The economic impact of higher defence spending

Increasing geopolitical tensions have brought to the fore the need to strengthen the EU’s defence capabilities. The Readiness 2030 package, put forward by the European Commission in March, aims to support Europe’s defence industry, deepen the single defence market and facilitate the stepping up of defence spending, inter alia through fiscal flexibility. The stylised simulations presented in this box, using the QUEST macroeconomic model, estimate the impact on economic activity and EU government debt of a linear increase in defence spending by up to 1.5% of GDP, starting this year and until 2028. The results of the main scenario show that real GDP would rise by 0.5% above the baseline by 2028, while the EU government debt-to-GDP ratio would be 2 pps. above the baseline by 2028. A higher share of spending devoted to R&D and infrastructure investment could generate more positive GDP effects in the longer term, while a higher import content of defence spending would reduce the overall economic stimulus. The macroeconomic effects will also depend significantly on factors that are not explicitly modelled, such as production capacity constraints as well as uncertain R&D spillovers. Importantly, the QUEST simulations - based on simplified assumptions and referring to the EU as a whole - are analytically distinct from the surveillance under the EU fiscal framework. ⁽⁴³⁾

A rapidly deteriorating strategic environment calls for a significant increase in EU defence spending. Russia’s war of aggression in Ukraine and decades of underinvestment in defence have underscored the EU’s vulnerability to external threats. This, together with the changing focus of traditional allies and partners, such as the US, to other regions of the world, has prompted a reassessment of the security risks faced by the EU. Additionally, rapid advancements in technologies for defence purposes and evolving warfare techniques, including through cyber and hybrid threats, require adaptation and modernisation of Europe’s defence capabilities. In this context, to restore credible deterrence, the EU faces the imperative of increasing and potentially reorienting defence capabilities.

European firms’ strategic response to tensions, disruptions and policy changes in foreign markets

Defence spending in the EU as a whole used to be low in international comparison but has started to grow in recent years. Since the beginning of the 1990s, following the end of the Cold War, Europe has enjoyed a ‘peace dividend’ that allowed restraining expenditure on defence. Based on COFOG data ⁽⁴⁴⁾, defence spending in the EU27 reached a trough of 1.1% of GDP in 2014, the year of Russia’s illegal annexation of the Crimean Peninsula. In recent years, Europe has worked ever more closely within NATO to respond to security threats. Defence expenditure in the Union increased to 1.3% of GDP in 2023, and it is estimated to have risen further in 2024, especially in Member States closer to the Russian border (see Graph II.3.1 for trends in the EU and Graph II.3.2 for a cross-country comparison). Defence expenditure as reported by NATO (for the EU members of the Alliance), which is methodologically somewhat different from COFOG figures, reached the 2% of GDP NATO target in 2024, though important differences remain across Member States. ⁽⁴⁵⁾ From an international perspective, EU Member States on average still spend less on defence than the US (2.9% of GDP in 2023) or the UK (2.1% in 2022). ⁽⁴⁶⁾

Defence spending in the EU is geared towards current expenditure, mainly compensation of employees. According to COFOG data, compensation for military and civilian personnel represents a significant share of current expenditure on defence, especially in countries with larger standing armies (see Graphs II.3.1 and II.3.2). Intermediate consumption, including items such as fuel, spare parts, maintenance, utilities, and outsourced services, has been growing due to rising operational costs and increased reliance on private-sector contractors for logistical and support functions. Capital formation, which reflects long-term investment in military capabilities including military infrastructure, new equipment such as aircraft, warships and tanks, as well as ammunition and missiles inventories, accounts for a relatively small share of defence expenditure in the EU, despite an increase in recent years. In 2023 it amounted to 19.5% of defence expenditure in the EU, compared to 40.7% in the US. Public research and development (R&D) expenditure on defence decreased over time to just 0.02% of GDP in 2023, compared to 0.3% in the US. Foreign military aid has increased significantly in recent years, largely on the back of military support to Ukraine. In contrast, compensation of employees accounted for 38.5% of US defence expenditure in 2024 while capital formation amounted to 33.5%.

