Washington is divided into two separate hemispheres: defense and economics; both will gain if they can work together

Coordination could improve policy outcomes in both domains

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We think of economic policy and defense policy as separate issues. One of the most common refrains heard by White House economists is, “Don’t worry about the economics of that, it’s national security.” But, in great power competition, economics is national security. Battles will be won or lost by how well we maximize our economic capacity and how quickly we can bring that production to bear. China knows this and Russia just appointed an economist as its defense minister. But the United States still fails to wield a unified strategy for defense and economics.

Economics is not a separate portfolio preempted by national security. Economics is a lens through which we evaluate and optimize decisions that require dividing scarce resources that may grow over time. These are particularly pressing questions for the Defense Department (DOD). Both the Treasury and DOD are responsible for the security of the United States. But each pretends that they can stay in their lane and succeed: they cannot. Economic policy and security are not independent, they are interdependent.¹ Failing to recognize this linkage often results in counterproductive policy effects.

Due to its size, DOD’s budget and the overall fiscal position of the federal government are inextricably linked

While the United States’ post-COVID economic recovery has been robust, the U.S. government’s fiscal policy related to its debt remains a significant threat to economic stability. This summer the International Monetary Fund (IMF) warned that high American deficits “create a growing risk to the U.S. and global economy”. Barring an ultra-low interest rate (assuming inflation can be contained) or a large productivity shock, the government will need to lower spending and raise revenues.

The DOD is the largest portion of the U.S. discretionary budget. In the 1990s, when the US last achieved a budget surplus, it did so in part by cutting the defense budget after the collapse of the Soviet Union. But today the world is getting more dangerous, likely requiring increased military expenditure rather than decreased.² The DOD’s budget for FY25 could increase to nearly $1 Trillion and DOD’s actual FY25 costs are likely to increase more than Treasury expects. 

The risk affects both US economic policy and national security. Cost overruns in defense procurement have become both large and increasingly common. Last month, Congress hauled in Navy leadership to account for its multi-billion dollar per-submarine cost overruns.³ In fact, the DOD’s estimates of cost overruns are often significantly less than what nonpartisan research services like the Congressional Budget Office (CBO) and Congressional Research Service (CRS) calculate. Nevertheless, because the security risks are so great, the government will have to cover most of the unexpected costs for defense procurement.⁴ This limits Treasury’s flexibility to responsibly manage the government’s finances when political brinkmanship forces Treasury ever closer to the debt ceiling.

Similarly, the government’s decreasing fiscal headroom is pressuring the DOD. Rising government debt makes borrowing more costly. Known cost overruns are already forcing difficult tradeoffs within DOD on what programs to fund and what technologies to cut. Additionally, many of these major weapon systems are sold to allies to help bring down the cost curve.⁵ But if overruns continue to grow, those allies may not be able to afford the purchase, threatening both the economics of the programs and the larger security partnership.

Treasury has economic tools for pursuing national security objectives, but without coordination, its efforts can be undermined by the local economic impact of DOD operations abroad

Due to differences in purchasing power and the Defense Department’s vast operational spending, even routine DOD expenditures can overshadow US economic policies and strategic priorities abroad. In practice, because defense spending is neither coordinated with nor accounts for local economic programs, the two often unintentionally undermine each other. This has repeatedly led to inconsistent results, obstructing long-term development and diplomatic objectives.

As an example, during the War in Afghanistan, the Treasury’s Terrorism and Illicit Finance division was a primary stakeholder in economically fighting the Taliban, Al-Qaeda, ISIS, and other malign actors. However, it was the DOD’s operations, which focused on tactical decision-making and not economic policy, that dominated the economics in the region, rendering Treasury’s actions ineffective.

The US overseas contingency operations (OCO) funding during the Afghan War far exceeded Afghanistan’s economy. The economic effects of provisioning a sophisticated military in a landlocked country were not always aligned with the broader strategic macroeconomic plan.⁶ When DOD operations inject multiples of a host country’s GDP into the local economy, the operation becomes the local economy.

Treasury had the analytical capacity and focus on the strategic economic impacts. But when DOD and Treasury were not aligned, DOD’s weight swamped the long-run economic efforts.

Afghanistan was a complicated mission, and this memo is not calling into question the decisions made there. For instance, the DOD entirely funded the Afghan military and, indirectly, paid adversaries to ensure Americans were not attacked and supplies were unmolested (both important). But DOD failed to understand or address the free rider problem. The large sums transferred caused some funding to end up with the Taliban while sowing unprecedented corruption throughout the Afghan government. DOD prioritized its tactical goals over strategic recognition of its dominant economic position and the net effects that had on US objectives.

Today, this phenomenon is playing out in the South China Sea. The US is expanding its presence in island nations from Palau to Singapore. But any US military presence is a tsunami of cash to a small island. DOD fundamentally changes the local market and incentives, even on islands within a larger economy like the Philippines.

