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Compared to other sectors of the UK economy, the arms industry receives disproportionate state subsidy. The industry is also exempted from major trade treaties, including the World Trade Organisation agreement on public procurement. Perhaps most important to investors in the industry, however, is the support arms production receives for research and development (R&D) costs and the use of public procurement to backstop demand. Despite its privileged role in the UK economy, the arms industry is smaller than this level of subsidy would imply, adding less in value to the economy and employing fewer people than automotive manufacturing, which struggles to access state support. In fact, in 2022 the defence sector only added £1.8 billion more to the UK economy than the chemicals industry in the North West of England alone.
Though they are privately owned, arms companies are considerable beneficiaries of state subsidy in the UK. In 2022, more than half of R&D costs were met by customers — either the UK Ministry of Defence (MOD) or other governments — for three of the four leading MOD suppliers where data was available, as illustrated by the chart below.
Arms companies also benefit from state procurement and demand with the MOD set to spend £242 billion on equipment procurement and support over the next ten years. As the chart below shows, MOD spending is concentrated among a few key suppliers which draw significant revenue from domestic production.
On the one hand, the distinct political economic architecture of the UK arms industry demonstrates that an active industrial strategy and public coordination can shape production, with implications for other sectors key to decarbonisation. On the other hand, it raises a set of important questions:
Who benefits from the outsized subsidy given to the arms industry?
What are the economic consequences of the state prioritising arms production?
Can some of the productive potential of the arms industry be repurposed to meet urgent social challenges and deliver more secure long term manufacturing jobs? If so, how?
The two key beneficiaries from the state’s prioritisation of arms production are investors in arms companies and the UK’s geopolitical allies.
State guarantees afforded to arms companies lead to strong average returns on capital invested in the sector, above the FTSE100 average. These benefits ultimately flow to internationally distributed shareholders.
The industry further provides a source of military and political power for the UK’s arms export customers. Both MOD procurement decisions and institutional support underpin export production: while domestic procurement decisions help facilitate export deals, the Department for Business and Trade employs at least 127 civil servants in the in-house organisation UK Defence and Security Exports that helps firms secure export contracts. Export relationships have become more concentrated since the Cold War with nearly half of the value of arms exports through Standard Individual Export Licenses last year flowing to Gulf Cooperation Council countries. Data on the value of Open General Export Licenses is not available although these represent the majority of arms sales to Saudi Arabia.
The layers of state support for both export and domestic production safeguard strong returns for arms company shareholders. But who owns the arms industry? As in most sectors of the global economy, the leading shareholders in major arms companies operating in the UK, including the MOD’s prime suppliers, are investment firms and asset managers. However, this part of the asset manager arsenal offers particularly strong returns backed by state procurement, research and development funding and institutional support. Returns do not flow to asset management firms themselves but instead to wealthy individuals and pension funds that pay a fee for investment firms to manage their assets.
Within this globally distributed share ownership structure, UK pension funds have particularly limited exposure. If we assume that pension funds allocate roughly in keeping with the relative size of companies in an index or a market then, to take three indicative examples, based on the relative positions of BAE Systems, QinetiQ and Rolls Royce in the FTSE All Share (the index of all companies listed on the London Stock Exchange), UK pension funds’ exposure to these firms would be approximately 0.16 per cent, 0.01 per cent and 0.07 per cent of their aggregate portfolios, respectively, for a combined allocation of less than 0.25 per cent.
QinetiQ, BAE Systems and Babcock International are three of the MOD’s prime suppliers. All three derived over 20 per cent of their global revenue from the MOD in 2021/2022. QinetiQ was part of the MOD — the Defence Evaluation and Research Agency — until 2001 while the predecessor to BAE Systems was under public ownership until 1981. Now, their collective industrial and technological capacity is under the share ownership of investment firms.
Global investment firms dominate the lists of top shareholders at all three companies. However, Klear Kite LLC, the largest shareholder of QinetiQ, is an outlier that illustrates the close political connections held by arms companies. In November 2022, Christopher Harborne, the sole member of Klear Kite, made the largest donation to a Member of Parliament’s office in history — £1 million to Boris Johnson.
In addition to state guarantees that help underpin shareholder returns and relationships with Gulf monarchies, arms production helps produce a set of challenging economic dynamics.
Cover image licensed to QinetiQ Group under creative commons (CC BY-NC-ND 2.0)