Economic impacts of defence spending in Europe: between growth and fiscal burden
Defence spending is a standard component of public expenditure in Europe and elsewhere. However, Russia’s invasion of Ukraine in February 2022 fundamentally changed political priorities and led to a dramatic increase in defence spending and defence budget plans across the NATO and EU member states. European countries are making gradual progress towards fulfilling their long-term commitment to spend 2% of GDP on defence – a target that many NATO countries had previously met only marginally. This elevated growth towards 3% of GDP and beyond is not only sparking a political and security debate, but also raising questions about the macroeconomic impacts and multiplier effects that such spending generates. Examining the economic aspects of defence expenditure is crucial not only for assessing the effectiveness of security policy, but also for understanding the broader impacts on economic growth, employment and innovation. This article sets out to summarise how current trends in the area of defence budgets will affect the functioning of the European economy.
Introduction
Defence expenditure has long been a widely discussed component of public budgets, and its role in the European context has increased in recent years. The deteriorating security environment after 2014, accentuated by Russia’s direct invasion of Ukraine in 2022, prompted EU and NATO member states to revise their defence strategies and significantly increase their military budgets (SIPRI, 2025; NATO, 2025). This raises fundamental questions about the economic consequences of growing armament – at both the macroeconomic and the fiscal and structural level. According to SIPRI, the biggest military spenders in nominal terms are the world’s largest economies: the USA (USD 997 billion), followed by China (USD 314 billion), the Russian Federation (USD 149 billion), Germany (USD 88.5 billion) and India (USD 81.8 billion). When military expenditure is measured as a share of GDP, Israel also ranks among the top spenders (see Chart 1). However, detailed data on this topic are very difficult to obtain for many countries. In addition, there is no standardised common methodology for defining what exactly falls under defence spending. According to NATO’s definition: “Defence expenditure includes all current and capital expenditure on the armed forces, including peacekeeping forces, on defence ministries and other government agencies engaged in defence projects, and on paramilitary forces when judged to be trained and equipped for military operations”. Spending on veterans’ benefits, civil defence and border guards (unless they are part of the armed forces) and financial support to industry are thus excluded. For infrastructure spending to be considered defence spending, it must serve military purposes and not be intended, even partially, for civilian use. Therefore, motorways and civilian airports do not fall into this category.
Chart 1 – Defence expenditure of selected countries
(% of GDP)
Source: SIPRI
Note: The data for China and Russia are largely estimates.
NATO member states should spend at least 2% of GDP on defence, but fewer than a quarter of them have met this commitment in the past. However, according to preliminary data, the majority (23) of the 32 NATO member states reached this threshold last year. EU member states differ in their attitudes to increasing defence spending. While Germany, Poland and the Nordic and Baltic countries are willing to raise their spending to the future goal of 5% of GDP, France and Italy are reticent (mainly due to budgetary constraints) and Spain is openly against such a sharp hike. It is interesting to note that countries’ willingness to increase their defence spending correlates with their geographical proximity to Kyiv. The closer a country is to Kyiv, the more willing it is to spend more on defence. If we look at the structure of defence spending in the EU, investments (equipment purchases, software solutions and soldier gear) account for an even smaller share of total defence spending (see Chart 2). Personnel costs make up a large part of the expenditure (roughly a quarter to a third). The smallest part is spent on infrastructure. Infrastructure spending is often mentioned in the debate about increasing defence expenditure, but the NATO definition provided above is very strict in identifying such spending.
Chart 2 – Total defence expenditure and defence investments in the EU
(% of GDP)
Source: European Defence Agency
Multiplier effects of defence spending
The macroeconomic impacts of defence spending are not clear-cut. While part of the traditional economic literature emphasises its stimulative effects through demand for goods, services and innovation in the defence industry (Keynes, 1936; Dunne & Tian, 2013; Hartley, 2011), other studies point to its potential crowding out of more productive civilian investments and to the long-term fiscal burden (Barro, 1990; Benoit, 1978; Deger & Smith, 1983). In the European context, it is also necessary to take into account the differences in individual countries’ budget capacity, their dependence on imports of military technology and the specificities of the common market (Brauer & Dunne, 2019; Hartley, 2011).
From a macroeconomic perspective, it is crucial to examine the fiscal multiplier. The fiscal multiplier measures how much GDP increases as a result of growth in government spending. For defence spending, the multiplier tends to be lower than for investment in education or infrastructure, because part of the funds is tied to arms imports. The most cited academic papers estimate the short-term multipliers to be roughly between 0.5 and 1.6; higher multipliers are assumed for debt-financed domestic investment capital expenditure during recessions. Conversely, lower (even close to zero) multipliers occur when the share of imports in investment is high and spending is covered by fiscal cuts in other areas.
Defence expenditure (defence investment) is accompanied by specific effects on the entire economy. The first effect is support for domestic industry. In countries with developed arms manufacturing (France, Germany, Italy, Sweden and the Czech Republic), an increase in defence contracts leads to growth in employment, exports and technological innovation. The second specific effect stems from technological spillovers, with defence technology R&D significantly influencing the civilian sector (e.g. aviation, cyber security and telecommunications). This indirect effect of defence spending increases long-term productivity. The third specific effect results from geographical dispersion, as investment in military infrastructure and bases stimulates regional economies, especially in less developed or remote regions.
