Europe is entering a new phase. The war in Ukraine and the changing geopolitical landscape have led European countries to substantially expand their defence and security capabilities. EU defence spending could reach 454 billion euros in 2026, twice the level recorded before the start of the war in Ukraine. And the increase is likely to continue, with potentially significant consequences for the economy.

Higher defence spending can support GDP growth in the short term by boosting demand. But the size and persistence of that impact will depend on several factors. The first factor is how spending is financed. When financed through debt, the initial effect is generally positive because it increases demand in the economy. But it also increases the budget deficit. And if higher defence spending becomes permanent, some of that initial stimulus may eventually be offset. Governments may seek to reduce the deficit by raising taxes or containing other expenditure. Households may also anticipate future tax increases and reduce their consumption. And if higher deficits push up interest rates, this could ultimately weigh on private consumption and investment.
 

“Defence build-up can support growth, but lasting gains depend on turning spending into economic capacity”

These risks cannot be ignored. Many EU countries are entering this new phase with high levels of public debt, higher interest rates than in the previous decade and limited fiscal space.

European instruments can help finance some of this additional spending. Member states can temporarily make use of greater flexibility under EU fiscal rules through the national escape clause, while the Security Action for Europe (SAFE) programme provides specific loans to support defence spending. Further proposals are also being discussed as part of negotiations over the EU’s 2028-2034 budget. Still, financing defence spending on a sustainable basis remains an important challenge for member states.

A second factor is how and where the money is spent. Investment, equipment and innovation tend to have larger and longer-lasting economic effects than current expenditure.
 

“The ultimate economic impact will be determined by how rearmament is financed and implemented"

Moreover, the greater the share of additional demand met by production within the EU, the greater the impact on the European economy. This is where an important constraint emerges. Europe’s defence industry remains fragmented across national markets, making it harder to achieve economies of scale and reinforcing dependence on imports.

uropean coordination could help address this. Joint procurement and less fragmented purchasing could increase efficiency, generate economies of scale and reduce import leakage. The European Defence Industrial Strategy (EDIS) and the European Defence Industry Programme (EDIP) are steps in this direction.

Overall, higher defence spending can support European growth in the short term, but its longer-term economic impact will depend on how it is financed and implemented. Sustainable financing, stronger European productive capacity and effective coordination will be key. Otherwise, part of the initial boost could be lost through higher imports, while inflationary pressures risks, public debt concerns and pressure on other budgetary priorities could increase.