The Debt Crisis Hiding Inside Europe's Rearmament Boom

Europe's defence spending surge is being funded largely by borrowing. Here is what the debt consequences look like for the next decade — and which countries are most exposed.

The political celebration of European rearmament — the relief that the continent is finally taking its own defence seriously, the satisfaction that the NATO two-percent target is now being met and in many cases exceeded — has not been accompanied by equally clear-eyed analysis of how the rearmament is being paid for and what the fiscal consequences will be.

The honest answer is: mostly by borrowing. The EU's SAFE facility provides common debt instruments backed by EU guarantees. The new EU fiscal rule exemptions for defence spending allow member states to borrow for military purposes without those borrowings counting against deficit rules. National defence budget increases are being funded predominantly through bond issuance rather than tax increases or reductions in other spending.

This is not inherently wrong. There is a strong economic case for debt-financing security investment: the benefits — deterrence of conflict, protection of the social and economic infrastructure that debt-funded investment ultimately protects — accrue over decades, making it appropriate to spread the cost over time. The analogy to household borrowing for a home that provides shelter for twenty years, rather than paying cash from annual income, is imperfect but directionally correct.

The problem is that this borrowing is happening in an environment where several major European economies already carry public debt levels that fiscal economists describe as requiring, rather than tolerating, additional debt reduction. Italy's debt-to-GDP ratio exceeds 140 percent. France's is approaching 115 percent. Greece, despite its impressive economic recovery, retains elevated debt levels from its crisis decade. For these countries, simultaneous defence spending increases, energy subsidy costs, and the servicing of existing debt creates fiscal arithmetic that is manageable in benign conditions but becomes increasingly difficult in conditions of higher interest rates.

The ECB's potential interest rate increase — being actively discussed in response to the Iran war inflation surge — would add directly to the debt service costs of these already-exposed sovereigns, creating a feedback loop between the geopolitical crisis and the fiscal constraints of the countries most needing to respond to it.