https:\/\/people.defensenews.com\/top-100<\/a>.<\/p>\nIn general, the more expensive and complex the weapon system, the larger the potential downsides of a fragmented industrial base. Not only does Europe lack its own fifth-generation fighter aircraft, but the plans to develop a sixth-generation one are currently uncoordinated\u2014and thus likely doomed from the start. On one hand, there is the Future Combat Air System (FCAS), a collaboration among France, Germany, and Spain\u2014currently in peril over questions of Dassault\u2019s future participation.8 FCAS not only involves the development of the Next Generation Fighter but encompasses work on autonomous drones and AI.<\/p>\n
On the other hand, Italy, the UK, and Japan are working on the Global Combat Air Programme to build yet another stealth fighter. Saab, the successful maker of the Swedish Gripen platform, is staying out of both efforts. Again, the question is not whether a variety of European companies could develop a next-generation fighter but whether such future platforms will be viable. The competition between the Rafale and the Eurofighter Typhoon has resulted in each playing a marginal role\u2014and the American F-16 dominating European skies.<\/p>\n
A version of this observation applies to European defense procurement in general. The Draghi report notes that between mid-2022 and mid-2023, 63\u00a0percent of all EU defense orders were placed with US companies and a further 15\u00a0percent with other non-EU suppliers.9 Of course, there are good reasons for international trade, including in defense, especially with allies and like-minded countries. Yet the absence of a viable and scalable domestic defense industry is a major vulnerability that Europe must address if it is to grow its role on the world stage\u2014or, at a minimum, police its own neighborhood effectively.<\/p>\n
The Policy Status Quo<\/p>\n
The central policy factor behind the inadequacy of European militaries and the industrial base that underpins them is the decades of underinvestment in defense. In 2024, two years into Russia\u2019s full-scale invasion of Ukraine and a decade since NATO\u2019s Wales Summit, where the 2\u00a0percent target was first set, defense expenditures by EU countries stood at 1.9\u00a0percent of GDP.10 In 2025, defense spending across EU countries is expected to reach merely 2.1\u00a0percent of GDP, or \u20ac381\u00a0billion.<\/p>\n
In comparison, the US Department of Defense is spending $908\u00a0billion in fiscal year 2025, or 3 percent of projected US GDP.11 Chinese defense spending has also been growing rapidly. Despite the recent increases in European defense budgets, Europe is facing a real risk of being left behind and defenseless in a worsening international environment. To be sure, investments have been growing at an exceptional rate, increasing in 2024 by 42\u00a0percent compared with 2023 and reaching a record high of \u20ac106\u00a0billion\u2014yet that growth is happening from a low base, and its effect on productive capabilities will be only cumulative.12<\/p>\n
There are several reasons European governments are not spending more\u2014some political and others perhaps related to uneven threat perceptions across the continent. The most important factor by far, however, is the adverse fiscal outlook that many European economies share as their sizable welfare states confront aging populations and sluggish economic growth. The average debt burden in the euro area is 88\u00a0percent of GDP; across the EU, it is over 82\u00a0percent\u2014far above the benchmark of 60\u00a0percent that the EU once set for itself.13 While the average figures hide much variation (Bulgaria\u2019s and Estonia\u2019s debt-to-GDP ratios are in the low 20s, while Greece\u2019s, Italy\u2019s, and France\u2019s are far above 100\u00a0percent), they suggest that the fiscal space to increase defense (or other) spending, without major overhauls to public finances, is limited.14<\/p>\n
Outside the EU, the United Kingdom (with a debt-to-GDP ratio of 96\u00a0percent) has had recent experience with bond vigilantes responding quickly to the 2022 \u201cmini-budget\u201d proposed by the short-lived Liz Truss cabinet. This suggests that the onset of debt crises can be sudden and unpredictable\u2014and that numerous EU countries with similar economic characteristics may be at risk of prompting the same bond market dynamics.<\/p>\n
Barring a sudden improvement in Europe\u2019s growth prospects or effective fiscal reforms\u2014both of which have proved elusive\u2014one possible remedy to this predicament is using the EU as a platform for issuing common debt and generating additional revenue that could be invested in defense. In response to the pandemic, the EU took the unprecedented step of issuing common debt of around \u20ac800\u00a0billion to be disbursed to member states as loans and grants under the auspices of the Recovery and Resilience Facility.15 It is not unthinkable that significant resources could be raised again with shared EU bonds to fund European defenses.<\/p>\n
