Lessons from the 1930s: Rearm according to the threat, not the fiscal rules

Six months before resigning as First Lord of the Admiralty, in protest at the Munich Agreement, Alfred Duff Cooper penned a Cabinet memo whose essence remains true today. 

‘The first duty of a government’, he wrote ‘is to ensure adequate defences of the country. What these adequate defences are is certainly more easily ascertainable than the country’s financial resources.’ Fiscal penury brings severe embarrassment, he continued, but catastrophic defeat in war is existential.

With the Conservative pledge to set defence spending at 2.5% of gross domestic product (GDP) by 2030, and Labour’s ambition to achieve this ‘when resources allow’, the political debate on the Council on Geostrategy’s Defence Pledge, which this author supports, is clearly live.

But it remains dogged by a fascination with percentages, and with fiscal rules that – as Cooper reminds us – can only apply conditionally under the threat of war.

As the United Kingdom (UK) approaches its next general election, and a likely Strategic Defence and Security Review thereafter, there is much to learn from the way rearmament was handled in the 1930s.

Between 1933 and 1938 the UK’s Defence budget grew from 2.2% to 6.9% of GDP. The aim was to boost the capabilities of the armed forces – primarily the Royal Air Force (RAF) – to a level where they could deter an attack by Germany. But the process was fraught with tensions – between the three armed services, and between the Treasury and the rest of government.

There are obvious limits to any parallels that can be drawn. Today, Britons are reliant on a combination of our nuclear deterrent, the NATO alliance and what remains of the open international order for our security. Our economy forms part of a globalised finance system and supply system, not a trade-protected Empire; and as revisionist historians remind us, the UK defence industry in the 1930s was actually formidable, despite a decade of disarmament.

Above all, today’s public sector is much bigger than it was on the eve of rearmament. In 1933, UK government spending stood at 26.8% of GDP. Today, public spending accounts for 45% of GDP.

Nevertheless, the institutional tensions and geographic dilemmas of the 1930s look familiar. In Spring 1934, following the departure of Japan and Germany from the League of Nations, the Defence Requirements Committee (DRC) – a newly formed sub-committee of the Committee of Imperial Defence – made an important grand-strategic determination: to focus on the German threat and to appease both Japan and Italy. 

It resolved to deter Germany by building an air force large enough to prevent mass bombing attacks on Britain and with the capability to respond in kind. It refused the Royal Navy’s request for a shipbuilding programme that would allow it to fight both Germany and Japan simultaneously (the Two Power Standard); and it blocked a request to build a four-division Field Army capable of fighting in Europe. Though the Cabinet reduced the size of the DRC’s initial programme, it maintained its overall intent.

The tension between the geopolitical and fiscal imperatives then unfolded in four phases. First, between 1933 and 1935, defence spending grew from £108 million to £137 million, financed by a reduction in the primary surplus. This programme was framed around ‘deficiencies’ – capability gaps in modern parlance. 

Second, in 1935, the Stanley Baldwin government announced a formal rearmament programme, financed by debt. It scheduled a five-year spending programme costing £400 million above baseline, to be financed by a National Defence Loan. From then onwards, fearing fiscal instability, the Treasury placed strict limits on the pace of rearmament, a stance known as ‘rationing’. 

Then, in 1937, Neville Chamberlain replaced Baldwin as the prime minister and adopted a proactive policy of outright appeasement. 

Finally, after Germany’s Anschluss with Austria in March 1938, fiscal restraint broke down. The final budget of the pre-war era allocated £2 billion to defence over the next five years, to pay for an expanded navy, a continental army, and conscription. At the same time the government took powers to compel peace-time factories to convert to war production.

Spending during the rearmament phase was, of course, then dwarfed by wartime military spending, which mushroomed to 50% of GDP by 1942 (see Chart 1).

One of the most striking features of this chart is the impossibility of repeating such resource reallocation under modern conditions. It would be impossible for defence to rise to 50% of GDP without squeezing either the civilian private sector or the welfare state out of existence. ‘Total war’, in a 21st century context, would be a disaster for any democratic state that attempted it. Which is why spending wisely on deterrence, in advance, is vital.

In the 1930s, the fiscal tensions were accompanied by three execution challenges:

1. Firms initially proved unwilling to reallocate capital, production plants and labour to war production. An acute shortage of workers was exacerbated by social norms which opposed the ‘dilution’ of the skilled labour force.
2. The rapid pace of innovation meant the armed forces were buying equipment that would become outmoded in wartime: of 406 fighter aircraft available to the RAF on 1st October 1938, 238 were obsolete or obsolescent.
3. The reward model for companies involved in defence production – a guaranteed 10% profit rate – encouraged profiteering, requiring a reduction of the rate to 7.5% and the attempt to impose a windfall tax (which was abandoned due to corporate opposition). 

