Is your portfolio locked and loaded for the next arms race?

In the September edition of the MI magazine I’m going to be analysing why military expenditure is going to rise in a multi-polar world. This will be good news for defence contractors. The world is a much more dangerous place than we thought it would be when the Cold War ended in the early 1990s – for a variety of reasons.

Remember the Chinese motto (or curse, depending on your point of view): May you live in interesting times. There are a number of potential flashpoints that could explode in our “interesting” age – one which is characterised by the return of great power rivalry and the rise of regional powers. But I am relatively optimistic: we are much more likely to be hacked than to be blown to smithereens.

Sorry, Professor Fukuyama – The “end of history” has been postponed

When the Soviet Union was quietly dissolved on Christmas Day 1991 it seemed that the Cold War was over for ever and that “the West” – particularly the USA – had won.

In its place there came a New World Order in which the USA strode the globe as sole superpower – indeed a hyper-power – able to impose its will as it thought fit through a massive military apparatus (as it did in Iraq in 2003). This reflected not just economic and military dominance but ideological pre-eminence. It seemed that liberal democracy, as exemplified by the American model and its European paradigms, would triumph for good.


America acquired the mechanisms of democracy – representative institutions, the separation of powers, an independent judiciary, the rule of law, checks and balances etc. – from Europe (and predominantly from Britain), as embodied by the ideas of Adam Smith, Thomas Paine, Montesquieu, JS Mill and so many others. But it was America which then exported those values and principles back to Europe in the aftermath of World War II, creating out of the smouldering ruins of Nazi Germany a viable and dynamic democratic state (if only half a state). From 1988 to 1991 the eastern European countries which had been under de facto Soviet control one by one broke free from Soviet tutelage and looked west.

The seeming inevitability of the triumph of American liberal democracy was articulated most succinctly by Professor Francis Fukuyama in his seminal book The End of History and the Last Man (1992). It is difficult to overstate the influence of this book on the mindset of the time. Fukuyama argued that the culmination of Western liberal democracy signalled the endpoint of humanity’s sociocultural evolution and the final form of human governance. He wrote:

What we may be witnessing is not just the end of the Cold War, or the passing of a particular period of post-war history, but the end of history as such: that is, the end point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.

There are a number of potential flashpoints that could explode.

Hegelian developmental philosophy (thesis, antithesis, synthesis) had run its course and with it, so had Marxism. With communism dead and discredited, it could confidently be asserted for the first time in 150 years that Marx’s prediction that communism would inevitably displace capitalism through the emergence of “scientific socialism” was the wrong way round. It was capitalism that was going to replace socialism across the globe. And America, leading the procession, would be its cheer leader.

What’s more, because most liberals believe that there has never been a war between democracies, it was assumed that the End of History would be the gateway to everlasting peace.

Things did not turn out as expected…

China held onto the apparatus of the totalitarian communist state yet managed completely to reform its economy on market principles. In so doing, it unleased a furious dynamo of economic development. Not since the early phase of the industrial revolution in Britain in the early 19th century did a nation transform itself so rapidly.

Now fast-forward more than 25 years after the fall of the Soviet Union. China did not become a liberal democracy – despite a brief moment in 1989 (the build-up to the Tiananmen Square massacre) when it looked possible that political reform might come. Nor did the Russian bear become a cuddly bear – despite a few years in the early presidency of Boris Yeltsin when Russians could do and say more or less what they liked.


Instead of becoming chummy democratic partners to the American hegemon, these two ancient powers emerged as assertive revisionist states determined to challenge this New World Order which they regarded as entirely designed to perpetuate America’s inherited advantages.

Liberal democracy did not sweep the world. Rather, the more recent trend has been one of authoritarian nationalism as exemplified by Mr Putin in Russia, Mr Erdoğan in Turkey and even, in the opinion of some, Mr Modi in India. The rise of a more puritanical interpretation of Islam, encouraged and financed by Saudi Arabia, Qatar and others, has also mitigated the advance of liberalism. Turkey is undoubtedly a less free and liberal country than it was 25 years ago.

The fault lines

So, everlasting peace, like the end of history, eluded us.

In my magazine article I will analyse exactly where the real geopolitical fault lines lie. They are: America versus Russia; Russia versus Europe; America versus China; America versus North Korea (!); India versus China; Saudi Arabia versus Iran (and Qatar); and Rest of World versus Islamic fundamentalism. Each clash has its own dynamic and its own exigencies: but I shall show that the same twenty to thirty corporations – the defence contractors – are necessarily implicated in all of these potential flashpoints.

America versus China

If Mr Trump believes that the current trade dispensation is inimical to America’s interest the Chinese can point out that it was in fact America which created the contemporary architecture of world trade – in its own interests. In the aftermath of World War II America was the prime mover in the creation of the General Agreement on Tariffs and Trade (GATT) in 1947 which formed the superstructure of the World Trade Organisation (WTO) when it was set up in 1994. Note that date: it marked the apogee of the sole American superpower after the collapse of the Soviet Union. Russia was not even allowed to join the WTO until it exhibited compliant behaviour. China itself only became a member of the WTO in December 2001, further to protracted negotiations.

For the Americans it is about restoring a level playing field; but for America’s adversaries it is about preserving America’s privileges which are ultimately guaranteed by American military power.

Of course, many of the stricken countries of 1947 to which America gave a helping hand, Germany amongst them, are now selling more to America than America sells to them. But thanks to American diplomacy, the US has a get-out clause. If imports threaten national security then the importing country can impose tariffs on the imported products. Section 232 of the Trade Expansion Act (1962) empowers the president to make that call. In June, President Trump asked Commerce Secretary Wilbur Ross to advise whether Chinese steel imports represent a threat under Section 232.

