The New Economics of Security: Priced for Permanence in a Fragmented World

Beyond short-term wartime dynamics, the global defence sector is undergoing a significant and far-reaching transformation. The recent increase in military spending, initially framed as a cyclical response to regional conflicts, is increasingly recognized as part of a broader structural repricing of security across global markets. This has also prompted a reassessment of defence firms’ role, shifting their perception from cyclical industrial contractors primarily tied to procurement cycles toward strategic assets embedded within the dynamics of geopolitical fragmentation and sovereign competition.

Consequently, this shift has contributed to the erosion of the post-Cold War peace dividend model, which underpinned global economic integration for more than three decades. In the aftermath of the Soviet Union’s collapse, advanced economies largely embraced the assumption that economic interdependence would mitigate conflict risk, thereby justifying sustained declines in defence expenditure. This assumption underpinned an efficiency-oriented model of globalization, optimized around lean inventories, cost minimization, and geographically dispersed supply chains, while assigning comparatively limited importance to redundancy and strategic industrial depth.

However, by 2026, this model had demonstrated its material vulnerabilities. Security considerations were no longer treated as external to economic policy, but rather embedded within it, as states sought to integrate defence production, industrial capacity, and supply-chain control into a broader framework of national resilience.

Recent data from the Stockholm International Peace Research Institute (SIPRI) indicates that global military expenditure reached USD 2.9 trillion in 2025, representing the eleventh consecutive annual increase and raising the global military burden to 2.5% of GDP — the highest level recorded since 2009. Leading this surge was the United States as the top spender, with China and Russia following as the second and third largest investors, respectively.

In parallel, Forecast International adopting a direct procurement-oriented narrower methodology, projects the continuation of expansion during 2026, as governments accelerate rearmament programs, missile-defence investment, and industrial-security spending. However, the implications of this transformation extend well beyond the expansion of military budgets, as states increasingly adopt a restructuring approach that treats industrial resilience, strategic commodities, energy systems, semiconductor capacity, cyber infrastructure, and defence manufacturing as essential and interconnected components of national security. Consequently, the distinction between economic policy and security policy is becoming progressively less clear, contributing to the rise of a new security premium economy model, in which resilience, redundancy, and sovereign production capacity are increasingly prioritized and reflected across both policy design and asset valuation. Hence, within this model, the dominant organizing principle of economic systems is no longer efficiency, but rather strategic durability and supply-chain control which outweigh it.

The Middle East’s 2026 escalation has significantly contributed towards the acceleration of this transformation, reinforcing the perception among governments and investors that elevated military expenditure is no longer considered cyclical, but rather structurally embedded within long-term national security planning. Across several nations, budgetary allocations to defence systems are no longer treated as temporary emergency measures, but rather as permanent pillars of industrial and geopolitical strategy. However, beneath the headline growth figures, a more uneven and complex reality emerges. The 2026 defence market has effectively evolved into a tale of two systems: one marked by European and Asian expansion, driven by sovereign rearmament and industrial-policy priorities; and another defined by a more constrained American market, weighed down by production bottlenecks, labour shortages, fixed-price contracts, and the structural limitations of globalization-era manufacturing models.

In 2026, European defence equities ranked among the strongest-performing industrial assets, reflecting their central role within a wider geopolitical, industrial, and security-driven economic realignment. European governments, after decades of reliance on US-led security guarantees, are increasingly pursuing strategic autonomy through localized defence production, regionalized supply chains, and the expansion of domestic military-industrial capacity.

According to estimates from SIPRI, European military expenditure in 2025 rose by 14%, reaching USD 864bn, representing the sharpest increase in Central and Western Europe since the Cold War. Within this regional surge, Germany increased its military spending by 24% while Spain increased defence expenditure by approximately 50%.

Crucially, 2025/2026 marks a historic milestone, as all European NATO member states have surpassed the 2% of GDP defence-spending threshold, with frontline eastern-flank states such as Poland leading capital allocations at approximately 4.3% of GDP.

This transformation is not simply military in nature; it also represents a wider industrial and macroeconomic shift. Across Europe, policymakers increasingly regard defence manufacturing as an essential form of strategic infrastructure, comparable to semiconductors, energy security, and critical minerals processing. Within this context, the revaluation of defence firms is increasingly extending beyond profitability metrics, rather incorporating their strategic function in sustaining sovereign resilience amid periods of heightened geopolitical instability.

