RaboResearch - Economic Research

The defence spending gap in the EU

Economic Comment

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  • On 22 March, the Trump team announced that the EU is temporarily exempted from the steel and aluminium tariffs, just hours before they had otherwise become effective
  • Earlier that week, the US had put five demands on the table that trading partners must abide to in order to be (permanently) exempted from those tariffs. One of those demands is to enhance security cooperation with the US
  • So far we do not know what exactly that means. But if it requires the EU has to step up its defence spending to 2 percent of GDP as agreed within NATO, it would be difficult for multiple EU Member States to fully comply, due to massive expenditure increases involved

This Economic Comment is part of the publication The Trump trade war intensifies: which segments are most vulnerable?

From temporary to permanent exemptions?

On 22 March, the Trump team announced that the EU is temporarily exempted from the steel and aluminium tariffs, just hours before they had otherwise become effective. Note the word temporarily: if the EU does not sufficiently adhere to US demands by the 1st of May, tariffs would yet come into effect. With respect to these demands, the EU might be open to team up against China as it too regularly accuses China of unfair trade policies. In fact, in May last year the EU announced 20 new anti-dumping measures on steel and iron exports from China. But, caving in to US demands could make the block look weak. Besides that, it is questionable whether the EU can please the US when it comes to the request to enhance security cooperation with the US.

NATO guidelines

At this moment, it is not publicly known what the US exactly means with “enhance security cooperation with the US”. Yet, Trump has claimed before that the EU needs to pay its fair share on defence if it wants to count on US support when necessary. While the US spends about 3.3 percent of GDP on defence, the EU only spends 1.3 percent of GDP (figure 1). This is much less than the agreed amount in NATO of 2 percent of GDP. Trump’s stance on this had already provoked some awareness of the issue around the block. But that does not mean that it will be easy for the EU to in fact raise defence spending to reach that percentage.

Importantly, while the EU has a common trade policy, defence spending is a national matter. In other words, it would require the Member States that are ‘underspending’ to individually increase their defence budget. This could be politically highly contentious due to the high expenditure increases involved in some countries.

Figure 1: Defence spending gap EU Member States
Figuur 1: Verschil defensie-uitgaven EU lidstaten en NAVO richtlijnSource: Macrobond, AMECO, Eurostat, Rabobank calculations

Increased defence spending would have major fiscal implications for some European countries, which will probably determine whether Member States are receptive to US demands to step up their efforts. Currently, only Estonia, Greece and the United Kingdom spend 2 percent or more of their GDP on defence, where Ireland and Luxembourg spend the least on defence as a percentage of their GDP. It should be noted, though, that Ireland is not a NATO member and as such has never agreed with other NATO members to spend 2 percent of GDP on defence.

Together, EU Member States would need to shore up defence spending by more than EUR 100bn a year, if the block as a whole wants to meet the 2 percent target. If we exclude all non-NATO EU members (Cyprus, Finland, Ireland, Malta, Sweden), it would be about EUR10bn less. As mentioned, at the individual country level, differences in additional spending would be substantial. At the same time, future US tariffs on EU goods would affect every country differently. Accordingly, the ‘trade-off’ between the impact of possible future tariffs against having to raise defence spending is not the same for each country.

European budget guidelines

Moreover, several Member States would violate European budget rules if they were to close the defence spending gap. While most would not breach the general budget balance maximum of 3 percent of GDP, there would be negative implications for the structural balance, something many Member States are already struggling to comply with under the current circumstances. Additional defence spending would need to be compensated in full by other spending cuts or higher revenues to meet the structural budget targets, which would certainly face much political and societal resistance.

In short

On the one hand, most EU Member States seem to be aware that they should increase defence spending to comply with NATO commitments and safeguard US support if necessary. Yet on the other hand, fiscal constraints appear to curb additional defence spending. It remains to be seen whether the EU can sufficiently comfort the US in the coming weeks to prevent the introduction of steel and aluminium tariffs on 1 May or other tariffs in the future.

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Author(s)
Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 68740
Hugo Erken
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 52308

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