NATO cash bonanza risks becoming Europe’s lost chance for growth

Rebuilding Europe’s military is the central motivation, but officials from Brussels to Frankfurt are also harboring hopes for an economic boon from the deployment of so much in the way of scarce resources

Europe’s plans to unleash trillions of euros in new defense spending will be a huge missed opportunity unless the region can work out how to raise productivity in the process.

Any economic benefits beyond bolstering its own military capacity are likely to be lost if countries don’t change the way they invest in their armed forces, and develop and produce weapons. That’s what calculations by Bloomberg Economics suggest, pointing to only a fleeting growth impact that peters out within three years.

As this week’s NATO summit brings that wave of money one step closer to reality, the prospect that so much taxpayer cash could just leak out of the region’s economy without meaningfully helping expansion is casting a shadow over politicians’ ambitions to shore up creaking defenses against Russia.

Rebuilding Europe’s military is the central motivation, but officials from Brussels to Frankfurt are also harboring hopes for an economic boon from the deployment of so much in the way of scarce resources. The European Central Bank said as much as recently as this month.

The region’s struggles to nurture its own research capacity, and to develop home-grown production stand in the way of that, potentially meaning that the end of the post-Cold War peace dividend from lower military outlays won’t be succeeded by a growth dividend from increasing them.

“How the money is spent matters more than how much is spent,” said Bhargavi Sakthivel, a global economist at Bloomberg Economics. “Investments in research and development drive far greater economic growth than simply purchasing equipment from abroad.”

Under pressure from Donald Trump — and fearful that he could abandon the continent’s defenses — European countries are collectively pledging to ramp outlays with eyewatering amounts. The US president is scheduled to attend the NATO summit in The Hague later on Tuesday.

Just to meet the alliance’s planned defense budget target of at least 3.5% of gross domestic product, Germany, the region’s biggest economy, will have to spend an extra €689 billion through 2035. Italy and France each need more than €400 billion, according to BE’s Sakthivel.

Such investment would stretch public finances that are already bloated. Italy and France have debt exceeding 100% of GDP, and deficits above the European Union’s limit of 3% of output.

But as with prior spending sprees such as the EU’s recovery fund unveiled during the pandemic, officials are optimistically counting on a growth fillip.

“While the uncertainty surrounding trade policies is expected to weigh on business investment and exports, especially in the short term, rising government investment in defense and infrastructure will increasingly support growth over the medium term,” ECB President Christine Lagarde said after unveiling an interest-rate cut on June 5.

Sakthivel’s calculations show only a muted impact however, with each of the four biggest economies in the euro area seeing a growth benefit of between 0.1 and 0.2 percentage point for 2025 — an effect that diminishes to zero within three years.

Those projections are based on the assumption that Europe will stick with past practice in its mix of spending, deploying most of its money on personnel, maintenance and equipment, and only 4% on research and development — so very little that is productivity-enhancing.

Meanwhile the region remains dependent on imports for large amounts of its materiel — almost 80% of EU equipment purchases emanate from elsewhere — limiting any benefit to domestic business. Then there’s a further hit to efficiency because of the reallocation of workers from the productive economy to an expanded military.

To be sure, the continent does have a domestic arms industry that can be built up, with existing companies within the euro zone including Rheinmetall AG, Leonardo SpA and Thales SA and plenty others in the wider region. That’s something equity investors are betting on heavily, whatever the consequences for the wider economy.

The EU Commission, in its forecasts released last month, took what it described as a conservative assumption that 10% of defense spending might aid productivity, based on combining R&D and infrastructure outlays within the bloc’s military budgets. They also projected a higher share in an alternative scenario.

That points to just how far officials are aware of the growth prize at stake. Whether the EU succeeds in ramping up local production of defense goods, and building up its own R&D, could make a serious difference. Bank of Italy Governor Fabio Panetta addressed that latter point in Milan last week, citing the example of the Pentagon’s involvement in the birth of the internet.

“In order to maximize the positive consequences of increasing our spending in defense we should invest in technology,” the ECB policymaker told a gathering of students. “Of course spending in defense is not the ideal way to support growth, but we have examples from the past of ways spending on defense was positive.”