Europe needs to rearm much faster
How to overcome the three constraints: fiscal rules, financial borrowing power and political feasibility
Strengthening Europe’s patchy defences is now at the top of the continent’s political agenda.
Germany’s new chancellor, Friedrich Merz, acknowledges that Europe can no longer rely on Donald Trump’s America for its security. France’s president, Emmanuel Macron, who has long advocated for EU “strategic autonomy”, is open to sharing his country’s nuclear umbrella with its European partners. The European Commission is launching a €150 billion pan-European defence fund. And NATO defence ministers yesterday agreed a set of new common capability targets.
At a summit in The Hague on 24-25 June, NATO leaders are also set to endorse a big hike in defence spending to 5% of GDP – with a target to spend 3.5% of GDP on the military, plus 1.5% of GDP on security measures such as strengthening critical infrastructure, intelligence services and cyber defences, by a still-unconfirmed date.
This is all good progress. But unfortunately there is still often a big gap between leaders’ bold rhetoric and their slow and inadequate actions.
Take Britain, Europe’s second-biggest military power. In the face of an “immediate” threat from Russia, the UK needs to be “battle-ready” and “armour-clad”, Prime Minister Keir Starmer declared at the launch of the country’s latest strategic defence review on 2 June. But even though the UK’s defences are threadbare – its army is tiny and it lacks an air-defence system against Russian missiles, among many other things – his government is not yet willing to invest in the necessary upgrades.
The UK plans to increase defence spending by a mere £2.2 billion this financial year. As a share of GDP, defence outlays are set to edge up from 2.3% last year to 2.5% in 2027, with an “ambition” to reach 3% by 2034 “subject to economic and fiscal conditions”. Vladimir Putin must be quaking in his boots.
The UK’s plight is emblematic of a broader problem across much of Europe. The need to boost defence spending in the face of unprecedented new threats is hemmed in by three big constraints: fiscal rules, financial borrowing power and political feasibility.
The underlying problems are a lack of economic growth, which strains public finances and disgruntles voters, and continuing complacency among many Europeans about the new threats to the cosy peace they have long enjoyed.
This essay explains why Europe needs to rearm massively and immediately. It argues that while this will eventually require tax rises and/or spending cuts, the best way to fund such a big emergency boost to defence spending is by borrowing more for a few years, preferably collectively. Done right, this could help streamline military procurement, better integrate Europe’s fighting forces and even provide a much-needed lift to Europe’s struggling economies.
Why Europe needs to rearm right now
The post-1945 geopolitical order that has long kept Europe safe under America’s nuclear umbrella is collapsing, as I explained at length in my Broken World essay.
The amoral rapprochement between Trump and Putin poses an existential threat to both war-torn Ukraine and America’s European NATO allies.
They can no longer count on the US to safeguard them against Russian aggression. As their mistakenly leaked Signal group chat confirmed, the likes of Vice President JD Vance and US Defence Secretary Pete Hegseth see Europeans as contemptible free-loaders.
The shared values that once cemented the transatlantic alliance have come unstuck. MAGA Republicans view mainstream European leaders through the prism of American culture wars, as fellow travellers of the US liberals that they hate and despise. Their affinity is with far-right nationalist politicians like Poland’s new president, Karol Nawrocki, not its centre-right prime minister, Donald Tusk. Mainstream European leaders are, in turn, aghast at Trump’s corrupt authoritarianism and his cosiness with foreign strongmen and far-right populists such as Germany AfD.
Their shared interest in European security is also greatly diminished. Trump is, at best, indifferent to the plight of Europe. As he repeatedly emphasises, an ocean separates the US from Europe, keeping it distant and safe from any European conflict.
Worse, Europeans’ dependence on their erstwhile protector makes them prey for a predatory US president who exploits any weakness as leverage. Witness Trump’s play to annex Greenland from NATO ally Denmark, or the likelihood that he will use the threat of abandoning US security guarantees to strong-arm the EU in trade negotiations.
