Germany and Europe should finance rising military spending through borrowing

"Both economic theory and our empirical results suggest that Germany and Europe should rely primarily on debt financing in the short term in order to increase defense spending quickly," says Christoph Trebesch, Director of the Research Center International Finance at the Kiel Institute for the World Economy and co-author of the Kiel Policy Brief "How to Finance Europe’s Military Buildup? Lessons from History".

Government spending for non-military purposes is rarely cut back

In principle, countries have three options for financing sharply rising defense costs: Borrowing, tax increases and budget cuts.

Over the past 150 years, governments have predominantly financed military armaments by taking on debt, often accompanied or followed by tax increases.

Spending cuts in other areas such as welfare and health, education, foreign affairs or interior, and economics were the exception during periods of military build-up and, if they did occur, hardly contributed to their financing.

This is shown by an analysis by the Kiel Institute on the financing of military buildups and wars from 1870 to 2020. It is based on newly collected detailed government spending statistics for 22 countries, as well as data on taxes and debt.

Do not repeat Britain's mistakes of the 1930s

One example of the dangers of a balanced budget policy in the face of a military aggressor is Great Britain in the 1930s. The Treasury insisted on a balanced budget and prevented large investments in defense until around 1937, although Nazi Germany drastically increased its military spending. As a result, Great Britain was inadequately prepared for war when Nazi Germany attacked Poland in 1939.

"Germany and Europe should avoid the serious mistake of Britain’s 'fiscal first' policy and act swiftly and decisively. A major war in Europe would be many times more costly than investing in an effective deterrent now," says Trebesch.

Fiscal rules must not stand in the way of effective defense

The authors therefore recommend exempting defense spending in Germany and Europe from fiscal rules such as the debt brake. A European financing mechanism or another German special fund would be alternative but less clear-cut solutions.

The higher debt burden could be addressed through higher tax revenues and reforms of social transfers and subsidies. In addition, a recently published Kiel Institute report shows that defense spending promotes innovation and growth, which in turn increases tax revenues and lowers the debt ratio.

"Financing the necessary military buildup primarily through budget cuts will not be enough and contradicts the evidence of the past 150 years. Ultimately, however, much will depend on how effectively any newly borrowed money is spent," says Trebesch.