Under this approach, European decision makers are actively debating a long-term Security Target framework for 2035, proposing a 5% GDP allocation toward core defence and security requirements; compromising a 3.5% dedicated explicitly to kinetic defence procurement, and 1.5% for funding broader economic security initiatives including regional semiconductor fabs, critical mineral stockpiling, and hybrid-threat cybersecurity grids.

This dynamic has been particularly consequential for firms such as BAE Systems, for which investor perception increasingly places greater emphasis on sovereign capability and production continuity under conditions of disruption or alliance fragmentation. This market-behaviour logic reflects a broader reconfiguration of capital allocation. Throughout the globalization era, valuation models are primarily shaped by efficiency gains and cost-optimization. However, recent conflicts have underscored an important structural reality: industrial capacity is as critical as technological sophistication. States that can maintain rapidly scale production, replenish munitions stockpiles and sustain supply continuity hold a clear strategic advantage in prolonged conflicts. Consequently, markets are increasingly assigning greater value to firms integrated into national rearmament agendas, over those dependent on fragmented just-in-time global production networks.

Europe’s rearmament agenda remains subject to material economic and industrial constraints. Weak growth, demographic aging, elevated energy costs, and rising debt burdens may limit the sustainability of long-term defence expansion, while industrial bottlenecks — including shortages in skilled labour, explosives production, and manufacturing capacity — continue to constrain procurement objectives. As a result, Europe’s defence buildup remains strategically significant, but uneven in its implementation.

By contrast, major American defence contractors face a more complex environment, despite historically elevated order backlogs. The primary constraint is not demand, but rather the structural limitations of the US defence-industrial model itself. For decades, the American industrial base evolved around a model of shareholder-efficiency, characterized by lean inventory systems, and globally distributed supply chains. Although this model has proven high effectivity during periods of geopolitical stability, it became less adaptable under conditions of sustained escalation and rapid procurement cycles.

The resulting structural paradox is clearly visible in 2026: the US defence appropriations bill has reached a record level, surpassing the USD 1 trillion threshold for FY2026, yet this unprecedented flood of liquidity is generating significant and severe inflationary overhead rather than immediate production throughput. Military equipment demand is on the rise, yet profit margins remain under pressure. Lockheed Martin, the American defence and aerospace manufacturer, illustrates this dynamic, with production delays and supply-chain rework across major aircraft programs weighing on investor sentiment despite elevated backlog levels. Similarly, RTX, the American multinational aerospace and defence conglomerate, has secured substantial air and missile-defence contracts under the Pentagon’s comprehensive Golden Dome initiative, a sweeping multi-layered framework for homeland and regional missile defence. Yet market sentiment remains constrained by concerns over prolonged delivery timelines and rising production costs.

At the core of this delivery friction lies a compounding domestic labour bottleneck, as the US industrial base faces an acute shortage of specialized machinists, precision welding technicians, and clearance-vetted software engineers required to scale production. Furthermore, many US defence companies remain structurally constrained by fixed-price contracts negotiated before the inflationary shocks and geopolitical disruptions of the mid-2020s. As input costs, logistics pressures, and labour shortages intensified, contractors were increasingly compelled to absorb cost overruns, rather than passing them through.

Historically, periods of geopolitical escalation tended to translate into both revenue acceleration and margin expansion. In 2026, backlog growth no longer necessarily implies profitability expansion, as revenue growth increasingly coexists with margin compression. This divergence reflects a broader structural reality: hyper-efficient global manufacturing systems are increasingly incompatible with prolonged geopolitical confrontation. Survival in the modern defence sector demands a paradigm shift, trading pure optimization for localized industrial depth, redundancy, and subsidized surge capacity.

China continues to serve as a pivotal force shaping the restructuring of the global defence landscape. According to SIPRI estimates, China’s official defence expenditure surpassed USD 310 billion in 2025; however, broader assessments that account for dual-use infrastructure and related strategic investments indicate that actual spending may be relatively higher. China’s military modernization agenda is contributing to an acceleration of regional rearmament across the Indo-Pacific. In response to evolving strategic balances, Japan, South Korea, Taiwan, Australia, and India have all expanded defence investments. Simultaneously, China’s industrial policy adopted a dependency reduction model toward Western defence technologies, while Western firms remain largely excluded from Chinese defence procurement channels. These dynamics have reinforced the emergence of two distinct defence-industrial ecosystems.