In a nightmare scenario, Trump might openly side with Putin, not just against Ukraine but also against the US’s longstanding NATO allies. As Edward Lucas recently argued in The Times,
All of Europe is awakening to the reality that the era of American hegemony is ending. If we are lucky, the withdrawal will be gradual and manageable. If we are unlucky, it may be quick and chaotic. Most worrying (and increasingly plausible) is that Trump decides he prefers Russia and actively undermines our security.
One reason for Europe to rearm immediately, then, is to try to buy time. Trump has called for Europe to spend 5% of GDP on defence so that it foots the full bill for American protection. That is not an unreasonable demand. And the hope is that hiking defence spending might delay the US’s withdrawal from Europe long enough for it to rearm enough to deter Putin on its own.
Even more importantly, an immediate surge in defence spending would provide insurance against the threat that Trump might suddenly abandon Europe, or indeed betray it by siding with Putin.
Thus while targets to increase spending by the 2030s are all well and good, the pressing threat to Europe requires an immediate response.
Europe is, in effect, already at war with Russia. Ukraine is in the front line; brave Ukrainians are dying not just to defend their own country, but also all of Europe.
Russia is also increasingly attacking the rest of Europe directly through sabotage, arson, assassination and disinformation.
Meanwhile, far-right, pro-Putin politicians, notably Hungary’s prime minister Viktor Orbán, seek to undermine Europe’s defences from within – with Trump’s support too.
The good news is that Europe is perfectly capable of defending itself, if it wants to.
It’s big: the combined population of the EU, the UK and Norway is 523 million, more than 3.5 times that of Russia (146 million).
And it’s rich: Europe’s combined GDP is nearly five times bigger than Russia’s in purchasing power terms (and nearly 11 times greater at market prices).
But it needs to put its money where its mouth is. Russia has ten times more nuclear weapons than do France and the UK, Europe’s only nuclear powers. Its military expenditure last year ($462 billion) was higher than Europe’s ($457 billion) after adjusting for differences in purchasing power, according to the International Institute for Strategic Studies (IISS). Moreover, the war in Ukraine highlights how Putin is willing and able to impose much greater costs on Russians to achieve his war objectives than Europeans are so far willing to accept to defend themselves.
Threatened by Putin and potentially betrayed by Trump, Europe therefore needs to massively rearm, and quickly.
Three priorities
Europe’s immediate priorities are three-fold: defending Ukraine, deterring Putin and reducing dependence on Trump.
Europe needs to support Ukraine’s war effort both financially and militarily until it can negotiate a peace settlement with Russia from a position of strength. To that end, Europe should seize the €200 billion in frozen Russian assets, as Martin Sandbu has rightly argued in the FT. If Europeans are too scared to use the power they already have, how will they ever deter Putin in future?
Europe also needs to step up its battle-ready military capabilities to deter further Russian aggression.
And it needs to develop European alternatives to the US’s nuclear umbrella and its cutting-edge hardware such as Patriot air-defence systems, while also tapping into cheaper and more effective new technologies, such as Ukrainian drones.
Replacing the US’s role in Europe’s defence is a massive endeavour, especially since decades of underinvestment have left huge gaps in its military readiness, from manpower to weapons, equipment and munitions, as a recent report by Bruegel, a Brussels-based think tank, documents.
Since time is short and the needs are huge, this increased investment needs to be frontloaded. While Poland’s military spending is already heading towards 5% of GDP, most European countries spend scarcely more than 2% of GDP on defence, and some much less than that.
Defence spending therefore ought to promptly rise to Polish proportions until Europe is able to stand up to Putin without Trump’s aid.
Three constraints
European governments can fund this increased defence spending in three ways: through tax hikes, cuts in other spending, or higher borrowing.
While a long-term rise in defence spending will eventually need to be financed by higher taxes or spending cuts, the need for speed and scale make it sensible to fund a big emergency boost with a temporary rise in borrowing, especially because it would be an investment in Europe’s present and future security.
But policymakers face three constraints: fiscal rules, financial borrowing power and political feasibility.
