Can Europe afford to rearm itself? With Jeromin Zettelmeyer

Episode Summary

Executive Summary: The episode examines Europe’s push to rearm amid Russian aggression and uncertainty over US support, focusing on whether NATO’s new spending goals are financially and industrially feasible. Guest Jeremy Zettelmeier argues that meeting the targets will require both budgetary sacrifice and a deeper European defense market, plus shared funding for truly common military capabilities.

Main Topics: NATO’s new defense spending commitments (Priority: 5/5): The discussion explains NATO’s push to raise core military spending to 3.5% of GDP and broader defense-related spending to 5% by 2035, marking a major shift from the old 2% guideline. How European states will finance rearmament (Priority: 5/5): Countries below target, especially those with high debt and deficits, will likely rely on a mix of extra borrowing in the short term, delayed adjustment, higher taxes, and cuts to civilian spending over time. Fiscal strain and country-specific difficulties (Priority: 5/5): France, Italy, Spain, Portugal, and Belgium face the toughest adjustment because they start from low defense spending levels while also carrying fiscal pressures under EU rules. Germany’s debt-rule reform and economic effects (Priority: 4/5): Germany’s loosened debt rules could lift defense and infrastructure investment, supporting growth, but also create tension with EU fiscal benchmarks and raise debt levels. Creating a European defense single market (Priority: 5/5): Zettelmeier argues Europe needs a more integrated defense industrial base to lower costs, increase competition, and generate scale, rather than relying on fragmented national procurement systems. Joint European funding and common defense assets (Priority: 5/5): The conversation explores EU- or NATO-level financing for shared capabilities such as air defense, satellites, and fighter jets, which would reduce dependence on the US and keep such assets in common ownership. SAFE and the idea of a rearmament bank (Priority: 4/5): The episode compares existing EU lending via SAFE with a proposed rearmament bank, concluding that lending alone is insufficient without stronger common procurement and market integration.

Key Arguments: NATO’s targets represent a large but manageable long-term increase: about 1.5% of GDP on average over 10 years, though the near-term burden is much heavier for some states. Countries with high debt and low starting defense budgets will struggle most; the likely path is partial compliance, delayed fiscal adjustment, and some reliance on debt financing. Defense spending cannot be expanded efficiently if each country keeps buying from its own national suppliers; Europe needs scale, cross-border procurement, and competition to avoid excessive costs. Germany’s new borrowing flexibility will likely boost growth through defense and infrastructure investment, but it also widens tension with EU fiscal rules and increases debt. The most economically justified case for common borrowing is for assets that serve Europe collectively, such as integrated air defense, satellites, and long-range capabilities. SAFE helps by lowering borrowing costs, but only marginally; it does not solve the deeper problem of fragmented procurement or create common defense capacity. A rearmament bank that only pre-finances procurement is less ambitious than a true defense single market and would therefore be less effective at lowering costs and coordinating industrial production.

Data Points: NATO core military spending target: 3.5% of GDP - Benchmark for military spending by 2035 under the new agreement Broader defense-related spending target: 5% of GDP - Includes civilian defense and critical infrastructure in NATO’s wider definition Current NATO guideline: 2% of GDP - Previous benchmark referenced in the discussion Typical current spending in many European NATO members: around 2% of GDP - Majority of European countries, including the UK, are near this level as of end-2024 Low-spending countries: 1.3% to 1.5% of GDP - Portugal, Spain, and Italy are described as significantly below target Poland defense spending: above 4% of GDP - Poland is already well above NATO targets Baltic states defense spending: well above 3% of GDP - Frontline countries already spending substantially more than the average Average increase needed: about 1.5% of GDP over about 10 years - Estimated lift required to reach NATO’s new average target France EU fiscal adjustment need: about 5% of GDP - Adjustment required under new EU rules, before adding defense increases Italy EU fiscal adjustment need: about 3.5% of GDP - Fiscal adjustment required under EU rules Spain current defense spending: about 1.3% of GDP - Used as an example of a country starting from a very low base German extra-budgetary infrastructure fund: 500 billion euros - Germany plans to spend this over 12 years German infrastructure spending pace: about half in the next four years - Implying roughly 5.5% of GDP in extra spending over four years SAFE funding envelope: 150 billion euros - EU lending instrument for member-state defense borrowing SAFE borrowing cost advantage: about 20 basis points - Estimated subsidy from borrowing via the EU versus markets German constitutional deficit limit: 0.35% of GDP - Constraint that still applies to the non-defense budget under Germany’s new rule

Pivotal Quotes: "Europe has a weapons problem." — Sam Fleming: Sets up the central question of whether Europe can afford and organize rearmament "The real target is to be ready for a potential invasion by the Russians within a couple of years." — Jeremy Zettelmeier: Explains why the 10-year spending goal may not match the immediate security timeline "We need to be able to create competition between European companies. And of course, we also need to generate more scale." — Jeremy Zettelmeier: Summarizes the case for a European defense single market

Implications: Europe’s rearmament push will reshape budgets, industrial policy, and EU fiscal politics. The biggest gains come from joint procurement and shared capabilities; without them, higher spending will be slower, costlier, and more nationally fragmented.