Security demands cast new shadow on Europe’s finances

LONDON: Europe’s leaders have long known the region is living beyond the means of its ageing, stagnant economy. The question is whether the ructions created by Donald Trump’s second White House term mean they will do something about it.

Less than a month after the president was sworn in, the continent’s once staunch US ally declared it was done paying to keep the peace in Europe. Trump, said Defense Secretary Pete Hegseth, “will not allow anyone to turn Uncle Sam into ‘Uncle Sucker’”.

But if Europe must now shoulder the cost of its own defence -- right at a time when on its eastern flank Russia is waging war with Ukraine -- that risks blowing apart budgets that are already struggling to fund the welfare states that are often seen as the envy of the world.

“We will have to face difficult days, make complicated decisions and even sacrifices which we weren’t expecting until now to ensure this security,” French Foreign Minister Jean-Noel Barrot told the Munich Security Conference on Saturday.

However, some fear a political backlash if governments simply slash social spending to buy more soldiers and guns. “Then we will have division of our society and the only ones that will benefit will be the far-right parties,” German Defence Minister Boris Pistorius told the Munich meeting.

One option for Europe might be to hope Trump’s departure in four years’ time will allow the transatlantic bond to be restored. But the mood at the Munich gathering suggested that European leaders finally accept that America’s pivot away from their continent -- signalled in less confrontational terms over a decade ago by Barack Obama -- means they must now step up.

“Our most important task as political leaders is to protect our people,” said Danish Prime Minister Mette Frederiksen. “Two per cent is not nearly enough,” she said of a barely met target for Nato members to spend on defence as a share of national output. Twenty-three out of 32 Nato members met the target last year after recent increases.

BORROW MORE?

So where might Europe find the money?

Its post-World War Two social contract was built on the idea that Europeans would pay high taxes to get solid welfare safety nets, health provision and pensions in return. Add to that the labour pacts that led to shorter work weeks and longer holidays.

Many voters already feel their governments have reneged on that deal -- and have abandoned mainstream parties in favour of radical ones that are riding high on the discontent. The challenge posed by Trump takes the political and economic stakes to a whole new level.

It is hard to put a number on how much it will cost to secure peace and rebuild Ukraine: the shape of any peace is unknown given Trump’s desire to cut a deal with Russian President Vladimir Putin.

However, it is easier to quantify the cost to national budgets if EU countries more than doubled defence spending to the levels that were routinely a feature of the Cold War era. Ratings firm S&P Global estimates that attaining defence spends of 5.0 per cent of GDP would cost them a total $875 billion a year, or “far beyond what individual states can finance without offsetting such outlays with other spending reductions or likely pressuring their creditworthiness”.

But others say Europe, which topped up existing budgets with new funds to assemble a 2-trillion-euro stimulus package after the Covid pandemic, can find the money if it wants to. While the United States has national debt around 120 per cent of its output and runs annual deficits of the order of 6.0 per cent, average debt across the EU stands around 81.5 per cent of GDP with a deficit of 2.9 per cent, according to EU data.

In a commentary for the Financial Times last week, former European Central Bank chief Mario Draghi estimated that since 2009, the United States has used deficits to inject five times more money into its economy than the countries of the eurozone have -- 14 trillion euros versus 2.5 trillion.

Moritz Kraemer, chief economist at LBBW Bank and formerly S&P Global’s chief ratings officer, noted the euro did not have the dollar’s status as the world’s reserve currency and that “therefore, the level of sustainable debt is lower”.

But others doubt whether markets would take fright if a country with the sound finances of Germany or the Netherlands sought extra borrowing to meet an existential security need. “Many EU countries could afford to have higher public debt,” said Zsolt Darvas, a senior fellow at European economics think tank Bruegel. “The issue is the political will.”

A GERMAN ELECTION

It is this political will that is about to be tested.

European Commission chief Ursula von der Leyen told the Munich conference she would back “escape clauses” to free national spending on defence from EU rules on deficit caps. She would need support for this from national governments.

While the EU is banned from using its own 1.2-trillion-euro budget to buy weapons, some suggest that EU nations and non-EU Nato allies such as Britain and Norway could form a “rearmament bank” with funds injected by members and capital raised on markets.

Finnish ex-premier Sanna Marin said such moves would mean leaders persuading their publics of the urgency of increased defence -- especially in those nations further away from the Russian threat than her own country or eastern EU states.