BREAKINGVIEWS-Some dos and don’ts for Europe’s defence buildup

By Hugo Dixon

LONDON, July 7 (Reuters Breakingviews) - Now that European members of NATO have pledged to spend 5% of their national output on defence, they need some principles on how to deploy the cash. These include cutting reliance on the United States fast, integrating their fragmented industries to gain economies of scale, building a coalition that includes the United Kingdom, and pushing as much of the cost as possible off government balance sheets.

The continent’s key and urgent strategic challenge is to be able to defend itself against Russia now that it can no longer rely on the United States. European leaders should not kid themselves that agreeing to lift annual spending on defence and related matters to 5% of GDP by 2035 does the trick. This is partly because Europe needs to meet the Russian threat well before that date. It is also because what matters is not so much the amount of spending but whether Europe builds capabilities that the United States now provides and gets value for money.

What is more, many European governments are strapped for cash. Some such as Italy are already looking at creative accounting to meet the 5% pledge. If they hike taxes or slash social programmes to pay for defence, that may further boost far-right parties. Since many of these groups do not see Russia as a threat, the extra spending could be self-defeating.

STRATEGIC ENABLERS

Europe’s main need is to create its own “strategic enablers” independently from the U.S. This is military-speak for projects such as satellite-based intelligence, air defence shields, and a joint command and control system. Without them, Europe’s defence will be full of holes. Nuclear weapons also fit into the category, though they raise many other issues.

These strategic enablers would benefit Europe as a whole. They are also expensive and require technological expertise that any single country would struggle to assemble on its own. It therefore makes sense to create them collectively.

One option is to work through the European Union. But Hungary is sympathetic to Russia, while Spain does not want to ramp up defence spending. On the other hand, the United Kingdom can contribute a lot to Europe’s defence though it is no longer a member of the bloc. Further afield, Canada could also be interested in getting involved. So, it would be better to create a coalition of genuinely willing allies.

Working across borders would have other benefits. Europe’s defence industry is balkanised on national lines, with each government buying largely from domestic suppliers. This leads to a multiplicity of different products, each with small production runs and high unit costs. For example, Europe operates 12 types of tank, while the U.S. has only one. If European governments buy standardised products, they will benefit from more competition among suppliers, while economies of scale will lower average prices.

FUNDING CONUNDRUM

How to fund the ramp-up of defence spending? Germany, whose debt is relatively low, can just borrow the extra money. The other big economies – the UK, France, and Italy – will find it hard to keep pushing up their debt levels.

National borrowing will also do little to overcome the fragmentation of Europe’s defence industries. There will be no incentive to change deep-set habits where defence ministries buy from national champions to preserve local jobs.

The EU is hoping to counteract this by borrowing 150 billion euros and lending it on to states that collaborate with other countries. In most cases, however, governments can borrow at roughly the same rate on their own and so will have little reason to take the cash if it requires them to stop discriminating in favour of local industries.

A better plan is to create a new vehicle that commissions and then actually owns the strategic enablers. This entity could also procure other kit such as drones and ammunition – stockpiling them until individual countries need them. Such a mechanism could be set up with the explicit mission of driving European cooperation.

There are several proposals along these lines: the European Policy Centre’s special purpose vehicle, the European Rearmament Bank and the Bruegel think-tank’s proposed European Defence Mechanism. What they have in common is that sponsoring governments would commit some capital, which the fund would then leverage many times over by borrowing in the market. The coalition countries would therefore only have to find a small amount of money upfront. The fund’s debts would also not show up on national balance sheets.

The new vehicle could charge individual governments user fees for the strategic enablers, so spreading the cost of setting up satellite-based intelligence and other systems over many years. It could also warehouse drones and other equipment, with governments only paying when they need them.

Such a fund might also play a useful role in lending to smaller defence companies, which sometimes struggle to get finance. If it developed a venture capital arm, it could even spur the creation of the innovative military technology startups that Europe needs.

For a fund to have the necessary scale and expertise, at least the UK, France and Germany would need to be part of it. The UK is interested in the idea in part because it could ease the country’s fiscal problems, according to the Sunday Times. Britain’s debt will be 104% of GDP this year, the International Monetary Fund reckons. Such thinking may also gain traction with France. Though the country fiercely defends its national champions, its debt is even higher at 116% of output.

But such arguments will have little effect on Germany, whose debt is only 65% of GDP. For Berlin to come on board, it will have to believe that building European strategic enablers is essential for its own defence – and that creating a new collective fund is the only way to get its more heavily leveraged neighbours to invest.

Europe’s leaders might decide this is all too complicated. They might also think such drastic moves are unnecessary after the NATO summit where they placated Donald Trump, who was pushing them to spend more. This would be unwise. The U.S. president is so fickle that he could abandon Europe at any moment. The region needs to get its act together – and fast.

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