War economies are different

A factor in the collapse of the Roman and Spanish empires, and of the French revolution, was the ruinous cost of military expenditure. Fighting, and often losing, endless military campaigns can come at enormous cost. Prior to the 20th Century governments would typically run out of gold reserves, plunging the state into crisis. In the age of fiat currencies and mature bond markets, larger economies have extensive – though ultimately not infinite – capacity to borrow to fund wars.

Following the second world war, Germany and Japan faced restrictions on their armed forces imposed by the allies, but as a consequence they enjoyed a post-war peace dividend with their export-focused manufacturers profiting enormously as consumer markets became globalized in the 1970s, 1980s and 1990s.

The profile of a war economy is different yet it can be beneficial for economic activity, although this depends on the starting point, and is possibly only for the short term. Arguably, the outbreak of the Second World War did much to end the deep recession and high unemployment of the 1930s. Huge increases in government expenditure across western economies spurred factory output and unemployment fell, although economies had begun recovering before the war, and government debt rose sharply during the conflict.

Russia has faced a much longer and more expensive military campaign in Ukraine than it anticipated in 2022, and has faced strict sanctions from western powers. Yet while its economy has suffered in some respects, it has proved to be resilient.

Dr Richard Connolly, a specialist on the Russian economy and author of Russia’s Response to Sanctions, noted in an article for the UK think tank the Royal United Services Institute SA earlier this year that there are certain strengths to Russia’s economic position – also that it does not have all the features of a war economy, having not been compelled to introduce price controls or central control of the economy. It has maintained strong revenues from oil, and debt is just 15% of GDP, the lowest of the G20 economies. Inflation and interest rates are high, but many businesses and households have access to subsidized loans. There are labour shortages, but consequent wage increases, and high payments to families of army recruits, have boosted domestic demand and reduced regional economic inequalities. Imposition of capital controls has encouraged domestic investment.

Russia’s GDP growth was 3.6% in 2023, confounding anticipation of a fall in output, and growth continued through 2024. By mid2025, however, growth had stalled, with some features of stagflation.

In political terms, Russia’s invasion of Ukraine has prompted several European nations to increase military expenditure. The most significant development is in Germany. For decades following the hyper-inflation of the 1920s and the Nazi regime that followed, Germany’s political leaders were committed to fiscal conservatism and limited military spending. That has now changed.

The new Chancellor Friedrich Merz secured Congress approval for a relaxation on constitutional borrowing limits before he took office. Defence expenditure above 1% of GDP will be exempt from the debt brake, and there will be a fund for infrastructure of €500 billion.

These measures are having the effect of a stimulus. Goldman Sachs has raised its projected GDP growth by 0.2% this year, and by 0.5% to 1.5% for 2026. The economy has been flat for the past few years. Germany has attracted investors. It has not had to set high yields for bond issuance, because of high credit rating and the switch away from US dollar assets under the Donald Trump regime.

The country’s traditional strength in manufacturing has been coming under pressure as economic growth in the EU’s largest economy has stalled. Chinese manufacturers of EVs have taken market share in the European car market. Some German vehicle manufacturers have announced factory closures – but at a time of limited labour supply many of the skilled workers laid off are likely to be hired by defence companies.

Another by-product of the war economy is the stimulus from reconstruction. An end to the conflict in Syria presents such an opportunity. US President Donald Trump met the new Syrian President Ahmed al-Sharaa in May, shortly after announcing the end of economic sanctions, effectively normalizing relations with the west.

Turkish construction companies in particular are set to profit, helped by the geographic proximity and the fact that many Syrian refugees had settled in Turkey. The share prices of Turkish construction and cement companies soared in December, following the end of the Assad regime. In 2023 the World Bank estimated that the cost of damage to the built environment in Syria as a result of the civil war that erupted in 2011 was $11.4 billion.

Volkan Bozay, CEO of the cement industry association TÜRKÇİMENTO , said following the regime change that, while there could be political and logistical challenges in rebuilding Syrian infrastructure, ‘the potential is significant’.

The economics of conflict can be complex. The state will inevitably grow in size and influence, but there can be economic opportunities extending beyond the defence sector.