Worsened security in Europe has prompted EU member states to increase their defence capacity. This column argues that the NATO target to boost defence spending to 5% of GDP by 2035 could moderately increase EU GDP if supported by effective policy design. Reorganising defence production to exploit economies of scale is crucial, enabling more efficient procurement and reducing reliance on imports, while fostering greater integration within the European defence industry. The national escape clause of the Stability and Growth Pact gives time to adapt to increased defence spending without having to immediately cut other spending and raise taxes, while preserving fiscal sustainability. Over the medium term, public finances will need rebalancing to absorb the expanded defence expenditure.

EU member states are facing an important multi-year period of increased defence spending. To boost defence capability, NATO allies have committed to a significant increase in defence- and security-related spending by 2035. The NATO Hague summit Declaration of June 2025 indicates a target of 5% of GDP for defence spending by 2035, including 3.5% of GDP for core defence spending and an additional 1.5% of GDP for defence- and security-related expenditures.  According to Eurostat, defence spending in 2023 averaged 1.3% of GDP across EU member states, compared to 2.9% of GDP in the US (Figure 1a). Defence spending across the EU started to increase following Russia’s illegal annexation of Crimea in 2014 and after the invasion of Ukraine in 2022, although there have been substantial differences among member states. Member states geographically closer to Russia have generally moved faster to increase their defence spending (Figure 1b).

Figure 1 Defence expenditure in the EU and other international players

a) EU defence expenditure in the EU and the US, 2023

b) Distance to Moscow vs change in military expenditure over the last decade

Source: a) Eurostat, Bureau of Economic Analysis; b) Nato, Google Maps.

In this column, we assess the macroeconomic impacts of the ongoing shift in defence spending in the EU, providing insights into its fiscal sustainability and broader economic implications. The first part provides an overview of the current defence spending trends, and it assesses the fiscal sustainability implications of the increase in spending. The second part assesses the economic impacts including on production capacity and labour markets. Finally, the third part discusses the policy implications.

The ramp-up of defence spending by the member states will require a higher fiscal adjustment after the transition period under the national escape clause of the European fiscal rules

The urgent need to increase defence spending requires debt financing in the short-term in a context of heterogeneous fiscal space across the EU. The activation of the national escape clause provides member states with the flexibility to ramp up defence expenditure in line with the EU’s new fiscal rules (European Commission 2025a), thus giving member states time – until the end of 2028 – to adapt their budgets while defence spending increases.  After the end of the period of activation of the escape clause, the standard fiscal rules would again apply.

In macro-fiscal terms, the increase in defence spending mitigates the mild contractionary effect of the euro area fiscal stance in 2025-2028 implied by member states’ medium-term plans. The profile for the fiscal stance in the coming years will depend on how quickly member states ramp up their defence spending, and the way they adjust other components of their budget. Assuming a linear phasing-in of the national escape clause (reaching its maximum level of 1.5% of GDP at the end of its activation period, in 2028) by all euro area member states would correspond to an annual increase of defence spending of 0.37% of GDP. This would still imply a broadly neutral euro area fiscal stance for 2025, which would turn slightly expansionary in 2026 and remain contractionary in 2027-2028 (Figure 2a).

Figure 2  Euro area fiscal stance and adjustment needs

a) Euro area fiscal stance in 2025-2028

b) Adjustment needs in the second plans without extension (4-year adjustment in 2029-32) 

Note: a) The fiscal stance in the forecast also reflects the use of the flexibility for higher defence spending within the NEC.  In 2027, it is based on unchanged policies. In 2027, according to the MTPs, a mechanical assumption implies that the fiscal stance will be affected by the phase-out of the RRF. b)  Based on simulations and do not consider the deficit resilience and debt sustainability safeguards for the second round of plans. They do not prejudge the actual adjustment requirements for future plans, which will be computed in due time, based on latest outturn data and forecast.
Source: a) European Commission services’ calculations on the recommended net expenditure paths and European Commission Autumn 2025 Forecast; b) European Commission (2025b).

After the expiry of the national escape clause, higher defence spending demands a higher fiscal adjustment from member states. According to stylised scenarios, higher public defence spending during 2025-2028 will require an additional fiscal effort of 0.4 percentage points of GDP, on average, for the subsequent planning period starting in 2029 (Figure 2b; European Commission 2025). This additional adjustment, in combination with additional spending pressures related to the ongoing transition to a digital and decarbonised economy, and population ageing suggests a strong need to improve the quality and efficiency of public finances, so that the impact of fiscal adjustment is minimised.

From a fiscal perspective, debt-financed defence spending is a temporary solution that must be replaced by a gradual spending reprioritisation within national budgets. The national escape clause gives member states flexibility under EU fiscal rules to transition to a permanently higher level of defence spending. Member states should plan to rebalance their national budgets to support this increase in defence spending once the national escape clause expires. Eventually, higher defence expenditure requires containing other spending or expanding tax revenues and attention to the quality of public expenditure.

EU facilities are available to help member states to finance the increase of defence expenditure. Security Action for Europe (SAFE) is a financing facility which is designed to provide up to €150 billion in loans to member states; it has received strong demand by member states. The loans have clear eligibility conditions for contractors and subcontractors to ensure that investments serve the EU’s security and defence interests, bolster the European Defence Technological and Industrial Base, and promote common procurement. Additionally, defence projects can be facilitated through reallocated EU cohesion policy grants and European Investment Bank (EIB) lending, ⁶ with a focus on improving military mobility and building resilient defence infrastructure, particularly in eastern border regions affected by the Russian aggression against Ukraine.

