With British and American troops likely to begin withdrawing from Iraq next year, investors are beginning to ask whether the defence boom of the past four years is about to end.

The US Defence Department spends more than $200 billion (£99 billion) a year on the Iraq conflict and Britain has spent an extra £1 billion solely on urgent equipment needed for the war zone. As troops pull out, these appropriations will diminish and defence companies will be left fighting for a smaller pot of money.

When the US and the UK reaped a peace dividend from the end of the Cold War in the early 1990s, it caused a recession in the defence industry. Companies had to consolidate to survive and there are fears that the end of the present boom could trigger a similar shake-up. However, there are also reasons to believe that the defence sector will remain buoyant well into the next decade.

Although the Iraq budget supplements may be reduced, the United States is unlikely to withdraw completely and its commitment is likely to remain significant.

The UK will probably withdraw from Iraq completely next year, but this will be balanced by an increase in deployment to Afghanistan. Defence companies will benefit from the refurbishment of equipment returning from Iraq, much of which is in a poor state. Military planners will also learn from the mistakes of Iraq and start to place orders for better equipment. This is beginning in America with the acquisition of mine-resistant armoured protection vehicles, which are better at shielding soldiers from roadside bombs. BAE Systems could win more than $3 billion of new business in this area alone.

Defence companies are also set to benefit from the British Government’s commitment to increase the Ministry of Defence’s budget and fund new projects such as two aircraft carriers, which will cost £3.8 billion. The recent comprehensive spending review promises the MoD £7.7 billion extra over the next three years, but even with this increase the defence budget remains historically low, at 2.5 per cent of GDP compared with 4.4 per cent in the late 1980s.

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