Europe's Black Swan: Political conflict with Trump pushes Europe towards decisions it could not make before

In a pan-European format

Just one day after the conclusion of the Munich Security Conference (→ Re:Russia: Munich Discord), European leaders held an emergency meeting in Paris. French President Emmanuel Macron hosted the leaders of the United Kingdom, Germany, Poland, Italy, the Netherlands, Spain, and Denmark, along with European Commission President Ursula von der Leyen and NATO Secretary General Mark Rutte. Two days later, Macron convened another meeting in a hybrid format (with most participants joining online), which included the leaders of 18 European countries and Canada who had not attended the first meeting. This sudden gathering had a predominantly pan-European character, bringing together countries both outside the EU and outside NATO – an unprecedented development. Canada’s participation was explained by its NATO membership, its significant involvement in the 'Ukraine issue,' and, lastly, by Donald Trump's attacks on his northern neighbor, which have drawn Canada closer to Europe in opposition to American MAGA ideologues. Notably absent from both meetings were representatives from Hungary, Slovakia, Austria, Malta, Switzerland, and five Balkan countries.

The emergency two-day meeting was a response to the new US administration’s decision to conduct separate negotiations with Moscow without European and Ukrainian representation, as well as to Washington’s clearly stated intention to at least limit its responsibility for Europe's security. Next week, Macron and British Prime Minister Keir Starmer will travel to Washington to discuss the common European position with Trump. At this critical moment, three key questions face both the meeting’s participants and Europe as a whole. What can Europe do to protect Ukraine and ensure its security even if the US abdicates its responsibility in this matter? In the face of the Russian threat, what can Europe do to ensure its own security in the coming years? And, is Europe capable of embarking on a path toward separation and strategic autonomy from the United States?

At the heart of all three questions lies the most fundamental issue: money.

How much and from where?

Statements from participants of the Paris meetings – both immediately afterward and earlier at the Munich Conference – suggest that European nations are close to agreeing on financing a large-scale expansion of their defence capabilities, most likely through major collective borrowing. Ursula von der Leyen had already proposed such a plan in Munich. However, concrete plans and overarching decisions have not yet been made public. Polish Prime Minister Donald Tusk has promised that further details will be revealed following the EU summit at the end of March.

According to Bloomberg Economics, ensuring Ukraine’s defence and strengthening the military capabilities of leading European nations, including the United Kingdom, could require several trillion dollars over the next decade. The primary allocation of around $2.5 trillion over ten years would go toward reinforcing EU armies. This estimate is based on increasing defence budgets to 3.5% of GDP, a level discussed at recent NATO meetings. The EU as a whole will spend 1.9% of total GDP on defence in 2024, EU High Representative for Foreign Affairs and Security Policy Kaja Kallas said recently. Poland, Estonia, Latvia and Greece are already spending more than 3% of GDP, according to NATO. The UK had planned to spend 2.5% but fell short of that target.

NATO members' defence spending, 2024, % of GDP

Rebuilding Ukraine’s military capability is estimated by Bloomberg Economics to cost approximately $175 billion over ten years. Depending on the state of its armed forces at the time of a peace agreement and the size of the territory it needs to defend, the final amount could be higher or lower. Maintaining a 40,000-strong European peacekeeping contingent is projected to cost $30 billion, though Volodymyr Zelensky insists on a larger force, a position supported by military experts (→ Re: Russia: ‘Shame will be severe, weakness will be exposed’). If these expenditures are financed through debt instruments, the five largest European NATO members – the UK, France, Germany, Spain, and Italy – would need to borrow $2.7 trillion. Including debt servicing, the total cost would rise to $3.1 trillion over ten years.

Long-term benefits

In terms of content, the plans to build up Europe's defence capabilities are likely to be based on the first ever European Defence Industrial Strategy (EDIS; → Re: Russia: Paper Defence and Strategic Non-Autonomy) presented by the European Commission last year. The idea of collective borrowing was also first discussed at that time.

Investment firms and holders of European debt securities, have long expressed high interest in new issuances (→ Re:Russia: Paper Defence and Strategic Non-Autonomy). After the US lost its top credit rating, European AAA-rated debt securities have become especially valuable, Bloomberg notes. In general, the development of the military-industrial complex could bring certain economic benefits to Europe, stimulating growth and creating spillover effects (i.e., positive economic impacts beyond the defence sector itself). On the day European leaders met in Paris, stocks of European defence companies rose sharply: German ThyssenKrupp and Rheinmetall by 19.8% and 14% respectively, Swedish Saab Group by 16.2%, British BAE Systems by 8.9%, and Italian Leonardo by 8.1%.

