Business & Finance

Europe Defense Spending Rises as America Shifts Focus: An Economic Opportunity

2025 has presented significant challenges for Europe. With the highest risk of war on the continent in recent history and widening economic disparities between the European and American economies, Europe finds itself at a crossroads. While the United States continues to pull ahead economically, European nations are grappling with critical decisions regarding their security and financial future.

A significant increase in Europe defense spending appears inevitable as geopolitical instability intensifies. However, this increase presents not only security benefits but also potential economic advantages. The impact of heightened military expenditures will largely depend on factors such as financing methods—whether through taxation or borrowing—and how the funds are allocated. If European nations invest in domestically produced, high-tech armaments rather than relying on imported weapons, the defense sector could emerge as a driver of economic growth.

Europe’s Shift Toward Greater Military Independence

European countries are facing the prospect of bolstering their military capabilities without heavy reliance on the United States. In a recent statement, U.S. Defense Secretary Pete Hegseth urged European nations to take greater “responsibility” for their security, emphasizing that the U.S. remains committed to NATO but will no longer support an imbalanced relationship that fosters dependency. Further signaling a shift in policy, the Trump administration has engaged in diplomatic discussions with Moscow to seek an end to the ongoing war in Ukraine—without the participation of EU or Ukrainian officials.

This shift comes at a crucial time, as concerns about military threats escalate. French Foreign Minister Jean-Noël Barrot recently warned that “never has the risk of a war on the European continent, in the European Union, been so high.” This growing uncertainty has increased pressure on European leaders to rethink their defense strategies and significantly boost Europe defense spending.

The Economic Potential of Increased Defense Investment

The EU economy, the world’s second-largest based on World Bank data, grew only 0.9% last year, compared to 2.8% growth in the U.S. The gross domestic product (GDP) per capita in the U.S. remains twice as high as in the EU, further highlighting the economic gap. However, increasing Europe defense spending could serve as an economic catalyst, provided the funds are directed toward innovation and local manufacturing.

According to the Kiel Institute, an economic think tank based in Germany, “increased defense spending could significantly boost Europe’s economic growth and industrial base if outlays are targeted at high-tech, regionally made armaments.” A special EU summit scheduled for this week will focus on defense investments, with leaders expected to discuss increased support for Ukraine and a strategic roadmap for military expenditures.

Homegrown Defense Innovation: A Game-Changer

Investing in domestic military production could yield substantial economic benefits. Historically, defense spending has spurred technological breakthroughs that have found widespread civilian applications. Former European Central Bank President Mario Draghi emphasized this in a recent report, citing examples such as the internet, GPS, satellite imaging, and even the three-point seat belt, which originated from harnesses designed for fighter pilots.

A study published by the National Bureau of Economic Research in January indicated that the surge in U.S. military research and development after the 9/11 attacks led to notable increases in overall productivity. If Europe follows a similar model, its defense sector could become a hub for innovation, fostering long-term economic growth.

Import Reliance vs. Domestic Production

Although Europe may initially rely on military imports, experts predict that achieving self-sufficiency in weapons production will take approximately a decade. Frank Gill, a sovereign credit analyst at S&P Global Ratings, estimates that the first phase—reliance on imports—will last around five years, followed by another five years to build a robust domestic defense industry.

Despite the current dependency on imports, economic benefits can still emerge. For instance, Poland has been heavily investing in military aircraft since the Russian invasion of Ukraine. These acquisitions have led to the construction of new airfields, creating jobs and boosting economic activity.

To maximize the economic impact of Europe defense spending, experts suggest prioritizing local suppliers that produce both military and civilian-use technologies. Unlike the U.S., where many defense contractors develop dual-use products that benefit the wider economy, Europe’s defense sector remains highly fragmented. Consolidating production efforts and fostering collaboration between European nations could enhance efficiency and accelerate innovation.

Overcoming Fragmentation in the European Defense Industry

Europe’s defense industry operates along national lines, often favoring domestic “champions” over collaborative efforts. This approach leads to inefficiencies and duplication of resources. For example, different European nations tend to develop their own tanks, aircraft, and warships rather than pooling resources for collective manufacturing.

Roberto Cingolani, CEO of Leonardo, one of Europe’s top defense companies, emphasized the need for “continental solutions” to improve efficiency. By integrating defense procurement across EU nations, Europe can expedite military production, reduce costs, and minimize reliance on imports. According to S&P Global Ratings, streamlining operations could unlock significant economic benefits, making the region more self-sufficient and technologically advanced.

Financing Europe’s Military Expansion

The way Europe defense spending is financed will be crucial in determining its broader economic impact. If military investments are funded through tax hikes, they may not generate substantial economic growth. However, borrowing to finance defense expenditures could provide a fiscal stimulus without burdening taxpayers in the short term.

The European Commission has proposed a plan to enable EU governments to borrow more funds to strengthen their defense capabilities and provide military support to Ukraine. Germany’s potential new coalition government is also considering reforms to loosen borrowing restrictions, allowing for increased military spending. These developments suggest that Europe is leaning toward debt-financed defense investments, which could provide an economic boost in the near future.

The Road Ahead for Europe’s Defense Strategy

While some economists remain skeptical about the immediate economic benefits of increased Europe defense spending, the long-term potential is significant. Claus Vistesen, an economist at Pantheon Macroeconomics, cautions that the buildup of the European defense industry will take time, making it unlikely to deliver immediate fiscal relief. However, as Ilzetzki from the London School of Economics suggests, Europe has time to plan and execute this transformation effectively.

If Europe raises its defense spending from 2% to 3.5% of GDP and shifts toward domestically designed and manufactured weapons, GDP could see an estimated 1% increase. This economic boost would not only enhance security but also strengthen industrial capacity and drive technological advancements.