RPT-BREAKINGVIEWS-How to raise $420 bln a year for Europe’s defence

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon

NEW YORK, Feb 24 (Reuters Breakingviews) - Europe is on an urgent hunt for funds. The partial breakdown in the transatlantic alliance means the continent may need to double its annual spending on defence. The money will have to come from a mixture of national budgets, European Union funds and perhaps a new vehicle. Many sacred cows will be slaughtered on the way.

The cost of defending Europe keeps rising. Russian President Vladimir Putin’s invasion of Ukraine three years ago was bad enough. Now U.S. President Donald Trump, just a month into his second term in the White House, has sowed doubts over whether Europe can rely on the United States to defend it.

The current NATO target was for each member to spend 2% of its national output on defence. The alliance’s European members finally achieved that collectively last year, although a few countries, notably Italy and Spain, fell short.

As a result of Russia’s aggression, NATO members were already discussing raising spending to around 3% of GDP. But following Trump’s latest inaccurate remarks – that Ukraine started the war with Russia and that its President Volodymyr Zelenskiy is a dictator – Europeans are now realising they may have to defend themselves without American help. That could mean doubling spending to 4% of output, which would mean finding an extra $420 billion a year.

This is a huge sum of money, especially since the region will probably have to keep up the effort for at least a decade. But if Europe’s leaders can persuade their people to make sacrifices – admittedly a big “if” – the continent is rich enough to raise the cash.

UNITY OF PURPOSE

Europe’s problem is not just that it spends too little on defence. It is too divided. The EU has always played a limited role in security and lost the United Kingdom, one of its top military powers, following Brexit. What is more, some members, such as Hungary, are friendly to Russia. Others such as Austria are neutral.

Industrial fragmentation also plagues Europe’s defence industry, as national governments favour local suppliers. For example, the region operates 15 battle tanks; the United States has one. The region has a series of cottage industries rather than streamlined mass production. It has also under-invested in research and development. If it pours extra money into this balkanised structure, Europe will waste vast amounts of money and achieve little. An overhaul also requires unity of purpose and collective action.

Europe will have to abandon many shibboleths in the process. Germany will have to overcome its aversion to joint EU borrowing; France will have to accept that Europe will continue to buy U.S. armaments until it has scaled up its own industries; post-Brexit Britain will have to embrace Europe; and the EU will need to sideline obstructive members such as Hungary.

Extra research spending could spill over into civilian benefits, in the same way that the U.S. Defense Advanced Research Projects Agency (DARPA) is credited with sowing the seeds for technology successes. But defence expenditure mostly goes down the drain. Although governments can buy time through borrowing, they will ultimately have to raise taxes or cut other forms of spending.

EU METHODS

National governments will have to pick up most of the tab. The good news is that the European Commission, the EU’s executive arm, wants to exempt extra defence spending from the bloc’s rules limiting national debts and deficits. The bad news is that debt levels are already high in all but a few countries such as Germany. Sovereign credit ratings are likely to suffer if countries hike defence spending, S&P Global has warned.

What is more, national spending on its own will not drive the required unity of purpose. Central pots of cash could achieve that if they are big enough. Not only could such money go into transnational projects; a condition for participating could be that individual governments must direct their own defence spending towards common goals.

At the EU level, there are two main ways to raise significant sums of money. One is for the European Commission to issue bonds. Another is to redeploy the European Stability Mechanism, a vehicle created to manage the euro crisis.

The ESM has 422 billion euros of unused capacity. Although it would need to keep some of this for its original purpose, it could put around 300 billion euros into defence over perhaps five years – or even more if it relaxed its leverage rules. Ideally, it would lend to the Commission rather than national governments in order to drive collective action, though its treaty would first need to be updated.

NON-EU ANSWERS

Action at the EU level alone will not be enough because non-EU countries such as the United Kingdom and Norway play a big role in Europe’s defence. Involving them would require a new financial vehicle.

One idea is to create a special-purpose “rearmament bank” with a similar structure to multilateral lenders such as the World Bank. It would lend to both its government shareholders and defence companies, which often struggle to raise money because some investors shun the armaments industry.

Its promoters talk about starting with a small group of countries, such as Britain and Poland as well as Scandinavian and Baltic nations. These are like-minded countries which are eager to work together and might be willing to be bound by majority voting. The bank’s advocates say it should start with capital of 10 billion euros that could be leveraged up to 100 billion euros of lending.

Something along these lines could work. But it might be better to focus on lending to defence companies rather than governments, as 100 billion euros would otherwise not go far. What is more, the EU member states could benefit from a repurposed ESM while the United Kingdom could probably raise money just as cheaply by issuing its own bonds.

In any case, Europe will need a mix of solutions if it is to raise the huge sums of money needed. While doubling defence spending may seem a tall order, the region faces a potential existential crisis. The combination of Putin and Trump may be just enough to jolt it into action.

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