How the EU could raise additional billions for defense

The figure has been around since Ursula von der Leyen launched it: Europe must invest an additional EUR 500 billion in defense over the next ten years, according to the Commission President. Defense Commissioner Andrius Kubilius, on the other hand, considers investments in bridges, railroads and roads amounting to EUR 200 billion to be necessary with regard to military mobility alone.

The Lithuanian will list the options for financing in his White Paper, which he is due to present on March 19. In April, the finance ministers will discuss the topic at their informal meeting in Warsaw. At the EU summit in June, the heads of state and government want to decide on possible European defense projects and which financing options should be pursued.

The status quo is the option currently preferred by Germany and the Netherlands in particular. Supplemented by reallocations within the framework of the upcoming MFF, although the scope here is likely to be small in view of foreseeable distribution battles. German Chancellor Olaf Scholz once again made it clear that defense is a matter for the member states. Accordingly, defense spending should be financed via the national budget.

The pressure on national budgets is increasing, especially in larger EU states such as Spain and Italy, which have not yet reached the two percent target set by NATO. Significantly more money will be needed if, as expected, NATO raises the lower limit to three or 3.5% at its June summit.

The question is how France or Italy, with high debts and budget deficits, are supposed to cope with the additional national spending. "We are living in extraordinary times," said Ursula von der Leyen after the informal summit: The Commission will look at how the flexibility of the Stability and Growth Pact can be used even more.

Without a change to the EU fiscal rules, however, the options are limited. The fiscal rules do not allow defense spending to be excluded from the deficit calculation. However, the Commission can take increased defense spending into account when deciding whether to open an excessive deficit procedure against a member state.

At first glance, financing via the European Stability Mechanism (ESM) seems like an attractive option. After all, EUR 500 billion seems to be more or less lying idle there. During the euro crisis, the fund was set up to support member states with cheap loans in an emergency. The problem is that any use of the ESM would also have to include its complex governance, which is not designed for the problem of defense financing, explains Lucas Guttenberg, Senior Advisor for European Economic Policy at the Bertelsmann Stiftung.

In addition, the ESM would only grant more favorable loans. This would not circumvent the limitations imposed by the European fiscal rules. The additional financial leeway of this option would be limited to the difference in interest costs between normal loans and the more favorable ESM loans. Even if the entire EUR 500 billion capacity of the ESM were to be utilized, this would only result in additional financial leeway of a few billion euros. "The chaos is great, the benefit is small," Guttenberg summarizes the ESM option. What's more, the ESM funds would be missing if they were needed for their actual purpose in the event of another euro crisis.

The governance problem of the ESM could be circumvented with a SURE-like program, for example. SURE was the EU's first response to the Covid pandemic. The EU borrowed on the market and granted these loans to the member states at the same interest rate. Like the ESM construct, however, this only reduces interest costs and hardly creates any relevant financial leeway. In addition, it would be a redistribution from countries with low interest costs to countries with high interest costs, which does not necessarily correspond to the distribution of the need for higher defense spending.

The Baltic states and Poland want defense bonds, while Denmark and Finland have recently become open to the idea: In contrast to the other options, financing via common European debt would create new financial leeway. However, it is unclear how the money would be used. The Next Generation EU Covid recovery program distributed grants to member states based on their exposure to the pandemic.

In a similar program for defense, it would not be clear whether the money should be distributed on the basis of current financial leeway, economic strength, geographical proximity to Russia, or other criteria. It is unlikely that member states would want to finance each other's armies. "Anyone who wants to communitize defense funding is taking a major step towards integration and must also integrate defense policy decision-making structures," says Guttenberg from the Bertelsmann Foundation.

Joint financing is likely to have somewhat greater chances for projects where there is clear European added value. One example would be a European missile defense system, as proposed by Poland's Prime Minister Donald Tusk together with his Greek counterpart Kyriakos Mitsotakis. Poland and the Baltic states are also calling for European funding for the military fortification of the eastern flank. With regard to defense in space or cyberspace, there are other projects that cannot be financed nationally. However, Germany is pursuing its own project to protect against missiles with the "European Sky Shield Initiative", which is to be financed nationally.

The European Investment Bank (EIB) has also recently come into focus as a possible option. However, the EIB cannot create financial leeway in state budgets. It can only support the private sector in ramping up production capacities. And only when it comes to dual-use financing. In view of its credit rating, the EIB does not want to become a defense bank anyway. However, in January, 19 EU states asked the EIB to explore possibilities for an even more flexible interpretation of the rules.

Yet the EIB is not lacking in money at all. Eight billion euros have been made available for dual use, of which only one billion has been used so far, said EIB President Nadia Calviño last week at the annual press conference. The limiting factor is not the EIB's reluctance, but the lack of demand from the industry. This highlights the dilemma: Europe should be investing more in its defense, the industry is waiting for orders, of which too few come because funds are scarce in the member states or other issues take priority.