Defending Europe

Defending Europe

American spending on defence far exceeds Europe’s. The US spent about 3.2% of GDP on defence in 2023 compared with an average of 1.8% in European NATO members, below NATO’s 2.0% target. Almost all European NATO states have raised defence spending in the last decade in response to Russia’s invasion of Ukraine and rising levels of geopolitical risk. Countries closest to Russia – Poland, the Nordics and the Baltic states – have stepped up spending the most and have the highest military spending as a share of GDP.

• Perceptions of the threat tend to diminish the further west and south one goes. Eight out of NATO’s 29 European members, including Italy, Spain, Belgium and Portugal, spend below the 2.0% NATO target. Germany, Europe’s largest economy, only reached the 2.0% threshold last year after years of low spending. The failure of many countries to live up to their NATO commitments has been a source of frustration for successive US presidents. Donald Trump is the first to suggest that America could walk away from a military commitment to Europe.

• In terms of dollar spending, the US dwarfs its allies and its rivals. In 2023, the US spent more than $900bn on defence, 65% of all NATO spending, and equivalent to the total of the next nine highest spending nations combined. In dollar terms, the US spends more than twice as much as China and Russia combined.

• A more accurate way of looking at defence spending is to measure what money will buy in terms of manpower and material ($1m, for instance, goes further in terms of pay, rations and equipment in China than in the US). The US dominates on this measure too, though its lead narrows. A recent report from the International Institute for Strategic Studies found that on a purchasing power parity (PPP) basis, American defence spending was at roughly the same level as China and Russia combined.

• Although the US accounts for the majority of NATO defence spending, much of that spending relates to commitments outside Europe, mainly in the Pacific and the US. One 2019 study found that US direct military spending on Europe was equivalent to less than 15% of military spending by European NATO members. This estimate, however, comes with the hefty caveat that it excludes US nuclear weapons and America’s capacity to reinforce its position in Europe in the event of a conflict.

• What is clear is that a US withdrawal would leave a large gap in Europe’s defences. Not just US leadership and 90,000 personnel stationed in Europe, but communications and electronic warfare support, tanker and heavy transport aircraft, and ammunition resupply.

• So how does Europe, without America, measure up against Russia in terms of scale? Estimates vary, but most point to a significant mismatch. The Economist thinks that in the long term European defence expenditure needs to more than double to deal with Russia. Figures cited recently by Fenella McGerty, senior fellow for defence economics at the International Institute for Strategic Studies, suggest that on a PPP basis, Europe would need to almost triple its spending to match Russia.

• Yet Europe does not necessarily need to match Russian capacity 1:1 to deter aggression. A widely cited rule of thumb is that an attacking force needs three times the number of troops as the defending force to ensure success. This can be seen in Ukraine, a country with just 7% of Europe’s population and a fraction of its GDP, which has held back Russian forces for more than three years. The Economist’s defence editor, Shashank Joshi, cites the example of Israel which, although a small country with fewer than 10m people, has sustained investment in defence and built up its resources and capabilities to world-class standards.

• NATO’s European members make up one of the most economically developed and wealthiest areas of the world, with a population and combined GDP (measured in PPP) approximately five times that of Russia. In terms of economic heft and population, Europe far outstrips Russia.

• Conflicts, however, are not always won by the richer or most populous power. Political will and public support matter enormously. The next test of Europe’s resolve will be whether it can raise the money to rearm. Countries with low levels of public debt including Germany, the Netherlands and Sweden could finance increased defence spending through borrowing. Many European nations, including France, Italy, Spain and the UK, are more indebted and might need to raise taxes or cut other spending programmes. Without more borrowing, higher taxes or reducing spending elsewhere, Europe cannot increase defence spending. Germany has led the way with a plan to ease constitutional limits on public borrowing. Many others have yet to lay out a path to higher defence spending, let alone how it will be financed.

PS: Two weeks ago, we wrote about the soaring gold price. Since then, amid uncertainty about tariffs and America’s commitment to the defence of Europe, the gold price has risen by over 5% and ended last week at a new record high of $3,000 per troy ounce. In the last year, the gold price has risen by almost 40%.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.6% at 8,632. 