Self-imposed fiscal rules can help governments credibly commit to restrain their borrowing in ordinary times, thereby lowering their interest costs. But in an emergency – such as a financial crisis, a pandemic or a war – the immediate benefits of temporarily boosting borrowing far outweigh the costs of any potential loss of long-term credibility. Even in narrow economic terms, investing much more right now to deter Putin is much cheaper than having to fight a future war would be.
Fortunately, EU leaders now seem to recognise that. They have greenlit a borrowing splurge for defence for four years. Increased spending on defence will be exempt from EU fiscal rules, which broadly limit budget deficits to 3% of GDP. The European Commission reckons that if all countries raise defence spending by 1.5% of GDP, this would provide a €650 billion boost over four years.
Indeed, Germany wants to go further: it is now arguing for a permanent loosening of EU fiscal rules.
Germany’s about-face is truly remarkable. It has long been fiscally frugal and wary of military might; now it is leading the way on borrowing to rearm. Chancellor Merz, a lifelong Atlanticist and fiscal conservative, argues that Europe needs to achieve “independence” from the US and pledges to do “whatever it takes” to defend peace and freedom on the continent, deliberating echoing the phrase used by then European Central Bank President Mario Draghi to quell the crisis in the eurozone in 2012.
To that end, Merz struck a deal with his coalition partners to break the fiscal straitjacket of the constitutional “debt brake” introduced by then-Chancellor Angela Merkel in 2009 – to, in effect, allow unlimited borrowing for defence (for spending above 1% of GDP).
The sweetener for the Social Democrats is a €500 billion 12-year infrastructure investment fund. The Greens, who have not joined the coalition but whose votes were needed for the requisite two-thirds supermajority in the outgoing Bundestag, were won over with pledges that €100 billion of that fund will be used for climate measures. State governments will be permitted to borrow a bit more too. (That said, according to Jeromin Zettelmeyer of Bruegel, that extra infrastructure investment will fall foul of EU fiscal rules unless they are loosened again, hence Germany’s policy shift.)
Germany has ample scope to borrow more. Its budget deficit was 2.8% of GDP last year and its public debt was around 62% of GDP. Prior to the announcement of the increased borrowing, it could borrow for ten years for a mere 2.5%. Following the announcement, this rose by around 30 basis points (0.3 percentage points), and has since fallen back by around 10bp. More importantly, the reason that bond yields rose is that investors expected higher German growth, not that they feared for Berlin’s solvency.
While it remains unclear how far and how fast Germany will up defence spending from its current 2.1% of GDP, Merz’s dramatic move could be a game-changer.
Assuming a military increase of some 1.5% of GDP, and a smaller amount for infrastructure and climate, this amounts to a Keynesian stimulus of more than 2% of GDP that could help lift Germany out of its post-Covid economic stagnation, with spillover benefits for the rest of the EU too. It could also provide a lifeline to its struggling manufacturing sector; disused car factories can be retooled to make tanks.
Better still, the boost to domestic demand could limit the harm from Trump’s tariffs. EU exports to the US now face a 10% additional tariff, with the threat that this will rise to 50% if a trade deal isn’t struck soon. Exports of cars and car parts face a 25% levy; Germany’s totalled €36.8 billion last year, which is equivalent to 0.85% of its GDP.
While US protectionism will be painful in the short term, in the medium term it would be healthy if German growth came to rely less on exports and more on domestic investment and consumption.
The good news, then, is that EU fiscal rules are being eased, as are Germany’s more stringent domestic ones. But in order to borrow more, European governments don’t just need to ease the legal constraints on doing so, they also need the financial capacity to do so.
While fiscal rules are set by governments, financial borrowing power is dictated by bond markets. Germany has low government debt and abundant borrowing power; France and Italy do not; and countries outside the eurozone such as Poland also face much higher borrowing costs.
To ease that financial constraint, EU leaders have also agreed to allow the European Commission to use its triple-A credit rating to borrow €150 billion, secured against the EU budget, to lend to EU governments for joint military procurement.