None of these challenges were properly overcome during the pre-war period: lacking the will to direct the private sector, the government resorted to incentives rather than compulsion, both for capital and labour.

Strategically, the deterrence policy failed: Germany was not deterred from declaring war on Britain by the defensive power of the RAF or its long-range bombing capability. The refusal to form an army capable of operating in Europe until late 1938 contributed to the disaster at Dunkirk. 

Operationally, however, the investment in air power paid off: in 1940, during the Battle of Britain, the RAF maintained air superiority over the UK and prevented Germany’s planned invasion. So did the programme of industrial mobilisation. 

Despite its dissimilarity to today’s landscape, the stylised political dynamics of the rearmament in the 1930s can be summarised as follows:

• As the threat intensified, strategic geopolitical decisions were taken centrally, overriding the demands of individual services and implicit fiscal rules.
• Force priority and procurement decisions were filtered both through fiscal constraints (the Treasury’s fear of fiscal instability) and resource bottlenecks (capital, labour and technology).
• Though the Treasury’s rationing system was perceived as negative, some historians believe it enforced realism and sustainability on the programme.
• As the armed forces grew, competition for skills intensified between the services, the civil sector and the defence industry.
• As the threat of war intensified, the state’s willingness to override fiscal concerns and to direct the economy increased, becoming decisive in 1938-9.

Today, as in the 1930s, the fear that rearmament could lead to fiscal stress is legitimate. The Treasury’s initial bond issue for rearmament was under-subscribed, and had to be backstopped by the Bank of England. Nevertheless, Britain is today spending at 1933 levels on defence while arguably facing a threat level closer to that of 1937-1938. 

The most important lesson is that the forces must be designed to deter a specific threat, alongside specific allies – not for some abstract future war – mandating hard choices in a resource-constrained economy. And once the decision for rearmament is made, the tension between geopolitical and fiscal imperatives needs to be managed at Cabinet level.

Today, neither of these lessons are being followed. For unexplained reasons, the administration of David Cameron classified the Defence Planning Assumptions. As a result, there is no formal means for Parliament to hold government accountable for matching threats and capabilities. 

The Defence Select Committee has demanded a return to ‘meaningfully detailed’ annual reports on the warfighting readiness of the armed forces, and this author agrees. The next government should supply the Defence Select Committee with a declassified annual summary of the Defence Planning Assumptions, and an assessment of current capabilities against the 25 Defence Tasks.

More than two years into Russia’s war against Ukraine, no institution like the DRC has been created. Only the Cabinet Office National Security Secretariat, informed by the Joint Intelligence Committee, could have made a strategic determination comparable to the 1934 ‘decision for deterrence’ – which elevated defence considerations higher than the fiscal rules. But on the evidence of Rishi Sunak’s ‘2.5% by 2030’ pledge, it has not yet done so.

The experience of the 1930s shows the need for a single guiding intelligence at the interface between geopolitics and fiscal policy, which needs to be at Cabinet level and to include His Majesty’s (HM) Treasury. Its job should be to calibrate the fiscal and strategic risks holistically, with an understanding that – in the final balance – the latter have to outweigh the former.

Now, as in the 1930s, there are legitimate differences of opinion over how any defence budget uplift should be spent. Logically, the answers flow from a threat assessment; a net analysis of our allies’ capabilities, and of their willingness to use them; and from the deterrent concept agreed upon by NATO. The UK force design for a ‘deterrence by punishment’ concept would, for example, be significantly different to that needed for ‘deterrence by denial’.

To resolve these issues, the next government should create a body similar to the DRC, consisting of senior representatives of the Ministry of Defense (MoD), Foreign, Commonwealth and Development Office, Cabinet Office and HM Treasury. Its remit should be much tighter than that of the current National Security Council and its various sub-committees: it should be to make a strategic determination about defence spending and calibrate its costs and benefits.

With both Labour and the Conservatives now resolved to raise the status of the MoD’s military-strategic headquarters function, such an endeavour would not lack the capacity to execute.

Though policymakers today seem paralysed over the difference between spending 2.37% and 2.5% of GDP on defence, it is likely we will have to spend between 3% and 4% in short order, funded as in the 1930s substantially from borrowing.

But we need to move away from percentages. The most important lesson from the 1930s is the one Cooper spelled out: faced with an existential threat, it is more advisable to begin from a calculation of what is needed, not what can be afforded according to peacetime fiscal norms.

Paul Mason is Aneurin Bevan Associate Fellow in Defence and Resilience at the Council on Geostrategy. He is a journalist, author and political researcher and was economics editor at BBC Newsnight and Channel 4 News and now writes for The New European, Frankfurter Rundschau and Social Europe.