The Transformation of Defense Economies in the Age of Artificial Intelligence

I was talking to a friend who is an outstanding computer engineer. He studied and worked at universities and companies that are the dream of many young people anywhere in the world. He has now decided to study business administration (MBA), even though he already has a master’s degree in politics and technology, and has switched his specialization to artificial intelligence, not in programming, but in the management and economics of artificial intelligence (yes, there is now a specialization with this name).

The important thing is that he told me about an American company founded by Palmer Luckey after he sold his previous company, Oculus VR, to Meta for $2 billion in 2014, and then founded a new company called Anduril Industries. Believe me, this company is not going to change the shape of the global defense industry… it has already changed it.

I will talk about it later, but today I would like to address a topic related to the future of defense economics and artificial intelligence.

Let’s think together about the next stage in the evolution of defense economics. Many of us view artificial intelligence as a new tool that increases the efficiency of weapons, but the truth is that its importance lies in the fact that it fundamentally changes the nature and shape of the defense economy.

To understand this transformation, we need to answer an important question: What does it mean to have an “algorithm-based defense economy” instead of an “economy based on iron and nail factories”?

In traditional defense industries, value was created inside the factory; the factory that manufactures the aircraft, tank, or missile. Today, value is created in the code, data, and algorithms that make an aircraft or drone think smarter or perform a completely different task from others, even if they are of the same model. This is a radical economic shift, because you are no longer selling a piece of iron, but selling a knowledge system.

If we go back just ten years, the term “autonomy” meant a decision-making support system. Today, the world has moved toward systems called “human-out-of-the-loop systems,” meaning that decisions to kill or engage are made autonomously without direct human intervention.

This development is effectively creating a new economic class within the industry that we could call the defensive artificial intelligence class.

The most important aspect is that the companies that control defensive artificial intelligence are not the same ones that manufacture aircraft or radars, but rather new, independent companies that have entered the equation. Therefore, we can consider them a new class in the industry, such as Palantir, Shield AI, Helsing in Germany, or Anduril, which we have already mentioned. We are talking about software and cybersecurity companies that have become competitors to traditional arms manufacturers themselves.

You may now be wondering: Why don’t the old big companies do this work This is a valid and difficult question, and departments such as technology and innovation management at many universities have been trying to answer it for years.

Let’s get back to the heart of our topic: this shift is causing what economists like me (damn my modesty) call the unbundling of the defense value chain, i.e., the separation of the physical industrial system from the digital knowledge system, which is a field of research and development in itself.

A country that recognizes this early on (listen up, countries!) can create technological and economic advantages for itself at the same time.

To understand the importance of this change, let’s look at some numbers.

In the United States, more than 70% of defense AI contracts went to companies that were never part of the traditional defense bureaucracy, but rather to startups. Goodbye to the old industry giants and established companies in the market; today we are talking about companies that are only five or ten years old. This is really serious.

In Europe, the European Defense Agency has launched the AI4DEF program to reduce dependence on American technologies in smart applications, a massive program focused on sensor fusion algorithms and autonomous control - also through startups.

China, on the other hand, is doing the exact opposite. It is integrating the civilian and military sectors into a single framework known as civil-military integration, and is focusing on linking artificial intelligence to missile and drone systems through national supply chains. In other words, China is systematically weaponizing any civilian artificial intelligence technology.

From an economic perspective, this means that the defense sector has entered a new phase that could be called “the commodification of knowledge.” This phase may be familiar in other sectors, but it is the first time in history that defense has entered this phase. We used to view defense as a “heavy industry” requiring giant companies and huge investments, but now we are talking about a new reality: Every line of code and every machine learning model has become a real monetary value in the defense market.

This will change the balance of power in the defense industry and also change the nature of defense financing itself, because you no longer need huge industrial capital to build a tank or an ammunition factory; instead, you need human and knowledge capital.

Putting all this together, it can be said that the defense industry is gradually shifting from a mineral economy to a knowledge economy.

This brings us to a more serious question - one that could be the subject of master’s and doctoral theses:

How are countries that are still building their defense industrial bases dealing with this shift?

Do they start with iron and electronics? Or do they jump straight into software, smart control, and integrated systems? My view is that the shortest route for any country outside the big league is to enter directly through the door of defense artificial intelligence.

Not because smart weapons are easier - in fact, they are much more complex - but because the capital barrier is much lower. You don’t need factories worth billions, but rather laboratories and scientists, data, and flexibility in thinking, which are the resources that enable a new generation of countries to create a digital comparative advantage instead of a traditional industrial advantage.

Countries that have not yet realized the significance of smart defense economics will look at the world in just five years and discover that their pursuit of steel was a wrong and costly decision, and that those who preceded them were the ones who began building algorithms and codes.

We are witnessing a truly amazing scene: Artificial intelligence began as a civilian technology, then was adopted by the defense industry, and is now being developed to be transferred back to civilian sectors for their benefit.

Those who understand this logic are building defensive artificial intelligence systems today, not only for war, but because these systems will later extend to all civilian industries.

I hope that developing countries will recognize this change and bring about a real transformation, bringing back their children scattered around the world to build an industry with their minds, not with giant factories and huge investments. 

The opportunity is truly there, and even the very poor can take advantage of it.