The European industry is ramping up its defence production capacity

The primary goal of increasing defence spending is to safeguard Europe’s security and protect its borders, but it can have a positive impact on GDP. This is the case especially if the additional expenditure is focused on investment and R&D, rather than domestic imports of equipment or current spending (Ilzetzki 2025). The literature shows that in the US, defence spending tends to have a significantly positive impact, whereas the effects in European countries are often much smaller. This is largely attributed to differences in the levels of imported goods for defence procurement and in the composition of current and capital spending in the US and in most European countries. There are significant increases in key defence-related manufacturing, such as weapons and ammunition, ships and boats, and air and spacecraft (Figure 3).  Employment in all the considered sectors has also gone up by at least 10% between 2021 and the first quarter of 2025, with employment in the production of weapons, ammunition, and ship manufacturing registering an increase of around 20%.

Market capitalisation of EU defence producers has increased, indicating that European defence companies are expanding rapidly and gaining market share (Figure 4). The sector’s growing relevance in investors’ asset allocations may also reflect the market belief that European defence producers have the capacity to respond to increasing demand for defence products by EU member states. To ensure the sustainability of these trends, there is a crucial need for durable demand to support ongoing capacity production in the defence sector. Additionally, fostering an environment that encourages the entry of new firms will be essential to diversify production capabilities and enhance competition within the European defence industry.

The defence manufacturing sector may, however, face capacity constraints. Historical evidence for the US shows that learning by doing can drive large-scale increases in capacity, but current labour market conditions in the EU may serve as a constraining factor. Over the course of WWII, US shipbuilders and aircraft manufacturers saw an enormous decline in costs which appeared to correlate with growing experience (Ilzetzki 2024). Similar increases in capacity for EU member states may be constrained especially by different labour market conditions. The US labour market during WWII was characterised by low participation rates, particularly among women, which facilitated the increase in capacity. The current EU labour market, in contrast, faces constraints from activity rates and employment levels at record levels, demographic change, and limited immigration.

Figure 3  Production index in the defence-related sector 

Note: Data are missing for manufacture of military fighting vehicles.
Source: Eurostat short-term statistics database

Figure 4 Market capitalisation of top 5 EU defence producers relative to top 5 US

Source: Bloomberg.

Figure 5 Size of the military work force and employment in EU defence-related sectors       

Source: EU LFS special extraction.

Figure 6 Evolution of job hirings in EU defence industry vs overall economy, 2020-25

Note: The data covers all EU Member States plus Switzerland and European NATO members for which an indeed site exists Not that 100 equals the average monthly postings in 2021.
Source: Indeed database.

Overall, this suggests that higher defence spending may aggravate existing labour and skills shortages in specific occupations. While employment in defence-related manufacturing sectors represented a small proportion of EU employment in 2024 (Figure 5), increased labour demand in the military sector may worsen existing labour and skills shortages in some specific sectors or lead to wage increases in some industries.

Well-designed and coordinated increases in defence spending can have positive impacts on the economy

Increased defence spending, though primarily aiming at ensuring security, represents a valuable opportunity to ramp up investment and increase the potential for innovation. Simulations show that increasing spending to meet the new NATO targets by 2035 can have a modest impact on GDP in the short term. While European NATO members aim to spend a substantial amount on defence equipment, the impact on economic activity would depend on how much of the additional spending is directed toward areas such as research and development or dual-use infrastructure, which could have positive spillover effects on the rest of the economy. Moreover, producing more military goods in Europe rather than importing them is essential to have tangible benefits on the economy.

In that sense, meeting NATO’s 5% defence spending goal could moderately increase EU GDP, while the range of simulated outcomes underlines the importance of policy design. Considering both components – i.e. the “core 3.5%” and the “extra 1.5%” – EU GDP is projected to increase by about 0.8% by 2035 (Figure 7a) at the cost of an increase in the debt-to-GDP ratio (Figure 7b). This impact is, however, uncertain. It would be larger with lower import shares, a higher degree of frontloading, greater investment in infrastructure and R&D, and more growth-friendly financing.

Positive spillover effects on civilian industries are especially relevant for defence-related public R&D spending. Public defence-related R&D can lead to more private sector investment in R&D, driving innovation and creating spillover benefits, and can have a lasting impact on a country’s capital and the spread of innovation. There is evidence of that for the US (Antolin and Surico 2025), but also, more recently, for the EU (Moretti et al. 2025, Kraemer et al. 2025).

Figure 7 QUEST Simulation results, reaching the NATO 5% of GDP target by 2035, EU27

a) Real GDP (%)

b) Debt-to-GDP (pps)

Note : a) This figure reports the level of EU real GDP in percent deviation from a no-policy change baseline. The variables are reported in levels. Scenario range: combined impact across alternative spending, financing, and composition assumptions. b) This figure reports EU government’s debt-to-GDP ratio in percentage point deviation from a no-policy change baseline.
Source: European Commission.

Conclusion

We argue that well-designed increases in defence spending can have a positive impact on the economy. To fully reap those benefits, in line with the 2026 recommendations for the euro area (European Commission 2025c), investments in areas such as research and development and other types of investment that benefit civil industries and favour European-made military goods over imports have the greatest growth impact. Coordinating spending between countries may increase innovation and R&D spillovers across member states, reducing the risk of wasteful fragmentation across the EU and promoting technological advancements between member states and possibly between sectors. Pooling procurement efforts can generate economies of scale and stronger buying power. Promoting the development of industrial capacity would help sector efficiency, foster robust competition among existing defence firms, and encourage new suppliers to enter the market. The current situation of fragmented demand and supply along national borders create inefficiencies. National defence budgets often duplicate efforts, limiting defence R&D potential, while top industries fail to fully exploit the EU defence market hindering interoperability and limiting strategic autonomy.

Source : VOXeu