Market Update: A fighting chance: How Canada can beef up its defences and grow its economy at the same time – Full Analysis

Canada is embarking on a defence spending increase not seen in generations.

Prime Minister Mark Carney has committed to ramping up spending on defence to 5 per cent of gross domestic product by 2035, part of a concerted effort by members of the North Atlantic Treaty Organization to sharply increase military budgets after years of neglect and underfunding.

That’s the easy part.

But Canada now faces the challenge of figuring out what to spend the money on, and how to ensure the massive new spending also brings substantial, lasting economic benefits.

In addition to protecting the country, the federal government’s defence splurge is aimed at creating new businesses and elevating a sector to help breathe life into an economy struggling from the onslaught of U.S. President Donald Trump’s tariffs.

“It’s an enormous opportunity to build the cutting-edge industries of the future,” Mr. Carney said in a recent speech.

But what does it take to build a self-sustaining modern defence economy? And what’s the smartest way to spend an annual defence budget expected to reach $150-billion by 2035?

Ottawa plans to spend big on defence. But is there a long-term vision for Canada’s military?

According to data from the Department of National Defence, the last time Canada spent 5 per cent of GDP on defence was around 1959, after hovering just above 7 per cent during the Korean War. The funding Canada is allocating to defence this fiscal year will be the largest proportional year-over-year increase since 1952, said David Perry, president of the Canadian Global Affairs Institute.

Finance Minister François-Philippe Champagne said he sees the government’s defence spending plan as an “engine for growth.” He’s even gone so far as to tell rooms full of entrepreneurs and chief executive officers, on multiple occasions, that “every company should have a defence strategy,” encouraging them to tap into this historic spending.

Opinion: Is Canada ready for the big defence bill to come?

To do this, however, the Liberal government must spend strategically. Increased defence spending isn’t an automatic economic multiplier. Dr. Ethan Ilzetzki, at the London School of Economics, says economic miracles don’t often result from higher defence spending. Like other forms of public spending, the boost often doesn’t raise enough new tax revenues to pay for itself. “This is not some kind of magic money tree.”

Military spending can still stimulate growth and long-term productivity gains, he said. But only if circumstances are ripe for technological innovation, public and private sector collaboration, and strategic procurement policies.

“There’s an overemphasis on the flashy, big flagship programs. The nuclear submarines and the next generation of fighter aircraft,” said Dr. Ilzetzki. “We saw in Ukraine that very inexpensive drones can cause, in large quantities, more damage sometimes than the most sophisticated weapon systems. So, it does require a bit of a strategic rethink, rather than just buying the same old stuff from the same old producers.”

Canada is not the first country to take a hard look at its defence sector and conclude that there’s work to be done. Several of its allies offer valuable lessons in how to increase spending on defence in effective ways. Poland and South Korea are two compelling examples.

In Poland, the threat posed by Russia on its eastern flank is the impetus behind the country’s drive to invest heavily in artillery, soldiers and border security. The spending approach prioritizes large purchases to rearm itself after Poland made a large donation of supplies to Ukraine soon after Russia’s invasion in 2022.

Then there’s South Korea, which was invaded by North Korea in 1950, enduring three years of combat and a war that still hasn’t officially ended. South Korea pours a steady stream of funding into defence-related research and development. Its strategy emphasizes nurturing major domestic defence companies and prioritizing innovation to remain relevant in the continuously evolving world of warfare.

Each country’s approach has its own merits and downfalls. But they share at least one commonality: They’re both years ahead of Canada in building a defence industrial base and each provides valuable lessons to their North American ally.

Poland is under a lot of pressure these days. Russian President Vladimir Putin seems to be determined to re-establish the old Soviet Union. If and when he achieves his objectives in Ukraine, the worry running through NATO is that he’ll move through the vassal country of Belarus in an attempt to destabilize Eastern Europe – with Poland being an early target.

This is the geography that drives Poland’s defence spending said Paweł Markiewicz, executive director of the Washington D.C. office of the Polish Institute of International Affairs. “It’s to prevent any type of Russian imperialism from spilling over outside of Ukraine, or from Belarus into Poland. We don’t want that. We’re very happy here in Poland,” he said.

