How UK and EU could find more money for defence without spooking the markets | Defence policy

Can Britain increase defence spending without cuts elsewhere?
Rachel Reeves is constrained by fiscal rules that govern the extent of the UK’s debts and the annual spending deficit by the end of the parliament. Following lower than expected tax receipts and higher borrowing costs in the current financial year, it looks likely that the chancellor will need to make budget cuts when she makes her next financial statement on 26 March. Last week she said a rise in defence spending would mean making “difficult decisions across the board”.

Reeves fears a backlash from financial markets in response to higher, unfunded spending, pushing the cost of borrowing up in a repeat of the Liz Truss mini-budget debacle. Most analysts believe a rise in borrowing is expected by international lenders.

Could there be an opt-out of the fiscal rules for defence?
A crisis that forces major European countries to step up their funding for defence could be a gift to Rachel Reeves. It is the perfect excuse for suspending budget rules that most economists consider a barrier to reviving economic growth.

Reeves could say the prospect of an unstable peace deal in Ukraine constitutes an emergency. And rather than push defence spending from 2.3% of gross domestic product (GDP) to 2.5% as planned, the government needs to go further.

Ed Balls, a former Treasury minister and ex-shadow chancellor, told the Political Currency podcast that an argument could be made for extra borrowing in exceptional circumstances.

“There is a case for the UK Treasury saying that, for a fixed period, we’re going to carve the uplift in defence spending outside the fiscal rules,” he said.

“I think that is much more credible than a massive tax rise, and much more credible than undeliverable public spending cuts the markets won’t believe in.”

How about a defence and security levy?
The chancellor has promised not to raise income tax and national insurance but could see a way out with a defence and security levy – a tax by another name. Levies have been used before to boost specific departmental spending. In 2002, the then chancellor Gordon Brown designated a 1% increase in national insurance as a health levy to increase investment in the NHS.

Can the EU increase defence spending without breaking the rules of the stability and growth pact?
The EU can agree to break the stability and growth pact to allow for higher borrowing, just as it did during the pandemic.

Ursula von der Leyen, the head of the European Commission, said this month at the Munich security conference: “I will propose to activate the safeguard clause for defence investments”, before adding: “During the pandemic, we activated the safeguard clause because we were in a crisis. I believe that we are in another period of crisis.”

At the moment, newly implemented EU fiscal and debt rules limit government deficits to 3% of GDP and debt to 60% of GDP. A country exceeding the 3% deficit ceiling would not be placed under disciplinary action if an emergent excess is due to spending on defence.

However, a paper prepared by Poland, which holds the rotating EU presidency and sets the agenda for the bloc’s work, argues that the current interpretation of defence investment as only military equipment like tanks or planes is too narrow.

“In view of the security challenges, the interpretation of the increase in defence investment should be broad. It should include not only the purchase of military equipment but also capital support for arms and ammunition factories in order to build defence capabilities,” the paper, seen by Reuters, said.

EU leaders have yet to formally respond to Warsaw but are expected to embrace the need for a wider interpretation of military spending

Can the EU introduce defence bonds?
Earlier this year, France and Estonia proposed using defence bonds, and the idea has since gathered support from other members, including Italy, Spain and Poland.

But Timothy Ash, a Russia expert at the Chatham House thinktank, says Europe should first consider accessing the $330bn of Russian funds that are frozen in European financial exchanges.

EU leaders have agreed to use the interest generated by these funds to support Ukraine but have resisted sequestrating the capital, fearing a backlash from developing world countries worried that the assets they keep in Europe would also be vulnerable to being confiscated.

Ash, a long-time supporter of using Russian funds to support the Ukrainian war effort and reconstruction, said: “Europe should announce a huge $500bn to $1tn arms procurement programme, significantly funded from immobilised Russian assets, and commit to buy much of the weaponry from the US.

“Therein, if Europe came to Trump with the largest arms procurement deal in history, say $50-100bn a year for the next decade, securing in the process hundreds of thousands of US jobs, I doubt that even Trump could say no to that. Call it the Trump Defence of Democracy Programme, or whatever, to glitter in his eye enough to get his agreement. The defence of Europe is now a needs must – we must do whatever we need to do.”

Can Germany exempt defence spending from its debt brake clause?
The winner in the German election will likely spend several months forming a coalition. Only then will it come to a view about the debt brake, which limits Berlin’s annual budget deficit to less than 0.35% of the country’s annual GDP.

Friedrich Merz, the leader of the centre-right CDU, is expected to become prime minister and has spoken about the need to reform the debt brake, specifically to increase defence spending.

But he said in a televised election debate that the rule, which will need a vote in parliament that secures a two-thirds majority, would not be a priority.

“You can discuss everything, but that certainly won’t come at the beginning.

“At the beginning comes the potential for savings, comes growth and real restructuring of the budget, which is urgently needed,” he said.