Numerous considerations complicate the picture, however. First and foremost, the EU is not a conventional federation with coercive powers\u2014it lacks, among other constitutional prerogatives, the power to tax. Moreover, there is considerable political resistance to issuing common debt in several influential member states, not least in Germany. Given the EU\u2019s design, member states\u2019 consent and collective willingness to honor the EU\u2019s commitments are key to the bloc\u2019s credibility, including its ability to secure favorable financing terms. A one-off pandemic facility, limited in size and mostly weighted against loans that the EU extended to member states, might be a different proposition from a larger instance of debt issuance, especially if it goes directly toward procuring weapon systems and building military capability.<\/p>\n
It is a mistake to think of the EU as a deus ex machina, capable of mobilizing resources at will within its current constitutional setup. Adding a layer of EU-level debt on top of national debt burdens might seem convenient, but it has risks. As long as member states are liable for servicing EU debt and managing their own public finances, there is no reason financial markets should treat EU bonds any differently from some linear combination of national bonds\u2014and make judgments about debt sustainability by looking at overall debt burdens and their evolution.<\/p>\n
To navigate these challenges, EU institutions decided to set up a one-off facility, Security Action for Europe (SAFE), to finance urgent military purchases by member states, including big-ticket items such air and missile defense systems, maritime capabilities, and strategic enablers, through favorably priced long-term loans. SAFE, which is already oversubscribed, offers \u20ac150\u00a0billion in loan financing to national governments, funded by EU borrowing, in the hope of unlocking a total of \u20ac800\u00a0billion in extra defense spending. The scheme explicitly prioritizes European production by allowing no more than 35\u00a0percent of the component cost to originate outside the EU, European Economic Area, or Ukraine.16<\/p>\n
Alas, while a major improvement over earlier initiatives such as the European Defense Fund, the facility is too small to change the picture dramatically. It might be expanded, but it will be constrained by the amount of additional debt countries are willing to take on. In addition, the European Commission is planning to allocate \u20ac131\u00a0billion for defense under its new Multiannual Financial Framework (MFF)\u2014five times as much as under the current MFF\u2014to finance investment in dual-use AI, cyberwarfare, military mobility, and so on in 2028\u201334. Disbursed over seven years, such spending boosts hardly scratch the surface of what Europe needs to build up its defenses.<\/p>\n
If Europe is to succeed in rebuilding its hard power to keep revisionist adversaries at bay and enable the EU to throw around its geopolitical weight in its interactions with China and the United States, it must make different fiscal and economic choices. The existing social safety nets, pensions, and related programs must be revised to respond to the demographic and economic realities of the 21st century. Only then can European countries increase defense spending in a sustained fashion, which is necessary for growing the European defense industry and priming European militaries for a major war.<\/p>\n
Complementarily, the growth of defense budgets alongside entitlement schemes could be made sustainable by significantly improving the continent\u2019s productivity and growth prospects. This could be achieved by bringing down energy costs, cutting red tape, and aligning the single European market in key areas that continue to be subject to regulatory fragmentation.<\/p>\n
Unsurprisingly, reducing regulatory and policy fragmentation is central to improving the health of Europe\u2019s defense industry writ large. Even if the industry could suddenly work under the expectation of large and sustained purchases from European governments in the coming years, building up adequate production capacity is impossible without mobilizing private capital. There, the defense industry is facing the same challenge that is plaguing the European economy as a whole: Europe\u2019s inability to channel private savings toward their most productive uses. Because of the EU bank industry\u2019s continuing fragmentation, investment decisions display a strong domestic bias.<\/p>\n
This phenomenon was identified initially by economists Martin Feldstein and Charles Horioka, who demonstrated that under complete capital mobility, there should not be a link between domestic savings and investment in individual countries over time.17 Yet in reality, savings\u2014particularly within the EU, which theoretically should act as a space of full capital mobility\u2014display a substantial home bias. The introduction of the EU\u2019s common currency, the euro, reduced the link somewhat, but it resurfaced in the wake of the financial crisis of 2008, when banks and investors decided to reduce their exposure to foreign, albeit European, markets.18<\/p>\n