Poland is also under pressure from the west, where the rhetoric being put out by Mr. Trump led the country and its NATO allies to raise their defence spending target in June, at a summit in the Netherlands.

This year, Poland is expected to come out on top among those countries. It’s on track to hit about 4.7 per cent. That’s nearly a full percentage point ahead of the next biggest spender, Lithuania.

Canada is set to tie with Italy and Albania for 22nd, spending 2.01 per cent of GDP on defence. This follows decades of neglect here. According to NATO records, Canada hasn’t spent 2 per cent of GDP on defence since 1990 and it even dipped below 1 per cent at a low point in 2015.

The trajectory Poland set itself on to land close to 5 per cent is akin to the one Canada is just beginning. In 2014, Poland spent just less than 2 per cent of GDP on defence. A lot of NATO allies have been taking note of Poland’s success. “There’s also nothing like the absolute risk to your sovereignty to motivate you,” said Erin O’Toole, president of business intelligence and risk advisory firm ADIT North America, former federal Conservative leader and a former captain in the Canadian Armed Forces.

During Poland’s rise to the top, however, it has also racked up some of the largest fiscal deficits in Europe. And while the International Monetary Fund credits Poland with a high growth rate and manageable inflation, its recent outlook on the country’s finances contains warnings to practice prudency from here on out.

Defence spending must be done a specific way to spur economic growth. According to Dr. Perry, defence dollars spent on capital assets, such as infrastructure and equipment, as well as research and development, provide more long-term economic returns in the form of jobs and other benefits, than dollars spent on operations or services, for example.

But Poland’s rise within NATO has been less about rebuilding an economy and more about appearing strong in the face of a looming threat.

Captain Paweł Podgórny, defence attaché at the Polish Embassy in Ottawa, said that in 2022 Poland was among the first countries to rush to Ukraine’s aid with swaths of Soviet-era tanks, helicopters, fighter jets and armoured vehicles, much like Ukraine’s own supply.

“The advantage for Ukraine was that it was easy for them to operate this equipment because they were familiar with this technology at this stage of the war, the first months and years,” he said.

This opened the door to an extensive modernization of Poland’s armed forces, which found themselves suddenly needing to procure a whole host of equipment – and quickly. At the time, the United States and South Korea were the best candidates to supply Poland with that new equipment, Capt. Podgórny said.

Take, for example, Poland’s decision to purchase 48 South Korean FA-50 fighter planes for more than US$3-billion. The deal was signed in 2022, following the donation of the country’s old Soviet MiG-29 fighter jets to Ukraine and in anticipation of decommissioning its Russian-made Sukhoi Su-22 fighter-bombers.

The FA-50 is newer, yet similar to the fighters Polish pilots have been flying, making training fairly straightforward. Plus, 12 of the 48 jets were delivered early, in 2023, with the remaining 36 set to arrive between 2025 and 2028, after being equipped with combat systems and weapons specific to the Polish air force’s needs.

Similar reasoning is behind Poland’s purchase of 96 Apache attack helicopters in 2024 for about US$10-billion and 250 Abrams tanks in 2022 for roughly US$4.75-billion from the U.S. The systems were there when Poland needed them, Capt. Podgórny said, and Poland has a strong strategic defence alliance with the U.S.

Given Poland’s tight window to restock rapidly, its ability to find or build up domestic capacity to meet its needs has been limited. Instead, the country takes care to glean industrial benefits from foreign procurements where it can. For example, in an approximately US$6.5-billion deal signed this year with South Korea for a second batch of 180 K2 Black Panther tanks, Poland negotiated that roughly 60 be assembled locally by its state-owned defence group as part of a broader technology transfer deal.

Ammunition, however, is one item Poland isn’t relying on other countries to produce. After witnessing the rate of ammunition consumption in Ukraine, Capt. Podgórny said Poland is committed to bringing firepower production in-house.

In 2024, the Polish government allocated a little more than $1.2-billion to construct new factories, mostly dedicated to producing NATO-standard 155 millimetre shells. Then, in July, it announced four companies under the country’s state-owned defence group would receive roughly $928-million to build three ammunition factories, as part of an effort to scale up annual production to 150,000 shells in two to three years’ time.