That is really what Make America Great Again is all about. For the Americans it is about restoring a level playing field; but for America’s adversaries it is about preserving America’s privileges which are ultimately guaranteed by American military power.

India versus China

It is intriguing that the recent revelation that India’s population has overtaken China’s comes at almost the precise moment that India has overtaken China in its growth dynamic. China’s growth trajectory has fallen to (a still extraordinary) six percent per year, while India’s has accelerated towards eight percent. Let me give you five reasons why the super-confident Chinese Mister Toad is increasingly spying the Indian horse in his rear-view mirror.

Firstly, India is inherently politically stable. There has never been a Tiananmen moment in India’s post-colonial history.

Second, little by little, India is conquering the affliction of poverty – not fast enough, I admit. But it has at last put in place some vestiges of social security in tandem with an advanced system of biometric ID cards. The elimination of poverty will boost consumer spending and thus economic growth.


Third, tax reform is at last underway. From July there has been a single nationwide tax on goods and services, thus eliminating tiresome paperwork related to inter-state commerce.

Fourth, India is rapidly rolling out a high-speed internet connection for literally hundreds of millions of mobile phone users. Vodafone has recently merged its Indian operation with Idea Cellular (BOM:532822) thus creating the world’s largest telecommunications company with 400 million subscribers.

Fifth, as more cash is invested in the banking system, so more funds are made available to India’s rapidly growing banking and finance sector to invest in viable projects.

All this is happening in tandem with a massive expansion of India’s military capacity. The Indian Ministry of Defence believes that India needs US$233 billion to meet its arms and equipment requirements. This has been calculated according to the Long Term Integrated Perspective Plan (LTIPP) for 2012-2027. The head of the Indian army, General Bipin Rawat, has talked about the level of hollowness in the Indian Army in the case of a war on two-fronts (meaning a war with China and Pakistan at the same time). Hollowness is a military term that describes both lack of stocks of critical items and obsolescence in weapon platforms.

The Indian Ministry of Defence believes that India needs US$233 billion to meet its arms and equipment requirements.

India is procuring up to 10,000 missiles from Israel (check out Elbit Systems (NASDAQ:ESLT)) and one medium-range surface-to-air missile (MRSAM) regiment, composed of 18 firing units. The US defence contractor Boeing (NYSE:BA) has won bids to supply the Indian military with 10 C-17 Globemaster III strategic airlift aircraft (worth US$4.1 billion), eight P-8I maritime patrol aircraft (worth US$2.1. billion), 22 AH-64E Apache and 15 CH-47F Chinook helicopters. The helicopter deals alone are worth US$2.5 billion.

“India’s needs are enormous. Hence, for its navy, 57 aircraft are considered” said Dassault Aviation (EPA:AM) CEO Eric Trappier in May this year[i]. Dassault has a contract to supply the Indians with 36 Rafale jet fighters. India is investing over $1.62 billion domestically on military programmes, including advanced guidance systems, defence radars and sensors, as well as communications and electronic warfare capabilities.

Know your customer

Total military expenditure as a percentage of global GDP has been in steady decline over the last 60 years or so. It fell from just over 6 percent in 1960 to 2.225 percent in 2016. That might be about to change. Since the customers of defence contractors are all governments, it is interesting to compare how the top ten governments prioritise their military spending as per the table below.

Note that figures from the International Institute for Strategic Studies yield somewhat different figures since what constitutes “military expenditure” is a matter of definition. (Does one include the pensions of retired officers? And so on). In their ranking the UK comes out at fifth place – well ahead of France. Also, the decline in the value of sterling over the last year has obviously impacted the UK’s position in this league table.

The story this table tells is that most large countries are already spending around the 2 percent ballpark – China included. The USA – the world’s pre-eminent military power by far is spending well above this and boasts the largest roster of defence contractors. Russia and even more so Saudi Arabia are outliers who seem to have something to prove. Iran, by the way, has military spending of three percent of GDP.

The Future of Warfare

Mankind is preparing for war – but, thankfully, the general expectation is that it will never happen. If you download the September magazine you will get numerous indicators as to which defence contractors are in the forefront. But how worried should we be?

First, the good news. The technology will be such that ethical combatants will be able to inflict crippling blows on their adversaries without necessarily killing large numbers of civilians (as in WWII). This results from increased accuracy, robotisation and cyber-warfare. Robot soldiers are already in development. In fact, we already use robot airmen – though we call them drones.


Communications technology and mastery of the internet will be paramount. I wrote in the MI magazine in June: Before any gun is fired or missile launched by an unfriendly power, our utilities and communications systems will have already been paralysed. Investors should be sure to get exposure to the burgeoning cyber-security sector.

The bad news is that we may lose control of the entire security system at a critical time of great power rivalry – China wishing to wrest hegemony from America – as we did in August 1914. Unlikely (I pray); but possible.

Columns of marching soldiers; nuclear-powered submarines equipped with weapons of mass destruction; massive new-generation aircraft carriers; space-based missiles; intelligent drones; batteries of ballistic missiles; spy satellites; all-seeing nano-drones with facial recognition systems…These are all wondrous things – so long as they are intended to prevent conflict and are not actually used to kill people.

Aye, there’s the rub.

[i] See: http://www.reuters.com/article/us-dassault-avi-rafale-contract-idUSKCN18A138

[ii] Source: Stockholm International Peace Research Institute. See: https://en.wikipedia.org/wiki/List_of_countries_by_military_expenditures