Japan’s defence minister has told the BBC that the country’s military build-up is ‘critical’ to prevent war, a sentiment that echoes the UK’s own security posture. For a nation that has long relied on the US security umbrella and Article 9 of its pacifist constitution, this marks a profound shift. But as a financial editor who has spent two decades watching governments throw money at problems, I cannot help but ask: who is going to pay for this, and what will it cost the markets?
Let us start with the numbers. Japan’s defence budget is set to double to around 2% of GDP by 2027, a figure that sounds modest by NATO standards but represents a colossal increase in absolute terms. The government plans to fund this through a mix of tax hikes and bond issuance. But here is the rub: Japan’s debt-to-GDP ratio is already over 250%, the highest in the developed world. Any additional borrowing risks unsettling bond markets that have so far been placated by the Bank of Japan’s yield curve control. However, with inflation finally stirring in Japan, that policy is looking increasingly unsustainable. A spike in Japanese government bond yields would not only raise the cost of borrowing for Tokyo but could also trigger capital flight as investors seek higher returns elsewhere.
The defence minister’s comments come as the UK also ramps up military spending. Prime Minister Sunak has pledged to increase the defence budget to 2.5% of GDP by 2030. In both cases, the justification is the same: the threat from an assertive China and a revanchist Russia. But markets are deeply sceptical. The gilt market has already punished the UK for its fiscal profligacy; the Truss mini-budget disaster is a vivid memory. Japan, too, faces a reckoning. If the BoJ abandons yield curve control, the resulting rise in long-term rates could crush the government’s finances.
There is also the question of opportunity cost. Every yen or pound spent on defence is not spent on infrastructure, education, or healthcare. In an ageing society like Japan, that trade-off is particularly painful. The country’s population is shrinking, and its economy has been stuck in low-growth mode for decades. Throwing money at the military may boost the arms industry in the short term, but it does nothing to address the structural problems that have left Japan with a stagnant economy. The same applies to the UK, where productivity growth has been abysmal since the financial crisis.
One might argue that defence spending is a form of public investment that generates positive externalities: technological innovation, high-skilled jobs, and national security. That may be true, but it is a stretch. The history of military expenditure is littered with sunk costs and boondoggles. The F-35 programme is a prime example: a wonder of engineering that has become a fiscal black hole, with costs spiralling to over $1.7 trillion.
So what should investors make of all this? The immediate impact is likely to be higher bond yields in both Japan and the UK, as markets price in greater supply. That could feed into higher mortgage rates and lower consumer spending, further dampening economic growth. Over the longer term, both countries risk a debt spiral if they cannot boost productivity to service the debt. The only way out is through structural reforms that make their economies more dynamic. But that requires political courage, which is in short supply.
In the meantime, the mantra from Tokyo and London is that defence spending is an investment in peace. Perhaps it is. But in financial terms, it looks like a leveraged bet on a future that remains highly uncertain. As always, the market will have the final say.
