A new era of global rearmament is gathering pace, and it would mean vast costs and some tough decisions for Western governments already struggling with shaky public finances.
Despite world defense spending reaching a record US$2.2 trillion last year, EU nations have only just begun to consider what 21st-century security will require with an aggressive Russia stirring on their eastern borders, a volatile Middle East and the expansion of the Chinese military tugging Washington’s attention toward the Pacific.
Political leaders have been congratulating themselves on the progress toward NATO’s targets for members of the alliance to set aside 2 percent of their GDP on defense, but officials focused on security say that military budgets might need to emulate Cold War spending of as high as 4 percent to deliver on the alliance’s plans.
Illustration: Mountain People
If the US and its G7 allies were to reach such levels, that would equate to more than US$10 trillion of additional commitments over the next decade, calculations by Bloomberg Economics show.
“The post-Cold War ‘peace dividend’ is coming to an end,” Bloomberg Economics chief geoeconomics analyst Jennifer Welch said. “That’s likely to have a transformative effect on defense companies, on public finances and on financial markets.”
The brutal reality for the US and its allies is that Russian President Vladimir Putin’s advances in Ukraine mean they need to dramatically ramp up their defenses in eastern Europe at the same time as they counterbalance China — just as that country increases cooperation with Moscow.
Chinese President Xi Jinping (習近平) has been clear about his ambition to bring Taiwan under Beijing’s control, by force if necessary, and has increasingly asserted China’s territorial claims elsewhere in the Asia-Pacific region.
Those twin threats are pushing Western leaders — and their voters — to confront problems over taxes, welfare and government borrowing that have been building for years, as they come to terms with the tradeoffs that the return of great power competition would bring.
“I don’t foresee a fiscal crisis triggered by elevated defense spending,” said Massachusetts Institute of Technology professor of global economics and management Simon Johnson, who was previously chief economist at the IMF. “But I do worry about a national security crisis caused by a failure to defend your country.”
Analysis from Bloomberg Economics shows how the increasing burden of preparing for war would create a new fiscal paradigm for most NATO members.
Even just meeting the alliance’s 2 percent of annual GDP minimum for military outlays would stall much of the EU’s post-COVID-19-pandemic debt consolidation. Getting to 4 percent would push the bloc’s weaker sovereigns to make painful choices between even deeper levels of borrowing, significant cuts in other parts of the budget, or else tax increases.
France, Italy and Spain would be particularly exposed if the extra spending is funded through bond markets, with Rome’s public debt jumping to 179 percent of output by 2034 from 144 percent this year.
Even the US, which is already allocating 3.3 percent of its annual GDP on defense, would see borrowings increase to 131 percent from 99 percent over the next decade if it pushed its military budget to 4 percent.
The implications might feature when the IMF releases updated debt forecasts next week at its spring meetings. Its officials have already told countries to gradually start rebuilding fiscal buffers amid growth that is likely to be weaker in the next half decade than before the pandemic.
While the wars in Ukraine and Gaza have focused attention on Europe and the Middle East, the surge in military budgets is a global phenomenon.
China’s defense spending is to grow 7.2 percent this year — the most in five years.
Malaysia tops year-on-year growth projections for 22 Asia-Pacific nations with a 10.2 percent increase and total outlays of US$4.2 billion this year, according to analysis by defense intelligence firm Janes.
That is followed by 8.5 percent growth for the Philippines with US$6.6 billion.
US President Joe Biden’s administration is to request a 1 percent increase for a military budget that already dwarfs that of any other nation.
Matthew Kroenig, senior director of Atlantic Council’s Scowcroft Center for Strategy and Security, said it might need to double as a percentage of GDP.
“The US is nowhere near where it needs to be,” he said.
How a remilitarized world can reconcile such commitments with finite tax revenues and ever-greater welfare and health needs is set to become a searing political question in the years ahead.
It is with that in mind, and the prospect of a second term for NATO-skeptical former US president Donald Trump, that the EU’s 27 leaders late last month started difficult discussions over how to finance a major overhaul of their defense sector while also maintaining aid to Kyiv. Trump’s comments sewing doubt over US aid for Europe in the event of war brought added urgency to those talks.
Despite such worries, NATO members are unlikely to agree to a firm commitment to spend as much as 4 percent of GDP on defense any time soon. They last year agreed to sharpen their pledge to spend at least 2 percent, but even that drew intense debate.
For investors, the most appealing option would be to expand the issuance of jointly backed euro bonds that funded the EU post-pandemic recovery plan. Such a structure would take advantage of the clamor for more AAA-rated European securities and cushion individual countries from the increasing burden.
All the same, a prolonged era of higher interest rates that looks likely could yet stoke debt servicing charges and narrow public finance options, especially if it is coupled with significantly higher defense spending.
If governments duck politically hard decisions, that might only ensure borrowing costs remain high, said Christopher Smart, a former senior economic policy official at the US Department of the Treasury and the White House.
“We live in a world of politicians who prefer guns and butter,” said Smart, who is now managing partner of the Arbroath Group. “So I don’t know that it is going to force a whole lot of difficult choices, it will just lead to more debt, which will itself drive up rates.”
Those concerns are also behind the opposition to joint bond issuance from fiscal hawks in wealthier nations like Germany.
German Chancellor Olaf Scholz, speaking last month, did not rule out the issuance of joint bonds categorically, but did not show much enthusiasm either.
“We are not such big fans of such ideas,” he told reporters.
The backdrop to such discussions is NATO’s plan to deliver one of the biggest overhauls of its defenses since the end of the Cold War.
The alliance is aiming to put about 300,000 troops at higher readiness, with members able to scale up eight multinational battle groups on its eastern flank, each currently of about 1,000 troops, to reach brigade size of as many as 5,500.
“More is urgently needed,” said Oana Lungescu, an analyst at the London-based think tank Royal United Services Institute and a former NATO spokesperson.
The alliance needs to fill long-standing gaps such as air defense, to replenish weapons and ammunitions stocks, and to keep investing in new technologies to maintain its advantage over Russia, she said.
Ukraine would also need ongoing support as it endures a third year of war with Russia.
While all that might incur costs that political leaders have barely begun to calculate, it is probably still better than the alternative, Johnson said.
“You have to weigh that against what happens if you don’t spend the money,” he said. “What does that mean for your country, your economy and for investors?”
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