Guns and Growth: The Economic Consequences of Surging Defense Spending

”The growth effects of increased defense spending are crucial to the political debate in Europe—done right, the costs of military build-ups can be contained,” says Ethan Ilzetzki, author of ”Guns and Growth: The Economic Consequences of Defense Buildups” and Professor at the London School of Economics. ”This means Europe can decide on defense budgets in the light of regional security priorities, without being distracted by any fears of economic disaster.”

The debate about Europe's ability to defend itself took on new urgency after Russia launched its full-scale war against Ukraine in 2022. Many countries increased military budgets, with EU spending falling just short of NATO's target of 2 percent of GDP in 2024. But NATO Secretary General Mark Rutte has noted that Europe spent ”well over 3 percent” during the Cold War—and US President Donald Trump has even proposed a new target of 5 percent. 

Reviewing studies in macroeconomics, including productivity, public finance, defense, and peace studies, and economic history, ranging from conflicts in the 19th century to the US wars in Afghanistan and Iraq, the Kiel Report argues against the widely assumed ”guns or butter” trade-off: more money, labor, and raw materials channeled to military uses have not traditionally come entirely at the expense of private consumption.

But the success of governments in sustaining private activity depends on a number of factors. GDP growth will be lower, possibly negative, if increases in defense spending are financed from the outset by higher taxes. European governments should instead borrow to fund any temporary extra spending or the ramp-up to permanent budget increases, since it is more expensive to buy than to service and maintain weapon systems. They should also consider that some evidence suggests defense expenditures have the most economic upside in recessions.

Most importantly, European governments should ensure that more defense spending ultimately stays within the region. Around 80 percent of defense procurement currently comes from suppliers outside the European Union. But only domestic production can generate the so-called technological spillovers to other industries and productivity gains that make defense spending generate significant economic activity with each euro spent. 

”If Europe could develop the next generation of defense tech and other weapons at home instead of buying them from the US, the economic effects of additional defense spending could go far beyond short-term fiscal multiplier effects and boost growth in the medium term,” says Moritz Schularick, President of the Kiel Institute. ”An increase in European defense spending from just under 2 percent of GDP to 3.5 percent would currently cost around 300 euros billion per year—but the study suggests this sum could also generate a similar amount of additional economic activity, if properly spent on developing European capabilities.”

The next generation of armaments would require a reorientation of European research and development (R&D) policy. As the so-called Draghi report on European competitiveness pointed out last year, the US spends 16 percent of its military expenditure on R&D, ten times more in absolute terms than the EU's 4.5 percent. As the Kiel Report notes, there is evidence that R&D spillovers into the private sector mean that an increase in military spending of 1 percent of GDP raises long-term productivity by a quarter of a percent.

Another condition for success would be for European countries to organize and eventually finance military spending at EU level—ensuring the region’s freedom and ways of life is arguably the ultimate European public good. Procurement organized at this level would promote dual sourcing from multiple European suppliers to maintain competition and dissemination of expertise. It would also foster smaller ”dual-use” defense contractors whose advances spillover into the private economy quickly.

Ethan Ilzetzki will present the report at a press event at the Munich Security Conference on Friday, February 14, 2025, at 11:15 CET.