The relationship between defence spending and economic growth is ambiguous in the empirical literature. Conclusions vary depending on the sample, time period and methodology used. The OECD estimates that the fiscal multiplier may be 1.0–1.2 in this case, meaning that each euro spent on defence investment generates up to 1.2 euros in total GDP. An assessment based on models of the European Central Bank (ECB, 2025) estimates the average fiscal multiplier to be 0.93 over a two-year horizon. However, there is substantial model heterogeneity, with the projections ranging from 0.42 to 1.13. According to calculations by Oxford Economics, the average fiscal multiplier for the currently planned defence spending will be lower – at 0.6–0.8. Some meta-analyses (e.g. Alptekin and Levine, 2012) found a low positive net effect of defence expenditure on GDP, ranging from 0.056 to 0.066. Increased defence spending may have positive short-term effects on aggregate demand. However, these effects diminish over time. By contrast, other meta-analyses (e.g. Simpartl, 2024; Yesilyurt and Yesilyurt, 2019) concluded that the relationship between defence spending and economic growth is negative or insignificant. Based on an analysis of 405 estimates from 67 studies, Simpartl (2024) found a statistically significant negative effect of increased defence spending on economic growth of between −0.107 and −0.052.
The value of the fiscal multiplier for defence spending also depends on the period in which the economy finds itself. The multiplier is higher at times of heightened geopolitical tension. During the Cold War the multiplier averaged approximately 0.86, whereas after it ended it dropped by half – to around 0.41 on average (Antonova et al., 2025). The structure of the economy and capital is another important factor influencing the value of the multiplier. The multiplier tends to be higher in industry-oriented economies (usually around 0.94) than in service-oriented economies (usually around 0.76). It decreases as the costs of reallocating capital between the military and industrial sectors increase. Moving capital from industry to the military is less costly than shifting it from the service sector, as industrial activity can be more easily repurposed for military production.
Another crucial factor is timing of the expenditure and the intertemporal aspect of the fiscal multiplier, as private sector expectations also play a role. Defence expenditure is typically spread over several years – it is announced in advance and implemented gradually. This gives economic agents time to respond. Other things being equal, the prospect of future tax increases and higher interest rates leads to a reduction in private spending, which weakens the fiscal multiplier. This relationship is key to NATO’s goal of increasing defence spending to 5% of GDP in the medium term, as it corresponds exactly to the type of multi-year programme announced in advance, for which studies usually show a limited impact on GDP. As a general rule, the fiscal multiplier should be lower in the short run. In the long run, defence spending may be allocated more efficiently. This can have a profound and lasting impact on the production capacity of an economy – especially through support for industrial development, technological innovation and human capital development.
The value of the fiscal multiplier is also affected by how defence expenditure is funded. Financing through tax increases immediately crowds out private consumption and investment, which may even result in a negative impact on GDP. By contrast, debt financing is typically growth-supportive in the short term – unless it triggers expectations of future tax increases in the private sector, as mentioned above.
The volume of imports and the extent of international capital spillovers are much-debated and difficult-to-quantify factors influencing the value of the fiscal multiplier. It is often not clear in advance how big the share of imports will be in defence equipment procurement when military technology must be purchased abroad. In such cases, part of the expenditure stimulates the economies of trading partners rather than the domestic economy. This reduces the domestic multiplier but increases the positive spillovers to other countries. Importing countries therefore look for other mechanisms to achieve at least a partial positive effect on the domestic economy.
Such compensation instruments designed to enhance the economic stimuli for the domestic economy in the case of import-intensive defence investments include offset programmes modified into industrial cooperation. Offset programmes (compensatory trade agreements primarily linked to the purchase of military equipment) were widely used in European countries until the end of the 2010s. Following the entry into force of stricter EU rules[1] on public procurement in defence, many European countries abandoned mandatory (entitlement-based) offsets. In practice, however, these programmes still exist in the form of better legally formulated agreements, often referred to as industrial cooperation.[2]
Impact on inflation
Ramping up defence spending typically has an inflationary effect in the short run, when aggregate demand rises without an immediate corresponding increase in production capacity. ECB (2025) estimates that increased defence spending has only a modest effect on consumer prices. An increase in defence spending of 1% of GDP would lead to an average increase in HICP inflation of 0.1 pp over two years and 0.2 pp over four years. This relatively small impact suggests that the economy is expected to be able to absorb the increased demand without significant price shocks. However, other studies for the USA (e.g. Ben Zeev and Pappa, 2017) usually find a small inflationary effect in the short run. Historically, increases in US military spending, for example during the Korean and Vietnam wars, have been significantly inflationary. However, it should be emphasised that the fiscal expansions then were much more dramatic than those currently being considered by European countries. According to an Oxford Economics forecast, the impact on inflation will be significant in the short term due to insufficient production capacity in the arms industry.[3]
Table 1 – Defence expenditure and impact on inflation
| Source | Impact on inflation | Time horizon |
|---|---|---|
| ECB (2025) | +0.1–0.3 pp | 1–2 years |
| European Commission (2024) | +0.2 pp | approx. 3 years |
| Ramey (2011) | +0.3 pp | 2 years |
| Ben Zeev & Pappa (2017) | +0.1–0.3 pp | 1–2 years |
| Nakamura & Steinsson (2014) | 0 pp | 2 years |
Note: Effect of increasing government defence expenditure by 1% of GDP.
