The costly search for defense capabilities

Europe is rearming — yet between geopolitical pressure, fragmented markets, and tightening budgets, a new distributional conflict is taking shape. The path toward genuine European defense capability is blocked less by military technology than by economic and fiscal disunity. And the debate over joint financing has now become unavoidable.

By Prof. D. Michael Hüther

Three recent developments are shaping the discussion about how Europe can regain military strength:

1. The Stockholm International Peace Research Institute (SIPRI) reported this week that “in 2024, global arms sales reached the highest level we have ever recorded — totaling 679 billion US dollars.” The 26 European defense companies increased their revenues by 13 percent, outpacing their 39 U.S. competitors, who grew by 3.8 percent.

2. Negotiations between the EU and the United Kingdom over the latter’s participation in the €150 billion SAFE defense fund have so far failed.

3. European armies still operate roughly four times as many weapons systems as the United States — a sign of their fragmented defense market.

The rearmament drive began back in 2015 and continues to accelerate. European NATO members now face the challenge of meeting their defense needs in overheated markets while keeping spending sustainable. A major handicap lies in their inability to overcome the patchwork of small-scale contracts. Military buyers also have a preference for customization — unlike in the U.S., where standardized procurement enables economies of scale, albeit at the price of dependence on a few major suppliers. The 2024 sales figure cited above was generated by just 100 companies worldwide.

Market Order for the Defense Buildup

Europe’s ongoing armament push raises a fundamental question: under conditions of catch-up and accelerated rearmament, how should the security and defense sector be organized according to sound economic principles? Ideally, it would operate in a competitive market that offers governments multiple choices while avoiding excessive profits from strategic urgency.

In practice, defense technology creates tight interdependencies between clients and manufacturers. Production typically relies on complex partnerships and consortia, which reduce competition. Moreover, the Treaty on the Functioning of the European Union (Article 346 TFEU) exempts military procurement from internal market rules.

The EU’s Permanent Structured Cooperation (PESCO), launched in 2017, has so far failed to scale up joint defense projects effectively, as national export and transfer regulations still dominate.

Limited Cooperation So Far

Industrial partnerships — such as the Franco-German effort to develop a “tank of the future” by 2040 — remain rare exceptions and have yielded little evidence of efficiency gains, even if the European Commission granted approval relatively quickly. The EU estimates that roughly 80 percent of defense equipment is still purchased nationally. Appropriately, reforms to speed up procurement are also being advanced at the national level, as shown by Germany’s defense procurement law passed this summer.

The Case for a Common Defense Fund

The SAFE fund aims to create stronger incentives for joint procurement. But London’s participation — after years of obstructing deeper defense cooperation while still in the EU — remains elusive. Brussels’ insistence on a fair financial contribution that reflects both industrial capacity and expected economic benefit is understandable, given the rule that at least 65 percent of contracts must generate value within Europe.

From a competition perspective, that requirement can be questioned, but Europe’s need for technological resilience strongly supports it. Germany’s 2022 purchase of 35 F‑35 jets illustrates the risks of U.S. dependency, as each deal still hinges on Washington’s approval.

A Dedicated Defense Bank

One new idea gaining traction is the creation of a specialized European defense investment bank to finance arms procurement, modeled after the European Bank for Reconstruction and Development. In light of fiscal constraints across the eurozone, such an institution could pool capital contributions from member states to leverage significant lending capacity through high credit ratings. It could then finance both national buyers and defense firms, potentially bundling orders for global tenders — though this might raise concerns about strategic resilience.

Defense Capability as a Fiscal Test

Ultimately, the strain on public budgets cannot be concealed. Europe faces a political and social reckoning over how to allocate tax revenues between domestic spending and defense — a classic distributional conflict. The temporary exemption of defense spending from Germany’s constitutional debt brake cannot last indefinitely if debt ratios are to remain stable.

In the medium term, all defense expenditure must be reintegrated into the federal core budget. The fiscal groundwork for this needs to be laid now. Defense capability, after all, is not just a military issue — it is a matter of societal balance and geopolitical survival.

About the author:
Since 2004, Prof. Michael Hüther has headed the German Economic Institute (IW) in Cologne. From 1995 to 1999 he served as Secretary-General of the German Council of Economic Experts and later worked as an economist in the private sector at DekaBank. Hüther is deputy chairman of the Atlantik-Brücke.

This article was first published by Süddeutsche Zeitung Dossier.