The wars of the 2020s have generated a powerful narrative about the future of defense industrial policy. Cheap drones, agile startups, venture-backed innovation, and commercial technology adapted for military use now dominate policy discussions across NATO and beyond. Ukraine’s wartime adaptation and the rise of firms associated with the “New Defense” ecosystem have encouraged governments to rethink long-standing assumptions about how military capabilities should be developed and sustained. As a result, defense industrial strategies increasingly emphasize startup ecosystems, innovation hubs, and mechanisms to attract private capital. In the US, the Department of Defense has made these concepts explicit in a memorandum released on January 9, 2026 that attempts to overhaul its innovation ecosystem.
There is much to learn from these developments, but the lessons policymakers appear to be drawing are often incomplete. They offer insights into how governments might accelerate innovation, but they say little about the institutional foundations required to generate military capability at scale and sustain it over time. Defense markets are fundamentally shaped by government demand. States define requirements, allocate resources, structure incentives, manage complex acquisition programs, and commit to procurement over decades. Supply-side initiatives alone are unlikely to deliver meaningful military effects without those capabilities unique to government institutions.
The contemporary defense industrial thinking rests on two related misinterpretations: one military and one economic. On the military side, policymakers risk overstating the extent to which drones can substitute for more traditional forms of military power. On the economic side, they increasingly treat defense industrial development as an innovation ecosystem problem rather than a challenge of building effective procurement institutions. Together, these assumptions encourage governments to invest in visible and politically attractive initiatives while neglecting the more demanding task of strengthening acquisition institutions and improving the state’s ability to translate budgets into capability. Getting this balance right is particularly relevant for middle powers operating under severe resource constraints.
The Allure of the Drone Revolution
The appeal of these conclusions is easy to understand. Ukraine has demonstrated that relatively inexpensive one-way attack drones can perform missions once requiring assets of significant complexity and cost—strike aircraft, precision-guided munitions, and the airborne, space, communications, and command and control architecture to coordinate them. Ukraine has employed these systems along the front line and deep inside Russian territory, imposing costs disproportionate to its conventional military resources. Iran has demonstrated a comparable dynamic in a different strategic context, threatening Israel, regional partners, and US installations using missiles and drones despite lacking a modern air force.
In both cases, states facing more powerful adversaries have employed drones as asymmetric instruments capable of imposing costs and denying military success. This happens in two ways. Drones can contribute to deterrence by increasing the costs of aggression, and under certain circumstances they can support more limited forms of deterrence by denial, particularly where persistent surveillance, rapid targeting, and attritional effects restrain offensive operations. These are consequential military effects, and their relatively low cost has understandably captured the attention of defense planners worldwide.
The industrial dimension has been reinforced by developments in the United States. Venture-backed firms applying commercially derived technologies to military problems have drawn inspiration from the earlier experience of the space sector. Companies such as SpaceX demonstrated that private equity could generate innovation more rapidly and, in some cases, more efficiently than traditional prime contractors—though SpaceX benefited from a business model combining government demand with substantial commercial revenue streams via Starlink. More recent firms such as Anduril and Shield AI have pursued variants of this approach without the broad commercial markets that made the new space model financially sustainable.
The policy response has been consistent. For a more systematic understanding, I conducted an analysis of the defense industrial strategy documents, expanded in the present article to those published in the last three years by major powers (US, UK, France, Germany) and middle powers (Brazil, Australia, Turkey, Canada and Sweden). Looking at 24 individual policies across four categories: supply-chain (e.g., state grants and R&D financing, small and medium enterprises and startup support, private finance incentives), workforce (e.g., training and expansion), exports and international cooperation (e.g., incentives and frameworks), and acquisition (e.g., faster and simpler regulations, strengthening organization’s capabilities and authorities).
Across both major and middle powers, governments are prioritizing industrial resilience, production capacity, and the ability to mobilize during crises, with Ukraine as a common reference point. Major powers have generally combined these initiatives with broader efforts to reform acquisition systems (particularly the US and the UK), while balancing secondary efforts in institution building (workforce and export promotion). Middle powers, by contrast, focus mostly on supply-chain development initiatives, such as innovation accelerators and small enterprise support frameworks that substitute for more difficult institutional reforms.
There is also an increasing effort to mobilize private capital. European powers in particular are investing considerable policy effort in reforming financial sector rules— Environmental, Social, and Governance (ESG) classification, European Investment Bank mandates, export credit guarantees, and dedicated defense equity vehicles— to unlock private capital that regulatory frameworks had inadvertently excluded. But some middle powers like Canada and Australia are also setting up their own frameworks for attracting private capital.
What Drones Cannot Do
The drone revolution is real, but its strategic implications are frequently overstated. At the military level, inexpensive strike systems have lowered the barriers to standoff precision strike, allowing states with limited conventional capabilities to threaten adversaries in ways once reserved for major powers. They have also allowed for significant denial capability at the tactical level in ground operations, increasing battlefield transparency and making difficult to concentrate forces, delaying the tempo of maneuver and preventing exploitation of gains.
The economics of strategic defense have changed far less. The capabilities required to deny an adversary control of the air, protect critical infrastructure against sustained attack, project power over contested distances, or prevail in ground operations and consolidate gains remain concentrated among a small number of states. Advanced fighter aircraft for defensive and offensive counter-air operations, integrated air and missile defense systems, offensive missile forces, submarines, naval combatants, and the command-and-control architectures needed to coordinate them, continue to demand levels of technological sophistication, industrial depth, and financial investment that few countries can sustain.