The inflation impacts will of course be determined primarily by how the increased defence spending is financed. If it is covered mainly by issuing bonds, a larger inflationary impact than that predicted by the ECB study can be expected. Conversely, if it is financed by tax hikes or cuts in other government spending, it could even have an anti-inflationary effect.
Impact on productivity
Despite the unclear net effect, there are several well-identified mechanisms through which military spending can support long-term productivity growth. The first is the R&D spillover effect. Military R&D can be a powerful driver of innovation, creating dual-use technologies that also find broad application in the civilian sector. There is a significant difference between the USA and the EU in this area. While in the USA the share of R&D spending in the military budget is approximately 16%, in the EU it is only 4.5%.
Sustained and extensive government demand for military equipment also creates an environment in which companies can benefit from economies of scale and gradually reduce unit costs. This process, sometimes referred to as learning by necessity, enables firms to gain experience, improve production processes and build a large capital and knowledge base that can benefit the entire economy.
Investment in defence equipment in the EU has strong multiplier effects, especially in technology-intensive sectors (see Chart 3). High value-added industries such as aerospace and precision instruments benefit most, generating significant upstream effects in related sectors. Overall, therefore, defence investment in the EU primarily stimulates capital- and technology-intensive industries, which are also often strategically important for civilian innovation. This suggests that part of defence spending acts not just as purely fiscal expenditure, but also as investment in broader industrial capacity and technological development.
Chart 3 – Sector impacts of defence equipment investment in EU
(€Bn increase in gross output)
Source: Oxford Economics
Latest developments: EU Member States’ plans
The strategic question for European countries is how to link increased defence budgets with strengthening their own industrial and technological bases. Initiatives such as the European Defence Fund (EDF) and joint EU procurement programmes aim to enhance coordination and reduce dependence on non-European suppliers. If defence spending can be aligned with support for domestic R&D and innovation, its multiplier effect could be close to or even exceed the values known from civilian infrastructure investments.
At the NATO summit in The Hague in June 2025, member states agreed on an ambitious shift in defence commitments by adopting a new goal to invest up to 5% of GDP by 2035 in “core defence requirements” and defence- and security-related spending. The 5% goal breaks down as follows: at least 3.5% of GDP annually on “core defence requirements” (as defined by NATO) and up to 1.5% of GDP on related areas (e.g. critical infrastructure, cyber defence, civil preparedness and resilience, innovation and the defence industry). Direct contributions to Ukraine’s defence and its defence industry will also be included in the calculation. NATO member states will submit annual plans showing a credible path to reach this goal. A review of progress towards the goal is scheduled for 2029. In addition, countries can to some extent use EU funds to finance these investments. This would help mitigate the crowding out of private spending. Furthermore, the additional 1.5% of GDP may not lead to an increase in total budget expenditure in many countries, as a number of them have already been allocating the required resources to these areas.
Conclusion
Although increased defence spending strengthens security and can contribute to economic growth, it also carries economic risks. One traditionally cited risk is the crowding out of private investment by government investment. Higher defence budgets may also limit fiscal space for other public expenditure, especially in health care, education and infrastructure. Another characteristic feature is the procyclical nature of defence spending. High military expenditure can widen structural deficits during economic recessions or crises. Lastly, increased defence spending is very often associated with higher imports, which reduces the multiplier effect of investment described above.
Authors: Luboš Komárek, Mikuláš Zeman and Petr Polák. The views expressed in this article are those of the authors and do not necessarily reflect the official position of the Czech National Bank.
References
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Keywords
Defence spending, NATO, fiscal multiplier
JEL Classification
E63, H56, O40
[1] In 2009, the European Union adopted Directive 2009/81/EC, which prohibited mandatory offsets in defence procurement unless they were necessary for the security interests of the state.
[2] Examples include Poland and Finland, which continue to require technology transfers from foreign suppliers, even though these are not referred to as “offsets”. The Czech Republic has not officially used offsets since 2014. However, it also seeks to involve domestic industry in its acquisitions (for example of F-35 fighter jets and MADR radars) through other mechanisms.
[3] Arms exports (and imports) are not easy to find explicitly in standard statistics or reports (such as the balance of payments), as they do not appear as a separate item labelled “arms” or “defence”. They are included in broader categories, making them difficult to extract directly from regular statistics. Central banks (such as the CNB and the ECB) do not report arms exports separately but include them in aggregate goods exports. However, statistical offices (such as Eurostat and the Czech Statistical Office) do track trade in arms separately using tariff codes (e.g. CN 93). With some analytical effort, these data can be aligned with the trade balance, but the balance of payments itself does not separate them.