Europe’s defence spending is set to increase significantly in the next few years. If properly channelled towards technological development, this could boost productivity without decreasing social spending.
The seemingly ambiguous attitude of the Trump administration towards NATO and Ukraine have forced Europe to reconsider its security strategy and to reduce dependence on the US in this regard. Germany is in the process of relaxing its debt brake to allow potentially unlimited defence spending, and other countries are poised to increase defence spending as well. The European Commission recently announced the ReArm Europe Plan.
This marks a major shift that goes beyond purely defence and security issues, as new military spending will mean that European governments will face difficult budget decisions regarding their welfare states.
The “guns or butter” model is a traditional economic framework that describes the trade-offs governments face when deciding how much to spend on national defence and on social programs. Since economic resources are limited, governments should choose how much to spend on each. Our chart shows that, after the end of the Cold War, the four largest eurozone economies (Germany, France, Italy and Spain) massively increased social spending in real terms while letting defence spending dwindle.
With the threat posed by the Soviet Union gone, the American security umbrella was taken for granted, allowing European governments to spend more on “butter” than on “guns”. This was the so-called peace dividend enjoyed by the continent. Only since 2019 has defence spending in Europe started to rise in real terms above the 1996 levels, as a result of pressure from Washington on NATO members to meet the alliance’s target of 2% of GDP. Although our chart stops at 2022, this upward trend has continued over the last two years.
There is some truth in the guns-or-butter trade-off, especially for countries with little fiscal room to manoeuvre, as they might have to sacrifice social spending to accommodate more defence spending. This is particularly the case if such spending is to rise to the 5% of GDP demanded of NATO members by US Defence Secretary Pete Hegseth. However, cuts to social spending would not be entirely harmful as they could be derived from efficiency gains, from slashing bureaucracy or from revising outdated norms, such as by adjusting the retirement age in some countries (which could be a source of political friction).
Moreover, more defence spending, if channelled towards technological progress, could also lead to productivity gains that could expand, and not shrink, available resources, reducing the need for painful spending cuts. History shows that technologies developed in the military realm, from GPS to the internet, tend to quickly percolate into the private sector. According to some estimates, on average, a 10% increase in government-financed R&D generates an increase in privately funded R&D of about 5%.
The Draghi Report pointed out that Europe has to make substantial progress in this sense, as just 4.5% of its defence spending goes towards innovation-related activities, as opposed to 16% in the US. Finally, in order to reap the rewards of more defence spending, Europe will need to expand domestic production capabilities, as nearly 80% of European defence procurement is currently imported from non-EU suppliers.