This creates an important asymmetry. The barriers of entry for imposing costs on an adversary have fallen much faster than those associated with acquiring the capabilities needed to control the course and outcome of military campaigns. It is not yet clear whether middle powers will devote their fiscal capacity to exploiting the drone advantage or remain on the long-term path of acquiring conventional denial capabilities. Paradoxically, the more they do the former, the more they will deepen their disadvantage with larger, more diversified military powers. This trade-off will shape defense industrial efforts and the future of these markets.
The Economics of Defense Markets
The cheapness and attritable quality of drones have led to renewed focus on producing at scale. But part of the policy discourse has conflated “how to buy” problems with “what to buy.” Much of the current debate implicitly frames defense industrial development as an innovation ecosystem problem in which, if governments create the right regulatory environment, mobilize venture capital, and support startups, military capability will follow. However, this perspective captures only part of the problem and risks obscuring the more fundamental economic characteristics of defense markets.
Defense markets are politically constructed procurement systems in which governments simultaneously act as customer, regulator, financier, and co-developer of military technologies. Unlike commercial markets, where consumer preferences drive demand, defense demand is generated through political and strategic processes. Governments decide what capabilities are required, establish technical specifications, allocate budgets, determine acquisition timelines, organize tenders, and design and execute contracts.
Venture capital can finance experimentation and support mature-stage prototype development, but it cannot replace the government’s role as the early risk taker in research and development of concepts and technologies, nor as the ultimate purchaser of military capability. Firms cannot scale manufacturing facilities, expand workforces, or build resilient supply chains without credible expectations regarding future procurement. Therefore, the model of private equity-backed defense startups strains when government contracts take too long to materialize, leading to returns on investments taking more time than what would be acceptable for an alternative commercial project. This is why recent acquisition reforms in the United States have focused so much on procurement processes —new acquisition pathways, streamlined requirements generation, faster contracting and privately financed prototype development.
Now, these approaches suit certain categories of military capability well: software-intensive systems, autonomous platforms, some space applications, and selected unmanned technologies. The type of capabilities required by US Special Operations Forces also constitutes another suitable area for a streamlined process, where operators and acquirers are more closely integrated. But these approaches are far less consequential for large-scale programs involving high uncertainty, large fixed capital investments, extensive testing requirements, long service lives, and concentrated industrial structures.
Advanced combat aircraft, major naval platforms, missile defense systems, and elements of the nuclear enterprise conform poorly to commercial innovation models. The economics of defense acquisition mandate that for these types of systems, sole-source production environments will ensue, and if overruns occur, even fixed-price contracts will transform into cost-sharing in practice. The magnitude of the budgets and time involved will also call for a contractor with sufficient manpower, financial backing, and an extensive engineering and manufacturing track record. In short, different categories of military capability will require specific institutional arrangements because they embody different sources of technological, financial, and contractual risk, which is why there is no single optimal acquisition strategy.
Middle powers and most developed economies face these same shortcomings, but with the additional challenge of lacking an even remotely comparable venture capital market as the United States. The expectation that venture-backed private investment could alleviate budgetary burden at the developmental stages for middle powers is extremely optimistic.
What Middle Powers Should Do Instead
For middle powers engaged in challenging security dynamics with limited resources, it’s untenable to pursue every industrial objective simultaneously, nor can they assume that organizational models adopted by major powers will translate to their circumstances.
Therefore, for countries operating under permanent scarcity, the first order of business should be to develop institutional capacity for defense acquisition: a stable and qualified technical and contracting workforce, enabled with flexible and transparent procurement mechanisms, and stable budget resources. This is usually the most underestimated area of investment.
On a second order, one of the most common instruments middle powers have used to develop domestic defense industries is the requirement of industrial offset agreements. The historical record is mixed: many programs have generated maintenance activities with no technological upgrading, and investments have sometimes been dispersed across politically attractive sectors with no clear relationship to strategic priorities. Yet offset effectiveness depends heavily on the institutional capabilities of the states employing them. Governments must define what forms of industrial development they seek, identify realistic pathways through which foreign partnerships can support those objectives, and monitor implementation over time.
Lastly, middle powers should prioritize the limited number of capability areas in which domestic production offers meaningful strategic advantages—where supply chains are vulnerable during crises or where existing industrial competencies provide a credible foundation for development. For some middle power militaries, drones and selected categories of munitions may satisfy these conditions. Advanced combat aircraft or large naval platforms present a different set of challenges, requiring large and stable funding, and industrial infrastructures that typically only merge over decades.
In any event, the countries most likely to succeed in strengthening their defense industrial bases are the ones able to combine an openness to cooperate with foreign partners for technological transfers with the patient construction of institutional state capability. For middle powers in particular, the most consequential investments may ultimately be the least visible: procurement organizations capable of managing complex projects over time.
Martin Novella is a researcher focused on defense acquisition and industrial policies from a comparative perspective. He is a former National Director of Defense Industrial Policy at the Ministry of Defense of Argentina, and former Head of operations planning at the Military Fabrications SOE. He is currently Director of anticompetitive concerted practices at the National Competition Authority.
The views expressed are those of the authors and do not reflect the official position of the Irregular Warfare Initiative, Princeton University’s Empirical Studies of Conflict Project, the Modern War Institute at West Point, the Department of the Army, the Department of War, or the United States Government.
The main image is UK Royal Marines testing new technology and tactics during Exercise Olympus Warrior as part of LRG(X) at Cyprus taken from Wikimedia Commons.
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