonesia. On the other side he was shown piloting one of the Hawk aircraft that the UK had been delivering to Indonesia for many years for the use of the country’s former military dictator, General Suharto. Perhaps the worst example is that of the visits by Tony Blair and his foreign secretary Jack Straw to India both to discuss the Kashmir crisis and to try to clinch a $1bn Hawk deal that had been in negotiation for some years. The British government was obviously worried that India was also looking at Russian and Czech alternatives. Once again government spokesmen made “no apologies for lobbying in support of the British defence industry”, even though critics argued that the official sales pitch was at odds with Tony Blair’s plea to his counterpart Atal Behari Vajpayee to reduce tension with Pakistan. India, large though it may be, is still a poor developing nation and there is no evidence that the UK Department for International Development (DFID) was allowed to decide whether the purchase of military hardware was a priority for Indian development. Al Yamamah There is a further category which is not overtly a subsidy, but is certainly a special arrangement. This is the very obscure Al Yamamah deal with Saudi Arabia under which weapons were bartered for oil. Full details have never been published, but a great deal of information has been collected in The Arabian Connection, published by the Campaign Against the Arms Trade, which is a useful source even for those who might not agree with all the objectives of the Campaign [8]. The first Yamamah deal was negotiated in the middle to late 1980s and had its origin in the reluctance of the US Congress to sanction weapons exports to Saudi Arabia. American policies have fluctuated since then; but a second Yamamah agreement was negotiated in the late 1980s; and despite many difficulties it became operational in the early 1990s. Its biggest “achievement” was to produce a market for the Tornado aircraft, which was said at one time to have “saved” 19,000 jobs; and some would say that it saved BA Systems itself. The Blair government shows no sign of wanting to banish this kind of agreement, despite the distortions that the heavy investment in arms is producing in Saudi Arabia, the horrific human rights record of the regime there, and the basic instability of that regime. As for the argument about oil supplies, I have never seen why the US, Britain and France cannot— like other Western countries—buy their oil on the international market, remembering that Middle Eastern countries often need to sell the oil even more urgently than we need to buy it. Small arms The problem, however, is not confined to officially supported exports of high technology equipment such as aircraft and missiles. It is most often small arms that have been used for domestic repression in the last decade—the vast majority of the victims civilians and most of them killed by small arms. Clare Short’s 2000 White Paper on International Development stated: “Of the 40 poorest countries in the world, 24 are either in the midst of armed conflict or have only recently emerged from it. This problem is particularly acute in Africa … An estimated five million people have died” [9]. Sophisticated defenders of arms sales agree that there is a case for banning exports of small arms altogether except to the armed forces of Western democratic states. For instance, Philip Towle argues that “the profits Britain makes from this trade are very small” despite the benefits to some specialised manufacturers [10]. The Scott Report of 1996 advocated legislation to put control on arms exports and arms brokering on a permanent non-emergency basis. The Labour government has now introduced such legislation which will introduce a licensing requirement for trafficking and brokering in arms between overseas countries. The legislation is undoubtedly a step forward. But there might still be loopholes if companies operate through overseas subsidiaries outside the control regime. Moreover, the government is still inhibited by two factors: its reluctance to move too far ahead of competitor countries, and its belief that small arms can legitimately be sent to official governments as distinct from so called rebels. Finally, I come to a question that I am often asked by friends in government circles. What additional measures would you like to see taken? Those who know more about the details of the arms trade than I do are best placed to advise on the specifics. But let me all the same end with a few suggestions.
References
ECGD Subsidies Paul Ingram, Oxford Research Group In the words of the Export Credits Guarantee Department (ECGD) website, “Our role is to help UK manufacturers and investors trade overseas by providing them with insurance and/or backing for finance to protect against non-payment”. Note that their mission is explicitly to help the exporters and investors, not the UK economy. They do this in several ways:
It is this that is at the root of the debate raging at present between ourselves (Oxford Research Group) and ECGD on how to account for the subsidies involved in the government’s support for ECGD. The different approaches can be summarised as follows: The ECGD approach depends upon the concept of a lump of ‘capital required’ to back up the day-to-day operations of ECGD. This is often called the value-at-risk portfolio method. A notional rate of return to account for the cost of providing the necessary capital to back up the guarantees is added to the normal expenditure account. The problem with this method is choosing the appropriate rate of return (ECGD understandably underestimates this at 6%, when, for example, other government agencies may be required to return up to 13% of capital invested), and identifying an appropriate value for the capital. It also does not account for what is called ‘catastrophic risk’, that is to say, the eventuality of many multiple defaults, perhaps caused by a general meltdown of the international economy in a region. Catastrophic risk is exactly the sort of circumstance ECGD is designed to protect against, yet their methods of subsidy calculation take no account of this scenario. Our approach seeks to measure the premium rates that the market would charge and compare them to those charged by ECGD. This is a simple conceptual approach. As may be expected, there are several possible market mechanisms for taking on risk. In the case of arms exports, the customer is a recipient government, and governments issue bonds. Rates of return demanded by the market in the purchase of government bonds consist of two factors, the interest rate and the extra premium charged to account for the extra risk because of the particular government raising the finance. Comparing the bond rates with the dollar bond rate offered by the US government (deemed to be virtually risk-free) will determine the rate. Alternative market mechanisms may include options and credit derivative markets (where risks are traded explicitly). When such international finance mechanisms exist, questions are increasingly asked as to why the government is involved at all in distorting the market in the interests of a small number of arms exporters. Paul Ingram is senior analyst at Oxford Research Group and at the British American Security Information Council. He is co-author, with Ian Davis, of The Subsidy Trap: British Government Financial Support for Arms Exports and the Defence Industry (2001).
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