Relatedly, European reliance on bank financing, as opposed to equity, acts as a constraint on entrepreneurship, the scalability of promising firms, and, in particular, the growth of defense firms\u2014especially smaller ones. Whereas the US corporate sector is funded mostly through the capital market as opposed to bank loans (three-fourths external funding and one-fourth loans is a good first approximation), in the EU, it is the other way around.19 Yet bank financing, with the risk aversion it entails, is particularly unhelpful to innovative and smaller players. As a result, Draghi notes,<\/p>\n
Besides public funding, access to private financing remains a key challenge for the EU\u2019s defence industry. This is true in particular for SMEs [small and midsize enterprises] and mid-caps, which form the backbone of supply chains and are key innovation actors. A 2024 study on access to equity finance for defence SMEs estimates the equity financing gap at EUR\u00a02\u00a0billion and a debt financing gap of up to EUR\u00a02\u00a0billion for SMEs in the defence sector. These estimates are conservative, as they account only in part for companies engaged in developing dual-use technologies.20<\/p>\n
What Europe Needs<\/p>\n
Assuming Europe can reverse its decades of hollowed-out defense budgeting and set itself on a trajectory to seriously rebuild military capabilities\u2014while helping Ukraine defeat Russia\u2014it still must address the challenge of adapting its industrial capacity to the new era. This requires innovation, eliminating unhelpful redundancies and fragmentation, scaling up production volumes while encouraging competition, and an entrepreneurial spirit.<\/p>\n
The aim is not consolidation for consolidation\u2019s sake. The US example of deliberately reducing the number of key firms from dozens to just five has had its cost. In particular, many programs\u2014including, famously, the F-35\u2014were designed from the outset as make-work schemes, creating employment across the United States and passing on the cost to the taxpayer. In shipbuilding, programs such as the Littoral Combat Ship have been major disasters.21 An intimate connection between industry and its main customer has thus created pathologies that Europe would be well-advised to avoid, including by modeling its incentives for future defense industrial champions on the Asian approach of export promotion.22<\/p>\n
Environmental, Social, and Governance Goals<\/p>\n
While EU rules around environmental, social, and governance considerations do not explicitly ban investment in defense companies, the defense industry seems to carry a stigma among European bankers, financial institutions, and their clients. \u201cThe penetration of investment restrictions targeting the defence sector,\u201d a study published by the Brussels-based think tank Bruegel notes, \u201cincreased massively across European investment funds between 2015 and 2021.\u00a0.\u00a0.\u00a0. As of 2021, 14\u00a0percent of all retail assets under management in Europe were subject to some restriction on weapons-related investments\u2014a trend not seen in the United States.\u201d23<\/p>\n
Obviously, private actors cannot be mandated to invest in defense. Yet they can be encouraged to do so by public policy, including by signals from influential public actors. The European Investment Bank has a balance sheet of \u20ac547\u00a0billion, which it could decide to prioritize in EU-wide defense projects.24 Yet while it has lifted recently its outright ban on defense and security projects if they qualify as dual use, it still refuses to invest directly in weapons and ammunition production.25<\/p>\n
Savings and Investment Union<\/p>\n
A necessary condition for mobilizing private savings to fund a fast defense industry buildup is to facilitate capital mobility across the union. This should be done in a way that counteracts the strong domestic investment bias and ends the status quo, under which savings that accumulated in one European country stay there instead of flowing organically to places with the highest return rates. The key reason for the continuing lack of investment mobility is the fragmentation of banking and retirement fund regulation across EU countries. That limits the size and depth of Europe\u2019s capital market and its ability to fund ambitious investment projects, whether defense-related or not. Ultimately, this continuing regulatory fragmentation is holding back Europe\u2019s economic growth writ large.<\/p>\n
The solution that Enrico Letta proposes in his report on the single market is for the EU to work toward one simple regulatory rule book for banks and the financial industry.26 Letta rules out the possibility of establishing a single EU-level regulator at this stage but argues for a common, standardized framework and tight coordination between national actors, especially when overseeing financial institutions with potential. He states,<\/p>\n
The system must evolve similarly to the banking sector\u2019s single supervisory mechanism, where the ECB\u2019s [European Central Bank\u2019s] Single Supervisory Mechanism (SSM) directly oversees significant banks, while national supervisors manage less significant ones. Concurrently, a strengthened European Securities and Markets Authority (ESMA), in collaboration with National Competent Authorities, could assume more supervisory responsibilities for major entities based on criteria such as size, cross-border activities, and their systemic importance, encompassing trading venues, issuers, asset managers, and other financial market participants.27 (Emphasis in original.)<\/p>\n