After witnessing Russia’s invasion of Ukraine, border reinforcements are another local project for Poland. The country’s Eastern Shield spans 800 kilometres along its northern and eastern borders and is part of a Baltic defence line. The shield itself is a combination of man-made fortifications and natural obstacles, supplemented by storage facilities, shelters, logistics centres, and a drone detection and tracking system. It’s an expense of nearly $4-billion that Poland plans to finance with help from the European Union and NATO.

This spending surge builds upon decades of Poland worrying about its defence, said Michael Carpenter, a senior fellow at the International Institute for Strategic Studies and former U.S. ambassador to the Organization for Security and Co-operation in Europe. It’s a bipartisan issue for the country – and one that isn’t likely to stop receiving support any time soon.

According to a NATO report, Poland is expected to spend about half of its 2025 defence budget on major equipment, such as missiles and combat vehicles, and related research and development. About a quarter will go toward personnel, roughly 15 per cent to operations, maintenance and miscellaneous expenses, and nearly 4 per cent to infrastructure.

Again, spending 5 per cent of GDP on defence and related infrastructure in Canada will amount to more than $150-billion in 2035. In Poland, spending 4.7 per cent of GDP on defence this year means shelling out about $71.9 billion, or 20 per cent of its annual government budget.

That spending is swelling Poland’s annual fiscal deficit and its national debt.

Poland has one of the highest economic growth rates in Europe. But if the country maintains its current tax regime and spending habits, the IMF predicts Poland’s debt-to-GDP ratio will rise to 76 per cent in 2030. As a result, the IMF has upgraded its assessment of Poland’s risk of sovereign debt stress from low to medium.

To contend with this, the IMF suggests Poland increase revenues from property and personal income taxes or revert to a smaller public sector through means such as decreased wages. Taxes increasing are an inevitable part of a long-term military buildup, writes Dr. Ilzetzki in his report, titled Guns and Growth: The Economic Consequences of Defence Buildups. Otherwise, high public debt can lead to higher borrowing rates, inflation and a sovereign debt crisis.

Poland has moved hard and fast with its defence purchases over the past few years, owing to the invasion of Ukraine and rising geopolitical tensions. But its approach bucks the norm of what economists argue is the best way to broach defence spending in search of economic growth – through technological innovation and research and development.

Poland’s approach is one way to reach the coveted 5-per-cent NATO target. But as General Wayne Eyre, former chief of defence staff for Canada, pointed out, popular support for defence investment is not the same in Canada. “Their sense of threat is visceral. It’s very different from our own.”

Prime Minister Mark Carney’s messaging on the topic of defence has made it clear that it’s not enough to sell Canadians on the security benefits of defence spending alone, there must be clear economic benefits too.

But if economic gains are the goal, first Ottawa must make some tough decisions, Dr. Perry said. Which capabilities will define Canada’s defence industrial base and which will it continue to rely on others for?

There are a few obvious answers to consider, such as Canada’s clear strength in shipbuilding and quantum technology, and blatant lack of expertise in other areas, such as submarines. But beyond a handful of existing established players in the sector, the country is really starting from scratch in terms of deciding what it wants to be known for, Dr. Perry said.

“Step one is making some decisions about, fundamentally, what the government wants to see,” he said. Policy documents, such as Ottawa’s forthcoming Defence Industrial Strategy, will help with this.

For example, about 85 per cent of Canada’s defence industrial base is made up of small to medium-sized enterprises. The government could pick some of those to champion and help them grow into larger, prime contractors with a wider scope of capabilities. Or, it could facilitate deals with foreign companies to have them build more made-in-Canada systems, employing Canadians to do so.

Both of these approaches can spur economic gains, but only if they’re attuned to what Canada and its allies are actually looking to buy in the coming years.

“Trying to find alignment between what we’re going to buy and what the international opportunities are, where there’s actually a possibility for Canadian companies to make sales, realistically, would be part of that,” Dr. Perry said.

South Korea is a good example of a country that has positioned itself to meet market needs. The Indo-Pacific country has grown into one of the world’s top defence exporters, with an array of submarines, missiles, fighter jets and space launch systems being scooped up by NATO and non-NATO members alike.