Graph II.3.1:    The evolution of EU defence expenditure and its composition

Graph II.3.2:    EU defence expenditures by Member States in 2023

Notes: Capital expenditure includes gross capital formation and capital transfers. Source: Eurostat, Bureau of Economic Analys

The EU has a solid domestic production base of defence goods, but high fragmentation contributes to high import dependence. Although several globally competitive companies operate mostly in a few large Member States, the European defence industry is characterised by mainly national companies catering for domestic markets in relatively small volumes. Consequently, the EU’s defence efforts remain fragmented, with over 170 different weapons systems in use compared to 30 in the US. ⁽⁴⁷⁾ Low collaboration among European producers inhibits economies of scale, raising unit costs, hindering technological development and reinforcing the EU’s dependence on imports from the US. The US is the EU’s largest supplier of defence equipment, and its role has grown significantly in recent years. According to data by the Stockholm International Peace Research Institute (SIPRI), arms imports by European NATO members more than doubled from 2015–19 to 2020–24, and the share of imports from the US rose from 52% to 64%. The EU largely relies on the US for critical systems such as missile defence, aircraft engines, and drones, where European alternatives are often less technologically developed or uncompetitive. Without greater consolidation of its defence industry and procurement policies, the EU will struggle to reduce its dependence on external suppliers, limiting its strategic autonomy.

The Readiness 2030 Plan

The Readiness 2030 ⁽⁴⁸⁾ package provides financial levers to increase defence capabilities in the European Union. To allow for a rapid ramp up in defence expenditure, the European Commission has invited Member States to request the activation of the national escape clause ⁽⁴⁹⁾ of the Stability and Growth Pact in a coordinated way. By the cut-off date of the forecast, a majority of Member States has already decided so. ⁽⁵⁰⁾ This flexibility would allow Member States to temporarily exceed the net expenditure paths set out by the Council to finance increased defence spending. To safeguard fiscal sustainability, the Commission has framed the timing and scope of the national escape clause: the flexibility for higher defence spending is capped at 1.5% of GDP compared to a base year and will be available for a period of four years (2025-2028). ⁽⁵¹⁾ The expenditure qualifying for the clause is defined on the basis of the statistical category ‘defence' in COFOG. The plan also aims to help countries invest in defence through a EUR 150 bn loan instrument (Security Action for Europe, SAFE) ⁽⁵²⁾ support to the EIB group in widening the scope of its lending to defence and security projects, and the acceleration of the Savings and Investment Union to mobilise private capital. 

Potential fiscal and macroeconomic impact of higher defence spending

Simulating the impact of increased defence spending on growth and the general government debt through a macro model requires several assumptions. ⁽⁵³⁾ In the QUEST simulations presented in this box, the following assumptions are made:

• The additional defence spending is assumed to increase linearly until 2028, reaching 1.5% of GDP. This additional spending is assumed to be fully debt-financed. Such gradual spending profile appears appropriate in view of the potential bottlenecks in ramping up the EU’s defence capabilities. After 2028, the simulations are based on the technical assumption that defence spending remains above the baseline for decades to come ⁽⁵⁴⁾, increasingly financed by a broad-based tax increase, while non-defence government expenditure remains constant as a share of GDP.

   

• Further, it is conservatively assumed that only 10% of defence spending contributes to productivity gains, broadly corresponding to the current share of infrastructure and R&D spending within overall defence budgets in the EU. An alternative scenario explores the effect of a higher share of productivity-enhancing spending. 

   

• ·    Lastly, the main scenario assumes an approximately 20% import content of the additional defence spending. ⁽⁵⁵⁾ Another alternative scenario considers a higher import leakage of military spending, reducing the stimulus's impact on the EU economy.

Graph II.3.3:    The impact of higher defence spending on real GDP and general government debt in the EU

Economic activity increases moderately in the short term as the shift towards defence spending crowds out private demand, while the EU debt-to-GDP ratio rises compared to the baseline. According to the simulation results, the level of EU GDP rises to a limited extent, by 0.3% to 0.6% above the baseline by 2028 (depending on the scenario, see Graph II.3.3). ⁽⁵⁶⁾ EU public debt rises 2 pps. above the baseline in 2028, continues rising until 2032, and then gradually declines towards the baseline due to the tax increase starting in 2029. The muted effect on economic activity is due to the forward-looking behaviour of agents who anticipate higher future taxes in response to higher public debt, and to higher interest rates as increased spending drives up prices in the short term while higher debt also raises risk premia. The level of real GDP remains above baseline in the medium run (0.3% in 2034 in the main scenario). At the same time, the central bank’s response and the associated slowdown of private demand limits inflationary pressures (inflation remains around 0.2 pps. above baseline on average until 2028).