Complementarily, the proposed 28th regulatory regime can provide opportunities to create new ecosystems of venture capital and innovative startups, including in defense. Ukraine\u2019s drone production is a testament to the importance of a competitive, decentralized landscape with fast innovation cycles in modern warfare. The structural conditions in Europe are not exactly favorable. Although the EU and United States have similar startup success rates (around 20\u00a0percent in the first year and 50\u00a0percent after three\u00a0years), the US venture capital industry is six times larger than Europe\u2019s ($270\u00a0billion vs. $44\u00a0billion).28 A more market-friendly and pan-European regulatory and tax regime for venture capital could bring the scale necessary for the EU to become a real player in this area\u2014in a way the current overwhelming reliance on bank financing does not allow.<\/p>\n
Coordinated Defense Industrial Policy, Avoiding Duplication<\/p>\n
Clearly, the dreams of a \u201cEuropean army\u201d are utopian. Similarly, the prospect of using the EU as the exclusive vehicle for weapons procurement is distant. However, there is no question that the fragmentation of military procurement is a serious driver of the fragility and smallness of Europe\u2019s industrial base. Common initiatives, whether directed by the EU through SAFE or the MFF or pursued through coalitions of the willing, must introduce coherence to procurement decisions and industrial policy.<\/p>\n
The EU has gone a long way toward limiting state aid to industry, especially under its single-market rules, but it has done relatively little to advance a coherent industrial policy agenda, especially in defense. The current push to spend more must therefore be deliberately channeled toward common procurement and joint programs. The goal should not be to arrive at US-style consolidation between five or so main players, which presents its own challenges, but simply to weed out the blatant inefficiencies in the current European industrial landscape.<\/p>\n
Where Does the Money Come From?<\/p>\n
Even if the barriers to capital mobility across the EU miraculously disappear and financial institutions shed their aversion to the defense industry, the continent will continue to face the challenge of how to finance a military buildup in an age of massive debt burdens and sluggish growth. The best \u201csolution,\u201d of course, consists of stipulating that Europeans revive growth, adapt their social safety nets to demographic realities, and create the fiscal space necessary to sustain a prolonged expansion of military budgets. That would create incentives for private actors to invest, innovate, and scale up. Of course, a major economic policy reset appears out of reach of European policymakers, for complex political reasons endemic to democracies with aging populations, the structural nature of barriers to growth, and the absence of effective leadership.<\/p>\n
Alternatively, one can imagine that the EU, as a budding federation, could serve as a vehicle for raising the resources necessary to fund such buildup through its own debt. Yet such a move, executed at the needed scale, would break significant taboos and likely require deep constitutional reforms to the EU\u2019s architecture akin to those taken by America\u2019s Founding Fathers in the late 1780s. This is a difficult proposition in a political environment marked by deep divisions between and within EU member states.<\/p>\n
What remain are solutions that are necessarily imperfect\u2014falling short of the financial firepower that is required or not encompassing all EU member states, for example. Yet the perfect should not be the enemy of the good. Europe should stand ready to seize every opportunity to expand the resources available to the continent\u2019s defense industrial base.<\/p>\n
One such imperfect but decidedly helpful solution is the idea of a \u201cEuropean Rearmament Bank,\u201d modeled after the European Bank for Reconstruction and Development and advanced by an informal group led by that bank\u2019s former executive committee member, Guy de Selliers.29 The proposed bank would be built by a coalition of the willing, including EU member states and nonmembers with a keen interest in Europe\u2019s security. A rearmament bank would leverage capital contributions from these states into lending capacity extended at low borrowing costs to countries and defense companies on a project basis.<\/p>\n
The bank\u2019s scale depends critically on the involved coalition\u2019s width and the size of its contributions. Yet European Rearmament Bank proponents estimate that \u20ac10\u00a0billion in paid capital from major European governments could be leveraged into \u20ac250\u00a0billion in lending capacity for European countries to finance new procurement.30 If the bank grew into a major funder of Europe\u2019s rearmament effort, it could use its position to help consolidate different orders, avoid parochialism by making tendering international, and foster interoperability and NATO standards\u2014all simply by using carrots in the form of loans to cash-constrained governments.<\/p>\n