A deeper structural constraint lies beneath this fragmentation: defence production is becoming increasingly dependent on commodities and critical materials. Modern defence systems are increasingly reliant on semiconductors, rare earth elements, titanium, lithium, energetic materials, copper, and other specialized inputs. China maintains a dominant position in rare earth refining, while Western defence industries continue to face persistent bottlenecks in munitions, propulsion systems, and explosives, largely because of decades of industrial consolidation. Consequently, resource security has become central to defence strategy, extending rearmament policy into mining, refining, semiconductor fabrication, and energy infrastructure. Defence capability is therefore increasingly tied to commodity security and control over upstream industrial supply chains.

A major structural shift is emerging between traditional defence contractors and defence technology firms specializing in artificial intelligence, autonomy, cyber systems, and software-defined warfare. The US-Israel–Iran War underscored the strategic importance of missile interception systems, autonomous strike capabilities, and integrated sensor networks, provoking markets towards a capital reallocation model favouring scalable, software-driven defence architectures. This architectural shift is being accelerated by what may be described as the Cost-Inversion Dilemma. Modern kinetic engagements have exposed a stark macroeconomic imbalance, in which state militaries are increasingly compelled to deploy highly sophisticated, multi-million-dollar interceptor missiles developed by legacy defence primes against asymmetric salvos of comparatively inexpensive, mass-produced autonomous strike drones.

This economic asymmetry is increasingly driving capital away from conventional, hardware-intensive defence models and toward networked, software-defined capabilities centred on electronic warfare, autonomous jamming, AI-enabled targeting, and cost-effective counter-UAS (Unmanned Aircraft Systems) technologies. Industrial-era warfare was defined by scale and material production, whereas modern warfare increasingly centres on software integration, autonomy, electronic warfare, and precision-strike capabilities. AI-enabled systems shorten procurement cycles, reduce manpower requirements, and fundamentally reshape the economics of force projection. Firms such as Palantir Technologies, Anduril Industries, and Shield AI have benefited as investors increasingly assign value to long-duration government contracts linked to AI-enabled defence systems and defence digitization. Defence technology indices and exchange-traded funds have therefore outperformed broader benchmarks, driven by rising expectations that software-defined warfare will become a core pillar of future military procurement.

This transformation also reflects a broader financial shift: geopolitical instability is increasingly being incorporated directly into market valuation mechanisms. Defence-sector pricing is now shaped in real time by a range of factors, including conflict probability, sanctions risk, maritime disruption, supply-chain vulnerability, and alliance fragmentation. Prediction markets and geopolitical forecasting tools have therefore become supplementary sentiment indicators, reflecting the growing financialization of uncertainty. Defence equities are increasingly viewed less as cyclical industrial assets and more as market instruments shaped by expectations of geopolitical fragmentation and prolonged strategic competition.

However, meaningful constraints also shape this structure. Across Europe and the United States, governments are expanding defence commitments against a backdrop of weak growth, elevated debt burdens, and higher interest costs, intensifying the tension between fiscal sustainability and strategic necessity. If geopolitical conditions stabilize or fiscal constraints tighten, the sector could face downside risk following a prolonged expansion cycle. Similarly, segments of the defence-technology sector may remain exposed to valuation excess if investor expectations concerning AI-enabled warfare outpace the slower realities of institutional procurement processes and military adoption capacity.

In sum, the global defence sector is increasingly evolving into a strategic infrastructure system linked to industrial resilience, technological competition, and sovereign economic security, with its valuation reflecting a broader transition away from the assumptions that defined the post-Cold War globalization era. As geopolitical fragmentation intensifies, governments are increasingly restructuring production systems, supply chains, and capital allocation around long-term security priorities. The result is a structural shift in which resilience increasingly rivals efficiency as the dominant organizing principle of economic strategy. Defence markets are therefore increasingly shaped by expectations of sustained strategic competition across the international system, rather than solely by cyclical procurement dynamics.

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Bloomberg. “Iran Strikes Missile Math: 20,000 Iranian Drones Take on 4 Million Patriots.” Bloomberg, March 2, 2026. https://www.bloomberg.com/news/articles/2026-03-02/iran-strikes-missile-math-20-000-iranian-drones-take-on-4-million-patriots

CNN. “World Military Spending Report: SIPRI.” CNN, April 27, 2026. https://edition.cnn.com/2026/04/27/world/world-military-spending-report-sipri-intl-hnk-ml

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SIPRI (Stockholm International Peace Research Institute). “Global Military Spending Rise Continues: European and Asian Expenditures Surge.” Press release, April 27, 2026. https://www.sipri.org/media/press-release/2026/global-military-spending-rise-continues-european-and-asian-expenditures-surge