In the medium to long term, higher R&D spending and infrastructure investment could further boost the positive impact of defence spending on EU GDP. The “higher productivity” scenario, which assumes a 20% share of capital spending in total defence expenditure with higher benefits to private sector productivity, raises the medium-term GDP level by an additional 0.2 pps. ⁽⁵⁷⁾ By contrast, a higher import content of defence spending reduces the overall economic stimulus in the EU. 

These stylised simulations focus on selected channels under simplified assumptions and are not intended to serve as a debt sustainability analysis. Three caveats are noteworthy. First, production capacity constraints and labour supply shortages can limit the ability to rapidly scale up defence spending (Antonova et al., 2025). ^(58) (59) Without sufficient capacity, short-term demand increases may drive up prices rather than GDP. While the assumed gradual increase in defence spending is intended to allow for a slow adjustment to frictions, the simulations do not include more specific assumptions on labour supply constraints and product market frictions. Second, the scenarios presented here do not include any productivity spillovers beyond the regular productivity impact from public capital spending. However, the literature suggests that in the longer term, defence R&D spending can also spur private R&D, leading to small but statistically significant productivity gains (Moretti et al., 2025). This is consistent with findings of a positive long-run effect of defence R&D spending on GDP in the US (Antolin-Diaz and Surico, 2024). ⁽⁶⁰⁾ Such benefits could accrue mostly in Member States producing advanced military equipment. As a final caveat, these stylised EU-wide simulations are separate from and do not pre-empt the formal, country-specific assessments of fiscal sustainability, which will follow the activation of the national escape clause.

The estimated impact on economic activity is within the broad range reported by the literature. For a comprehensive literature review, see e.g. Ilzetzki (2025). ⁽⁶¹⁾ The available studies aligning with the Keynesian view argue that military expenditure stimulates aggregate demand, creating jobs and driving investment, particularly during economic downturns. For example, Barro (1990) suggests that in the short term, defence spending acts as a fiscal stimulus through the multiplier effect. In contrast, the neoclassical approach highlights long-term crowding-out effects as higher military expenditure can reduce private investment and increase fiscal deficits (Deger and Smith, 1983; Barro and Sala-i-Martin, 1992). ⁽⁶²⁾ Empirical findings on the multiplier effect are mixed. Some papers report a positive correlation between defence spending and economic growth particularly in the US (Atesoglu and Mueller, 1990; Ando, 2018), while others find negligible or negative effects, especially in Europe (Dunne and Nikolaidou, 2012; Kollias and Paleologou, 2016). ⁽⁶³⁾ Cross-country studies yield inconclusive results, suggesting that the impact varies by context, spending levels, and time horizon (Landau, 1996; Hou and Chen, 2014; Gómez-Trueba Santamaria et al., 2021). ⁽⁶⁴⁾ 

Defence spending in the Spring 2025 Forecast

While the simulations present the potential effects of higher defence expenditure, the forecast only includes so far credibly announced and sufficiently detailed measures. The Commission’s forecasts assume a continuation of existing budgetary policies, which is commonly referred to as the no-policy-change assumption. This means that the forecast does not make assumptions on policy choices still to be taken. Only those measures that have been credibly announced and sufficiently detailed by the cut-off date of the forecast (30 April) are taken into account. On this basis, the level of defence spending in the EU is estimated to have increased from 1.3% of GDP in 2023 to 1.5% in 2024 and is expected to reach 1.6% in both 2025 and 2026. These projections could be revised in coming forecast rounds to reflect additional decisions on defence spending.

Higher defence spending may result in a less contractionary fiscal stance in the EU until 2028 despite the planned fiscal adjustments. The Commission Spring 2025 Forecast projects a broadly neutral fiscal stance in the EU in 2025. Without the additional defence expenditure already included in the forecast (around 0.1% of GDP), the EU fiscal stance projected for 2025 would have been slightly contractionary. Similarly, the slightly contractionary EU fiscal stance implied for 2026-2028 by the consistent implementation of the medium-term fiscal-structural plans could also be offset by the use of the flexibility allowed by the activation of the national escape clause for higher defence spending. According to the Commission’s communication ⁽⁶⁵⁾, after the end of this flexibility Member States would have to sustain the higher defence spending level through gradual re-prioritisations within their national budgets, to safeguard fiscal sustainability.