Using a bank for financing would present two advantages over current policies. One, it would allow, under sound management, to expand the available resources through leverage\u2014in contrast to ad hoc funds or schemes such as SAFE. Two, because it would finance projects, not just procurement by governments (or investment by defense firms), it could structure the contracting to prevent cost inflation and excessive lead times. Short of a utopian, top-down overhaul of Europe\u2019s defense procurement systems, access to this mechanism provides a compelling way to avoid the usual pitfalls of fragmentation, overbidding, and delays.<\/p>\n
Conclusion<\/p>\n
This report is not a blueprint for a transatlantic divorce. Rather, it seeks to provide a recipe for putting the US-Europe relationship, particularly in the area of security, on a more solid and equal footing\u2014one that successive US administrations have long called for. It does not rule out a constructive role for the US defense industry going forward\u2014quite the contrary. The additional European spending and investment is an opportunity for US companies to set up new production capacity in Europe, co-funded on favorable terms by the new financial instruments developed in Europe, to better serve their European customers.<\/p>\n
Such outbound investment would have the added benefit of reducing America\u2019s trade imbalances, a professed goal of the Trump administration, while extending the existing relationships tying Europe and America together. Relatedly, China\u2019s domination of mining and supply chains surrounding rare earth minerals\u2014inputs to various industrial processes, including in defense\u2014should be a strong impetus for transatlantic cooperation upstream of actual defense production.<\/p>\n
That said, the success of an eventual emancipation and growth of Europe\u2019s defense industry, even if it comes at the cost of additional European purchases of US weapon systems and the emergence of a new category of competitors to US military exports, remains deeply in the US interest. The idea that European leaders can step up in managing their continent\u2019s security without disturbing any special interests benefiting from the status quo is an illusion. The sooner it is discarded, the better\u2014for the sake of Europe\u2019s security and the transatlantic alliance.<\/p>\n
Neither is this report calling for massive overhauls of Europe\u2019s institutional architecture. The EU, with its current membership base, is singularly unwieldy\u2014and not only because of \u201ctroublemakers\u201d in its midst, most notably Hungary. Its heterogeneity and deep domestic challenges in some core member countries, such as France and Germany, make rapid collective action on security, involving all 27 EU member states, highly unlikely. For that reason, this report proposes policies that can be enacted through a coalition of the willing (namely, the creation of a European Rearmament Bank) and EU-level policies that should not encounter great political resistance because of their technicality and overall desirability in improving the EU\u2019s economic competitiveness (by completing the savings and investment union). The spirit of the report thus goes, one hopes, with the grain of the European project by preferring incrementalism and incentive-compatible solutions over utopias while recognizing the enormity of the security challenge facing Europe in 2025.<\/p>\n
About the Author<\/p>\n
Dalibor Rohac is a senior fellow at the American Enterprise Institute, where he studies the political economy of the European Union, transatlantic relations, and the future of Central and Eastern Europe.<\/p>\n
Acknowledgments<\/p>\n
I am grateful to Edward Lucas, Niccol\u00f2 Comini, and Eduardo Castellet Nogu\u00e9s for helpful comments on an earlier draft. Katherine Camberg provided excellent research and editorial assistance. All errors are my own.<\/p>\n","protected":false},"excerpt":{"rendered":"Key Points The United States expects its European allies to take on a much greater burden of conventional…\n","protected":false},"author":2,"featured_media":304629,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[18],"tags":[23,3,21,19,22,20,25,24],"class_list":["post-304628","post","type-post","status-publish","format-standard","has-post-thumbnail","category-united-states","tag-america","tag-news","tag-united-states","tag-united-states-of-america","tag-unitedstates","tag-unitedstatesofamerica","tag-us","tag-usa"],"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/304628","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/comments?post=304628"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/304628\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media\/304629"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media?parent=304628"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/categories?post=304628"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/tags?post=304628"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}