Economics

• In a sign that a weakening stock market and uncertainty about government spending and trade policy is taking a toll, US consumer confidence fell to its lowest level since November 2022, with long-term inflation expectations hitting a 32-year high. Consumer confidence among Democrat voters fell to the lowest level ever recorded, including during the financial crisis in 2008-09
• The S&P 500 US equity index entered a technical correction, falling more than 10% from its February peak, amid fears that the ongoing US trade uncertainties will impact economic growth
• A poll of 220 US CEOs by Chief Executive magazine, carried out in early March, found that business optimism had fallen to the lowest level since November 2012
• A measure of US economic policy uncertainty compiled by three US academic economists reached its second-highest level of data going back to 1985  
• The EU and Canada announced retaliatory tariffs on US goods, worth $28bn and $21bn respectively, in response to the US imposing 25% steel and aluminium tariffs. The UK government said it would not immediately impose retaliatory tariffs
• The US reversed an additional 25% tariff proposal on Canadian steel and aluminium imports, while the Canadian province of Ontario reversed plans to impose a 25% surcharge on power exports to the US
• US president Donald Trump threatened to impose 200% tariffs on imports of alcohol from the EU in retaliation to the EU’s import duties on US whiskey
• US consumer price inflation fell to 2.8% in the year to February, with core inflation falling to a four-year low of 3.1%. Markets firmed up their expectations of three US interest rate cuts this year
• The Bank of Canada cut interest rates for the seventh consecutive time, to 2.75%, amid ongoing trade tensions with the US that are impacting Canadian business and consumer confidence
• UK GDP unexpectedly contracted by 0.1% in January, following growth of 0.4% in December, according to official figures. The decline was mainly due to falling industrial production while the service sector expanded marginally
• The UK government introduced its Planning and Infrastructure bill, aimed to reduce regulatory and planning burden for housebuilding and infrastructure projects 
• The UK ranks among the lowest of OECD countries for welfare generosity, with the poorest UK households worse off than those in Slovenia and Malta, according to a report by the National Institute of Economic and Social Research
• A poll of economists found that Germany could increase public debt from 63% to 86% of GDP, equivalent to nearly €2tn, without damaging future growth amid recent announcements to boost defence and infrastructure spending
• Euro area investor sentiment improved in March to its highest level since June last year, according to the Sentix index, amid recent announcements of debt-financed defence and infrastructure spending programmes

Business

• The FT reports that more than 200 major US corporates have reduced references to DEI and related terms such as ‘diversity’ in their annual reports
• Swedish start-up Northvolt, one of Europe’s most prominent battery manufacturers, filed for bankruptcy after failing to obtain further financing
• German defence company Rheinmetall says it is considering repurposing one of Volkswagen’s car manufacturing plants, which is due to cease production by 2027, to produce tanks
• Italian defence company Leonardo announced plans to launch 38 satellites by 2028 for military and civilian purposes, saying that it will provide European governments with an alternative to US-owned Starlink
• US electric car manufacturer Tesla said it would be “exposed to disproportionate impacts” from retaliatory import tariffs by other countries, in an unsigned letter to the US trade representative Jamieson Greer, the FT reports
• Car manufacturer BMW reported a 36% fall in profits in 2024, following weak Chinese demand, and warned that earnings are expected to remain at similar levels this year due to European and US tariffs
• OpenAI, the maker of ChatGPT, signed an $11.9bn contract with cloud computing company CoreWeave to receive AI infrastructure as part of efforts to boost its computing power
• Mobile network operator Virgin Media O2 said it will spend £700m on improving the speed and reliability of its network, amid the competitive threat from merger of rivals Vodafone and Three
• The UK government announced plans to abolish the Payments Systems Regulator and merge its responsibilities with the Financial Conduct Authority in a bid to reduce complexity of the UK’s regulation system
• UK prime minister Sir Keir Starmer announced plans to scrap the arms-length body that runs the NHS in England and bring the health service back under direct political control
• More than half of the global greenhouse gas emissions in 2023 were linked to 36 energy companies and cement producers, according to the Carbon Majors database, with state-owned companies comprising 16 of the top 20 emitters

Global and political developments

• Ukraine said it was willing to accept a US-proposed 30-day ceasefire with Russia. The US subsequently agreed to resume military assistance
• Russia said there are “grounds for optimism” for a ceasefire deal but there is “a lot ahead to be done”, as US envoy Steve Witkoff met Russian president Vladimir Putin to discuss further details about a potential ceasefire
• Switzerland’s new defence minister has said that cooperation and joint training exercises with NATO are “absolutely necessary” in a sign that the long-neutral country is reconsidering its defence needs
• Mark Carney, former governor of the Bank of England, replaced Justin Trudeau as the leader of the Liberal Party and Canada’s prime minister. He is expected to call a general election shortly
• Canada’s Liberal Party has seen a surge in poll ratings since the start of the year, attributed in part to increased Canada-US tensions
• Germany’s incoming chancellor Friedrich Merz has agreed a deal with the Green party for increased public borrowing to boost infrastructure and defence spending
• Romania’s constitutional court upheld a ban imposed by the electoral bureau on Călin Georgescu, the far-right frontrunner, from its presidential elections following allegations of violating electoral rules
• The UK government announced proposals to reform the civil service, including tighter performance monitoring of the highest-paid civil servants and the creation of “mutually agreed exits” of underperforming staff, in a bid to boost performance
• UK ministers are reported to have dropped plans to freeze a major disability benefit in response to opposition from Labour MPs

And finally… following a difficult year for the auto sector Volkswagen reported a surge in sales at its little-known sausage making business. Sales of VW’s currywurst, a bratwurst sausage covered in ketchup and curry sauce, reached a record of 8.5m last year, more than the 5.2m cars the company sold – record wurst year