At less than 0.9% of EU GDP spread over several years, €150 billion is too little. But now that the principle of joint EU borrowing for defence has been agreed, this amount could be increased. The EU’s Covid response provides a promising precedent: what began as a €100 billion joint borrowing scheme eventually expanded into a €750 billion one.
The stakes are highest in France, which is the EU’s biggest military power and has Europe’s only independent nuclear deterrent, as well as a bulging budget deficit and government debt of more than 110% of GDP. President Emmanuel Macron wants to lift defence spending from 2.1% of GDP to 3.5%. But France’s coalition government lacks a parliamentary majority, so this would need the support of either the centre-left Socialists or the far-right National Rally. Prime Minister François Bayrou had been angling for the former, with talk of funding higher defence spending by hiking taxes on the wealthy. But Macron has since instead suggested spending cuts that will be unpalatable to the Socialists.
One partial solution might be that Germany and others could contribute to France’s increased costs in return for it extending its nuclear umbrella to the rest of Europe.
A broader solution could be much higher EU borrowing. The hitch is that Hungary’s Orbán is openly pro-Putin, while four other EU countries (Austria, Ireland, Cyprus, and Malta) have maintained their official neutrality vis-à-vis Russia.
The case for EU bonds
Given that Trump’s toxic and erratic policies are undermining international investors’ trust in dollar assets, there would doubtless be huge appetite for a big issuance of euro-denominated EU-issued bonds, as I argued in a recent column for Project Syndicate.
The EU has already issued around €1.3 trillion ($1.5 trillion) in common debt. Some €620 billion in outstanding EU bonds were issued to fund Covid recovery programs; the European Investment Bank had €420 billion in bonds outstanding last year; and the European Stability Mechanism, the EU’s crisis-lending arm, had an additional €280 billion outstanding (in combination with its predecessor).
But the stock of EU debt remains tiny compared to the US Treasury market, and the flow of new bond issuance is relatively low and irregular. Pandemic-related collective EU borrowing was meant to be a one-off programme, and the European Commission’s new €150 billion facility to lend to EU governments for joint defence procurement is likewise time-limited.
Thus, there is a compelling case for capitalising on this opportunity to issue many more common bonds, and to roll over existing EU debt as it matures. Doing so would bolster the euro’s international role, boost the EU economy, and help finance a much-needed increase in Europe’s defence spending.
European leaders have long resented the “exorbitant privilege” that the dollar confers on America in the global financial system. The fact that US Treasuries have been the premier safe asset for both official-sector reserves and private-sector portfolios has lowered the US government’s borrowing costs, and thus the interest rates paid by riskier US borrowers, too. It has also given US policymakers exceptional freedom of action, not least during crises, when everyone else typically wants dollars. Although the euro is a long way from displacing the greenback, it has the potential to be a more important reserve currency and safe-haven asset.
As a geopolitical matter, EU leaders have already endorsed the idea that the euro should play a more important international role. This goal has become urgent now that Trump is wrecking the global order and threatening to use Europe’s dollar dependence against it.
As an economic matter, issuing EU bonds would help Europe’s economy in the face of US tariffs and Trump-induced, investment-chilling uncertainty. Since EU exports to the US are poised to shrink, fiscal stimulus may be needed to foster alternative sources of demand.
As a security matter, joint EU borrowing would enable Europe to raise hundreds of billions of euros more for its own defence and that of Ukraine, and in a way that does not burden stretched national public finances or require unpopular tax hikes or spending cuts.
As a financial matter, a greater issuance of EU bonds would be helpful for eurozone banks whose holdings of domestic government bonds otherwise tie their fate to that of the government that backstops them. This dynamic was the source of the “doom loop” that drove so much of the 2010-12 eurozone crisis.
The main objection to issuing common EU debt is, of course, political. Frugal northern European governments have traditionally not wanted to bankroll what they view as southern European profligacy. But Germany and other fiscally conservative governments are now much more open to common EU borrowing, owing to their pressing need to rearm (Berlin is much closer to the Russian border than Rome, Madrid, or Lisbon).
