Defence spending is surging. It’s unaffordable and won’t last

After years of berating by Donald Trump, NATO countries in Europe are getting back into the weapons game and doling out fortunes on everything from warships and drones to fighter jets and interceptor missiles. So is Canada. The spending orgy cannot last.

The headlines of mega-buck weapons deals seem to suggest that the spending is just getting started after the post-Cold War lull that left arsenals depleted. France last week announced the sale of four frigates to Sweden, the newest NATO member, for €4.3-billion. In July, Canada selected Germany’s TKMS to supply it with a dozen attack submarines valued at $24-billion (excluding ongoing maintenance and running costs). Greece just signed a €3-billion air-defence system to be built by Israel.

The shares of European defence giants – Rolls-Royce, Rheinmetall, Airbus, Safran, Leonardo, Saab and Thales, among others – have climbed several hundred per cent, some 1,000 per cent, since Russia’s full-scale invasion of Ukraine four years ago. They went from relatively small and lifeless subsets of the main European markets to their rock ‘n’ roll party sections. Guns delivered butter to investors.

How long can this rally last?

Opinion: So thick is Ottawa bureaucracy, even Carney’s hand-picked defence man has had enough

On paper, theoretically, a long time. NATO last year at the Hague summit received firm political commitments from the alliance’s 32 member states to spend 3.5 per cent of GDP on core defence products and systems – the bang-bang bits – plus 1.5 per cent on broadly defined security-related programs, such as infrastructure and cyber-attack resilience. That took the total spending demands to a hefty 5 per cent. The previous target “guideline,” which was set in 2014, was 2 per cent.

Going to 3.5 per cent is a staggering increase. Based on recent GDP figures and defence spending levels – a few countries were already close to that level – the collective annual outlays would rise by US$2-trillion or more. The biggest relative increases will have to be made by the dozen and a half countries now loitering at about 2 per cent. The laggards include Canada, Italy, Spain, Belgium and Germany.

There is no easy financial or political way to afford such massive spending hikes – forget about the need to do so (is Russia a serious threat to NATO when it can’t defeat Ukraine?) or the price tags of the equipment (why buy submarines when naval drones might do the trick?).

Let’s start with the financial side. National debt loads are rising among most NATO countries and, at last count, eight of them had debt-to-GDPs of 100 per cent or greater – sometimes far greater. Greece and Italy are at about 140 per cent, France at 116 per cent, and Canada at 110 per cent. With debt loads this high, their ability to borrow a lot of money to fund a defence spending orgy is constrained, especially as higher interest rates needed to keep inflation in check seem likely.

Among the big NATO countries, only Germany, with a debt-to-GDP of about 64 per cent, has the headroom to ramp up spending.

Spending sprees by most of the countries will, at some point, run into the bond vigilantes who will inevitably demand a fatter coupon to take on the risks of owning the debt of a country with potentially waning financial health.

Opinion: Canada, debt-ridden and stretched, faces an uphill task of 5% defence spending

The other way to finance the defence spending surge is to raise taxes or divert funds from social programs, both wildly unpopular among voters. Of course, strong economic growth would pay for more spending by boosting tax revenues while enlarging the denominator in the debt-to-GDP ratio. But some of the biggest economies in the NATO family, especially those in Western Europe, have growth rates of 1 per cent or less – near stagnation. Canada’s growth was strong in the second quarter but could fall next year, when Donald Trump’s newest tariff barrage is unleashed.

The political side could work against wholesale increases in defence spending.

Take Germany, where the Alternative for Germany (AfD) party has become the country’s most popular political movement and is set to win this weekend’s regional election in Saxony-Anhalt, a former East German state. The party, labelled as “right-wing extremist” by Germany’s domestic spy service, could become a force on the national level, too.

AfD is an anti-Islam and anti-immigration party, but its economic positions have resonated with voters. It is billing itself as the “peace” party and opposes the country’s rearmament campaign in good part because of its expense. It was dead set against Chancellor Friedrich Merz’s elimination last year of the country’s constitutional “debt brake” to allow virtually unlimited defence spending.

AfD wants the government to devote its resources to managing Germany’s economic decline as manufacturing jobs vanish, not to buy guns. Roberto Vannacci, a former army general who is leader of Italy’s new far-right, socially conservative National Future party, has called NATO’s new defence spending targets “folly,” partly because he thinks the EU and NATO are exaggerating the Russian threat. The polls are moving in his favour.

Rearmament among NATO countries will continue, but it’s highly unlikely that the 3.5-per-cent commitment, let alone the 5-per-cent one, will be reached – both are unaffordable for most member states. Investors beware.