Dividends

Without the massive surge in defense spending, the German economy would have posted a net decline in GDP since 2022, instead of extremely modest 0.2% growth. For the EU as a whole, defense spending has accounted for as much as 20% of growth since 2022. While the contribution to GDP from the defense sector is still small, much of this is the result of the cruel bargain staked out between the US – which set the 5% GDP defense spending target – and other NATO member states. The EU is still importing the majority of its military products, heavily benefiting the US and non-EU states like Turkey. But future EU plans aim to correct this. In economic policy, the effect of public spending is measured by its multiplier effect – a multiplier of one means that for every Euro spent, a Euro is added to GDP. A multiplier less than one implies that for every Euro spent, less than a Euro in total output is generated. Military spending typically has a lower multiplier (below 1) than other types of spending, like infrastructure projects. In order to achieve the highest multiplier possible, defense spending is ideally spent on high tech R&D, rather than on personnel. The Europeans currently spend much more on personnel than they do on research and procurement. Ukraine represents an opportunity to change this. European-owned ventures providing weapons to Ukraine can effectively generate their own demand, by lobbying their own governments to issue new debt to fund procurement deals. Much of the spending in the beginning phases of the war went towards procuring existing systems, rather than researching new ones. But the Danish model envisions Ukraine as a vast laboratory for European defense contractors. As European-Ukrainian joint ventures convert vast sums of R&D money into weapons, they can be tested in the field immediately, and then sold around the world. After several years of new industrial projects, up front construction costs can now be paid off through regular operations. And defense expenditures haven’t even reached half of the European target yet. The biggest negative impact on the European defense spending multiplier is the percentage of that spending that goes towards imports, because they add to the exporter’s GDP, rather than Europe’s. But the share of spending going towards imports is steadily beginning to fall.

There are several issues with the European plan. Public spending funded by tax increases tends to permanently lower the multiplier effect of that spending, while debt financing will increase a multiplier temporarily. But if a country’s debt-to-GDP ratio gets too high, or servicing the debt becomes a burden, the multiplier can become negative. Historically, defense spending has been financed with increasing public debt, and that’s the plan for Europe. This summer, the European Council activated a provision in the Stability and Growth Pact called the national escape clause that will allow 15 member states to exceed the normal EU limit for deficit spending. The war in Ukraine and the need for increased spending were cited as the rationale. Taking on excessive debt to fund defense, and in turn stimulate the EU economy, is a form of kicking the can down the road. Italy, France, Belgium, and Spain have surpassed 100% debt-to-GDP ratios, while Portugal, Austria, Hungary, Poland, and Slovakia are being observed under the EU’s Excessive Deficit Procedure for their deficit spending. The UK’s ratio stands at 103%, and Germany’s ratio has increased by a massive 25% this year alone. With the German economy stagnant, and the multiplier effect of defense spending well below one, the Europeans are digging themselves into a long term hole.

Defense sector gains have been major. The sector’s weighting as a percentage of the overall European market has tripled since 2022, outperforming the market as a whole by a factor of six. But the average European hasn’t seen the benefits. Defense employs around half a million people within the EU, but employment gains have been modest, adding around 50,000 jobs. Meanwhile, traditional manufacturing has been plagued by losses of over a million manufacturing jobs over the last five years. Germany alone has lost 600,000 manufacturing jobs since 2022. At best, the European defense spending strategy seems to offer a way to maintain stagnation, rather than achieve growth. But outside of economic concerns, it’s functioned as an ingenious political solution. Rather than dealing with the EU’s economic problems head-on, the Union’s governments have been able to launder a massive economic stimulus plan as a solution to a violent external threat. A courageous facade has been erected to cover clinical – and probably irresponsible – fiscal policy. Appealing to morality, ideology, and fear has been widely successful, and European populations have mostly accepted the messaging. Because of this, it’s highly unlikely that the EU will tolerate an early conclusion to the war in Ukraine. They stand to lose the justification for their spending, lucrative contracts for their defense sectors, tens of billions on loans that Ukraine will be unable to pay, and the massive investments they’ve made into military-industrial infrastructure. Their dream of a generational extractive project in the form of a debt-ridden, prostrate Ukraine, a place outside the EU but with every trade and economic agreement written solely to benefit it, stands at risk of being destroyed by a steadily advancing Russian army. Anything less than a permanent war footing could potentially spell disaster. If Ukraine or the NATO spending project collapses, expect major upheaval across the continent.