Australia Must Choose Defense or Social Spending, Rabobank Says

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(Bloomberg) — Australia confronts a “guns or butter” choice between a bigger defense budget and expanding national disability insurance and other social programs, according to Rabobank, which calls for economic statecraft to navigate a risky regional security environment.

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For now, the government is opting for “butter,” but it retains substantial fiscal headroom to bolster military spending when compared to peer economies, Rabobank economist Benjamin Picton said in a research note on Tuesday. The nation’s debt is lower than that of counterparts as a share of its gross domestic product.

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Australian officials have warned that the nation faces its most complex strategic circumstances since World War II. The government aims to pivot its military posture to deterrence, including via drones and missiles, to complement a planned fleet of nuclear-powered submarines due to be delivered in the 2030s under the AUKUS deal.

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But Canberra is caught between the expanding military footprint of China, which is also Australia’s biggest trading partner, and its traditional US ally that’s seeking to check Beijing’s expansion in the Asia-Pacific.

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Picton pointed out the contradiction of Australia deepening military engagement with Washington via AUKUS to deter China while trying to keep defense spending low enough to “remain relatively inoffensive” to Beijing. 

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“This have-your-cake-and-eat-it-too approach carries risk that Australia will be forced into supporting US foreign policy interests against its own, while also being under-prepared if a major conflict were to break out, or if the US were to revise its strategic doctrine in the Western Pacific,” Picton said. 

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As a result, Australia faces higher defense, social programs and debt servicing costs which may put pressure on long-dated government bonds, Picton said. 

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Another risk is the “potential for bifurcation of the global economy into competing blocs,” he said. “This is a tail risk, but if it were to occur it would necessitate a choice between economic ties to China or security ties to the United States.”

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Picton described the implications for Australian exports, imports, FX, monetary policy, capital markets and energy from choosing either China or the US and concluded that “the bifurcation scenario would be a disaster for Australia” regardless of who it selected.

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“Australia’s vital strategic interests lie in doing everything possible to avoid making this choice,” he said. A more skillful application of deeper economic statecraft could at least help Australia to build greater resilience and insure against worst-case geopolitical scenarios.”

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