China leverages its economic initiatives by building casinos in Saipan, financing high-capacity fishing refineries in Papua New Guinea, and boycotting local exports in the Philippines and Taiwan. China uses geoeconomic coercion as its primary tactic to achieve political and national security goals. When the Philippines challenged China’s expansive claims on Scarborough Shoal in 2012, China stopped buying the country’s banana exports, wiping out the industry and local economies. This year, the Philippines invited the DOD to move significant US forces onto bases across the Luzon Strait from Taiwan. Treasury doesn’t buy many bananas, but it is engaged with the Philippines through its Pacific Banking Forum. It should interface with DOD so they can jointly optimize contracts, procurement, and basing such that the US strategic efforts are maximized.

Treasury and DOD need to work together to achieve strategic success

Nowhere is this partnership more important than in countering Russia’s invasion of Ukraine. DOD is not preparing for Ukraine’s economic recovery. The US security apparatus argues that any economic recovery needs basic security guarantees as a precondition. Therefore, as long as hostilities are ongoing, the US can’t know what the security picture will look like so effort should be focused on security. Similarly, Treasury is bogged down in making sure Ukraine’s daily balance of payments clear.

Both Treasury and DOD’s current efforts are critically important and they are doing them well. But they miss an important truth: there is nothing the United States can do to move Ukraine away from Russia’s border. So, Russia will remain a military threat. The best strategy for Ukraine’s long-run security is to help it achieve an economic growth rate that can outpace Russia’s allowing Ukraine to bring more equipment and technology to bear faster than Russia can in a future fight. Much of the US national security apparatus incorrectly assumes that if the western world transfers roughly $500 billion to Ukraine, then recovery will be achieved and economic recovery planning will follow.⁷ The IMF’s economic model is more nuanced taking high, medium, or low values of possible capital and labor flows into Ukraine as parameters and then estimates how Ukraine’s economy can recover. But no US government agency or multinational is developing a strategy to achieve a high population return and private capital infusion rate that will get Ukraine to a better economic and secure future.⁸ This is even more difficult than it seems. 

Even prior to Russia’s most recent invasion, Ukraine was in long-term population and economic decline.

Treasury and DOD need to be working together now to form a NATO and EU economic recovery strategy so that labor and private capital can immediately flow to Ukraine when hostilities… pause.

Defense and Economics: two halves of the same walnut

Most people think of NATO as a first-principles organization, growing purely out of the need to defend against the Soviet Union. We forget NATO was a necessary component of the European Recovery Program enacted into law a year earlier in 1948. The European Recovery Program– better known today as the Marshall Plan – started to stabilize Western Europe’s economies but it became clear the countries needed more confidence in their external security before they would specialize and trade with each other. NATO was formed to underwrite the security for the Marshall Plan. Together America’s economic policy and defense strategy, which President Truman called, “two halves of the same walnut,” succeeded in achieving long-term European security and prosperity. Today more than ever, US national security policy and, in particular, the initiatives of the Treasury and Defense Departments need to be coordinated to achieve our strategic goals.

1. The CHIPS Act is another example where US agencies responsible for economic policy (the Commerce Department is the program lead) are intertwined with defense and national security.

2. The large increase in China’s nuclear forces is further destabilizing the bipolar nuclear balance that existed between the United States and Russia. To prevent a cycle of proliferation, the United States has to reassure its allies that it has enough missiles, submarines, and warheads to extend its nuclear umbrella over all of them. The United States will have to dramatically increase its defense spending to modernize and grow its nuclear forces. This is on top of existing military requirements, adding to the government's fiscal pressure.

3. Submarines aren’t the only area of cost overrun, just an example. Another is for U.S. Coast Guard (USCG) Icebreakers. While the USCG is not part of DOD, the DOD has taken over the procurement for its Icebreaker program. In 2021 the fixed cost for the lead ship was estimated to cost $1.2 billion in total. As of summer 2024, the government has spent over $1.7 billion on only 40% of technical design completion and zero construction has begun.

4. Last year, the next-generation ballistic missile submarine, the Columbia class, saw its expected costs increase by $20 billion. This year that program cost has further ballooned and the lead boat will be at least $17.5 billion and at least 12-16 months delayed, further increasing maintenance costs and pressure on the aging Ohio ballistic submarines that will have to stay on patrol longer until relieved.

5. Australia for example has agreed to purchase 3-5 American submarines as a part of the strategic AUKUS treaty and the cost overruns are a major risk to the security pact.

6. The FY2018 State Department budget just to secure the embassy was $713 million, in a less than $20 billion national economy.

7. The US Government is using the World Bank’s estimate of the cost of damage and reconstruction of $486 billion over 10 years. But US government agencies fail to recognize the nuance of this estimate, it includes lost opportunity costs from the invasion and estimates for low-carbon and climate resilient improvements on equal footing with primary concerns like unexploded ordnance removal. Furthermore, transferring over 2 times Ukraine’s GDP, without creating the local economic absorptive capacity to use those funds will only inflame corruption.

8. Population flight is particularly important because it can depress future investment demand as well as curtailing effective use of aid earmarked for recovery. Analyses of Puerto Rico following Hurricane Maria in 2017 are consistent with this point. Only about 20% of US Government earmarked recovery funds were able to be distributed to the local economy because its lasting population loss sapped its absorptive capacity. Total external investment in Puerto Rico follows a similar trajectory to its total population, rather than outpacing it following recovery from the disaster. (Becker, Devine, Lam, Schultze, and Spectorov 2024).