Top executives from companies attending the Munich conference highlighted several key conditions that will allow the European defence industry to scale up in conversations with the Financial Times. They emphasised the need for large, long-term contracts worth tens of billions of euros. Pan-European projects involving cooperation between companies from different countries should play a crucial role. Significant investment must be directed toward research and development (R&D), as Europe’s defence sector lacks innovation. Additionally, purchasing European-made products must become an absolute priority for European armies.

Increasing defence spending to 3.5% of GDP would boost the region's overall GDP by 0.9-1.5% annually, according to experts at the Kiel Institute for the World Economy. They estimated the required volume of additional investments to be roughly in line with Bloomberg Economics’ figures: about €300 billion a year, or €3 trillion over ten years. The scenario of GDP growth will be realised under two conditions, the Kiel Institute specialists warn. First, investments must not be financed by raising taxes. Second, procurement must be reoriented toward European products. Currently, up to 80% of products are imported, predominantly from the United States. If these conditions are not met, GDP may not grow and could even decline.

Following former European Central Bank chief Mario Draghi, who developed the strategy to enhance the EU’s competitiveness (→ Re:Russia: Europe's Rut), the experts at the Kiel Institute emphasise the importance of increasing investments in R&D. According to Draghi’s estimates, the United States spends 16% of its military budget on R&D, while the EU spends 4.5%. In absolute terms, the difference in spending is tenfold. Since knowledge and technologies will flow from the defence sector to the civilian sector, the Kiel Institute experts estimate that a 1% increase in military spending as a share of GDP will lead to a 0.25 percentage point rise in long-term labour productivity.

Short-term constraints

However, these are long-term consequences that will, to some extent, affect the European economy as a whole. In the short term, European leaders face internal political constraints regarding the additional financial commitments they must undertake at the national level. Notably, according to Bloomberg sources, the decision to delay announcing the results of the Paris meeting was made in connection with the upcoming German Bundestag elections on 23 February. This circumstance vividly demonstrates how uncertain national politicians feel when making decisions that could shape Europe’s future.

Although the idea of borrowing implies that the current fiscal burden, as well as the financing of current expenditures, will not change, the question of funding sources is sowing discord among European countries. For example, Germany had previously consistently opposed the use of debt instruments. The rift with the United States, whose depth was exposed at the Munich Conference, may force the Germans to change their stance. At the sidelines of the conference, German Foreign Minister Annalena Baerbock confidently stated that a large-scale financing programme – unprecedented in the security field – would be launched in the near future. She referenced the experience of programmes implemented during the European debt crisis and the COVID-19 pandemic, which were financed through Eurobonds and Crown Bonds.

French President Emmanuel Macron has been a strong advocate for issuing European defence bonds, while German Chancellor Olaf Scholz has opposed the idea. Friedrich Merz, the leading candidate for Germany’s next chancellor, says he is open to discussing collective borrowing, but will reject it unless all EU members agree to a proportional increase in defence spending. In addition to Germany, the so-called ‘Frugal Five’ – the Netherlands, Austria, Denmark, Finland, and Sweden – also oppose collective borrowing. These high-GDP countries fear that they would bear a disproportionately large financial burden. This same group, led by Germany, effectively blocked the borrowing proposal last year. At the time, a European financier told Bloomberg that it would take another black swan event like a pandemic for Europeans to decide to borrow collectively.

Now that swan has appeared in the form of Trump’s return to the White House. At the very least, northern European countries and the Netherlands, like Germany, appear to be softening their stance, sources told the Financial Times. In the current environment, they are unlikely to resist, according to experts surveyed by Bloomberg. However, a fully developed and approved borrowing mechanism is unlikely to be in place before the end of the year, which does not align with the urgency of Europe’s geopolitical challenges.

A more likely scenario is a transition period in which additional spending would be financed from other sources. The EU may allow member states to relax budgetary discipline to increase defence spending through national debt issuance. Current rules limit an EU member's budget deficit to 3% of GDP and national debt to 60% of GDP. According to Politico sources, exceptions may be introduced, allowing countries to exceed these limits if the extra spending is directed toward defence. A few days ago, Scholz proposed relaxing similar budget rules in Germany as soon as a new government is formed.

In addition, extra funds could be sourced, for example, from the NextGenerationEU programme, which was created to support the European economy during the pandemic. According to Deutsche Bank estimates, cited by Bloomberg, about $400 billion can be accumulated by issuing national bonds and redistributing funds from existing European programmes. This should be enough to start with.