In 2024, South Korea had the 14th-largest economy in the world and the fourth-largest in Asia, with semiconductors, shipbuilding, aeronautics and defence as key pillars. Yet, it’s not a NATO member and has been spending close to 2.3 per cent of GDP on defence for the past few years, according to its Ministry of National Defence.

Faced with its own unique threat in the form of North Korea, the Republic of Korea, as South Korea is known officially, has bolstered its own defence capabilities and become a major military exporter.

Whereas Poland has placed a heavy emphasis on imports, South Korea has focused on nurturing a domestic industry that can equip armed forces at the speed of relevance. It’s a good example of the long-term, capability-first thinking that’s likely to lead to economic gains from defence spending, Dr. Ilzetzki said.

At the foundation of South Korea’s industrial base are a handful of well-established prime companies. Defence firm Hanwha Corp., for example, is the country’s seventh-largest business group, with operations in aerospace, shipbuilding, finance and even retail, among others. Its presence in regions outside the capital city of Seoul, such as its shipyards in the city of Geoje, is an anchor for economic development and local employment.

The 73-year-old company is also one of two finalists bidding to supply Canada with 12 submarines.

A few factors have set up companies such as Hanwha for global success. One is its willingness to work with countries on localization requests and industrial benefits. For example, the Homar-K rocket launchers that Poland is purchasing from Hanwha Aerospace will have manufacturing and assembly split between the two countries, as well as specifications to make them interoperable with other Polish systems.

These kinds of deals make a big difference to buyers, Capt. Podgórny said. Compared to other countries, he added, “Koreans are much more open. They don’t have a problem with the transfer of technology,”

South Korea’s openness has given rise to its prominence as a global arms exporter. In 2024, it was the 10th-largest, exporting around US$9.5-billion worth. By 2027, it strives to become the fourth-largest in the world, behind the U.S., Russia and France.

Growth in South Korea’s defence industry is driven by government support, competitive pricing and the ability to deliver systems at speed, said Julie Kim, a post-doctoral fellow leading the Korea Program at the Canadian Global Affairs Institute.

Key to its efficiency is the country’s centralized defence procurement agency, known as DAPA or the Defence Acquisition Program Administration, Dr. Kim said. Established in 2006, the agency brought a process previously done by eight different government institutions under one roof.

DAPA plays a critical role in South Korea’s mission to remain relevant in the rapidly evolving world of warfare, ensuring its own forces and foreign customers aren’t buying outdated technology, Dr. Kim said. The agency works in tandem with other government initiatives and legislation, such as the country’s Defense Technology Security Act and its Defense Innovation 4.0 plan, to ensure the country’s industrial base continues to innovate and, in doing so, its technology is protected.

Back in Canada, a struggling manufacturing sector and an emerging defence sector set the scene for Mr. Carney’s grand economic plan.

After months of a relentless trade war and tumultuous tariff policies under the direction of Mr. Trump, key sectors such as lumber, steel, aluminum and automobiles are faltering. Lifelines of government support are keeping manufacturers afloat, for now. But the manufacturing sector’s gradual decline has continued since the turn of the century, with its output as a percentage of GDP dropping roughly 7 percentage points to less than 9 per cent this year.

But where one door closes, another opens. Mr. Carney’s bulging defence budget is an opportunity for Canada to re-establish a burgeoning domestic industry, one that Canadians control, rather than relying on the U.S. It could be used to redeploy skilled workers and resources from industries hit hard by tariffs, and to innovate and build out new supply chains.

Bombardier Inc.’s recent discussions with Swedish defence giant Saab AB are a key example of this. Saab has floated the possibility of building both its Gripen fighter jet and the GlobalEye early-warning surveillance aircraft in Canada, creating what it says would be 13,000 jobs and a significant technology transfer between the two countries.

Canada hasn’t had a made-in-Canada fighter jet enter full service with its air force since the 1980s. Saab’s offer hinges on Canada actually buying some of its Gripen jets and making the bold decision to diversify away from the U.S.’s F-35 fighter jets.

But it serves as a glimpse of what’s possible for Canada’s defence sector.