Policy Article

Arming for growth


  • Moritz Schularick
Publication Date

Germany is currently unable to defend itself and the economy is sluggish. The state should make a virtue of this necessity and stimulate growth by spending on armaments.

Kiel Institute Expert

There is war in Eastern Europe, the Middle East is a powder keg, China and the US are in different ways becoming more unpredictable. In this unstable world, Germany has to contend with the double whammy that it is “not capable of defending itself,” as Defence Minister Boris Pistorius said last year, and its current economic prospects are “dramatically bad,” as Economy Minister Robert Habeck conceded more recently. But the country could turn these problems to its advantage by raising defence spending to keep tyrants at bay and stimulate growth.  

Germany currently spends around 80 billion euros per year on defence, almost two percent of its gross domestic product (GDP), but it could certainly reach higher. During the Cold War, West Germany’s annual defence spending often hit three and sometimes five percent of GDP, as the Kiel Institute for the World Economy recently calculated. But after the fall of the Berlin Wall, the reunified Germany reduced its military outlays to as little as one percent of GDP—and reaped a handsome peace dividend in the form of higher social spending. 

The country is on a path to comply with NATO’s two percent spending target—but only with some difficulty and only temporarily. Its 100-billion-euro special fund for defence spending, which the Bundestag passed after Russia’s attack on Ukraine, will soon be used up. Beyond this, the government has earmarked only about 50 billion euros in annual defence spending in its medium-term budget planning. This is a lowly 1.3 percent of GDP and far below the sort of prudent investment from which the Bundeswehr—or NATO—can currently profit. 

Moreover, should Donald Trump win the US election in this autumn, Germany and Europe would find themselves with a NATO-sceptic in the White House who would be a threat to the US’s traditional security guarantee. Trump has repeatedly instrumentalized this uncertainty and could continue to do so to encourage NATO allies to buy US weapons. In this way, any sizeable increase in European defence spending could see billions upon billions of euros bypass a spluttering domestic economy to be spent in the weapons supermarket of the US. 

To avoid this, Germany and Europe must boost the capacity of the region’s arms industry so they can defend themselves—and support Ukraine’s fight against Russian aggression—with European production. To achieve this, governments have to give the sector planning security by agreeing long-term supply contracts at attractive prices—just as they did with the vaccine industry during the COVID pandemic. Defence companies would then have an incentive to invest—and governments the opportunity to buy “made in Europe” at scale. 

The example of other countries suggests that Germany should raise military spending to around 150 billion euros or 3 percent of GDP a year by the end of the decade. This increase roughly corresponds to the size of the 2022 special fund—just as an annual, not one-time expenditure. This would still be lower than the 4 percent of GDP that its Eastern neighbour, Poland, spends on defence. The US also spends more, around 3.5 percent of its GDP, on defence. It does so despite the fact that it is neither threatened by Vladimir Putin's regime in the same way as Europe, nor has neglected its defence capabilities to the same extent as Germany in the last few decades. 

Such an increase in German defence spending could become a real boost to for otherwise sluggish economic growth in Germany and Europe. Recent economic research in the US—for example by Valery Ramey and her co-authors—shows that the so-called multiplier effect of defence spending on GDP growth can be expected to come in around one (and even higher when debt financed). In other words, an additional 100 billion euros in German defence spending would increase German and European GDP by around 100 billion euros, especially if the production takes place in Europe.   

Since these billions would mainly flow into capital-intensive industries, they would have little effects on a labor market already beset by a skills shortage and on inflation. If anything, they could support the much-needed structural transition of the German economy from its reliance on combustion-engine car production to more high-tech sectors. The war in Ukraine has again shown the degree to which warfare is now intertwined with technology and innovation. Higher German investment in defence technologies would likely have a positive effect on the use of technology in the rest of the domestic economy in the medium term. 

Germany would have three ways to finance such additional spending. It could raise taxes, reduce government spending in other areas, or increase government borrowing. But higher taxes would weaken the economy at a time when the country wants to show economic and political strength. And spending cuts would hit social expenditures, which account for almost 40 percent of the federal budget. Necessarily drastic short-term reductions in social spending would be counterproductive because they could well lead to more political and social instability. 

That leaves government borrowing as the best way to fund increased defence spending. Germany should amend its “debt brake,” or constitutional limits on sovereign borrowing, to allow for more investment in defence. It should also support France's initiative for joint European defence investments to profit from economies of scale in production organized at a European level. These moves would not only boost growth, but also bolster peace and freedom in Europe—the most important foundation for Europe’s economic prosperity. 

The German text was published as an op-ed in issue 14/2024 of “Der Spiegel” on March 27, 2024. 

Cover image: © stock.adobe.com | penofoto.de