Perhaps most importantly, a bold move to issue common bonds would give the EU greater agency. Instead of merely reacting to Trump’s every betrayal and flip-flop, Europeans would be taking control over their own destiny. If not now, when?
Political feasibility
Political feasibility is the third constraint; voters need convincing that defence spending needs to rise, and that this requires higher borrowing, and eventually spending cuts or tax rises.
Germans seem convinced that their country needs to rearm: 70% say that it is good that Germany plans to spend significantly more on defence. A similar proportion of French people think their country needs to do so too. But Britons are less convinced. Only 49% favour increased defence spending; 57% oppose paying higher taxes to fund it; and 53% are against cutting other spending to pay for it.
For sure, the UK government could make better efforts to convince Brits that higher defence spending is necessary. But it is also hamstrung by its own self-imposed political constraints.
Since the UK has Brexited, the EU’s fiscal rules no longer apply, but the newish Labour government remains hamstrung by its own rules that it is loath to compromise. Since those rules allow it to borrow to invest, it could include investment in defence in that, but it hasn’t.
At the same time, the government is reluctant to raise taxes again, so soon after promising that its big hike announced last year was a one-off. And while it is trimming welfare spending and shortsightedly slashing the international aid budget to pay for slightly higher defence spending, here too its room for manoeuvre is limited because it has pledged not to return to austerity.
The upshot is that Starmer has boxed himself in: he knows Britain needs to spend much more on defence, but political constraints prevent him doing so.
The way to square the circle for both France and the UK could be by borrowing more collectively. As I have argued in Project Syndicate, a coalition of willing European governments could set up a special purpose vehicle separate from the EU which could issue joint bonds backed by guarantees from participating governments. This would not only bypass recalcitrant EU members; it would also allow for participation by non-EU defence partners such as the UK. And it could be crafted in such a way as not to fall foul of UK fiscal rules.
Bruegel, a Brussels-based think tank, has proposed an even better solution: a European Defence Mechanism (EDM). This new intergovernmental institution independent of the EU would bring together a coalition of willing governments, both EU and non-EU. As such, it would be open to the UK, Norway and Ukraine, and not hamstrung by a potential Hungarian veto or Austria’s neutrality.
It would function a bit like a multinational bank: member governments would contribute capital, and the EDM would then borrow to purchase military equipment collectively. This would give member governments greater borrowing power. And joint purchasing would cut costs, help rationalise Europe’s disparate defence manufacturers and facilitate military co-operation.
One ingenious suggestion is that the EDM would own the military equipment until the member governments needed to take delivery of it, delaying and spreading its costs. And in the case of pricey collective equipment such as a pan-European air-defence system, it could hold the asset on its books longer term and charge members an annual service fee.
While the EDM would involve a step change in European cooperation in defence, it would be a big step forward.
Conclusion
The primary aim of rearming right now is to deter Putin and keep Europeans safe, and the best way to do so is by borrowing collectively.
But increased defence spending could also provide broader economic benefits: good jobs, investments in manufacturing communities, increased domestic demand and higher productivity. The Kiel Institute estimates that increasing defence spending by 1.5% of GDP could raise EU GDP by between 0.9% and 1.5%. Economists at Goldman Sachs expect a 1% fiscal boost to translate into 0.5% higher GDP.
Commitments for a big and sustained boost in defence spending would give European defence companies the confidence to invest in expanding production. While some essentials may need to be purchased from the US initially, Europe should aim to reduce its dependence on the US over time.
Higher defence spending could also help promising European defence tech startups such as innovative Ukrainian drone makers and Helsing, a German company that uses AI to make smart airborne and underwater drones. More broadly, investing in military research and development (R&D) can also boost the private sector. One study suggests that a 10% increase in defence R&D results in a 4% increase in private R&D.
The takeaway is simple. Europe is at risk of attack by Putin’s Russia and abandonment by Trump’s America. It needs to rearm massively, right now.