We are happy to receive suggestions for improvements This paper reflects only the opinion of the authors, not that of the SWP or DGAP.

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1 Background paper: What NATO's 2% target means for European defence budgets in 2024 Claudia Major, Christian Mölling, Torben Schütz, Alicia von Voss 1 The 2% debate: Come to stay The burden-sharing debate in NATO Current defence budgets: No turnaround, few model students Three good reasons to increase budgets Security policy environment and transatlantic protection Europe continues to shrink the legions Defence inflation is steadily eating up the budget Prospects for defence budgets towards Required increase to achive the 2% target by The magic of numbers The 2% target as an ambivalent measure More money does not equal more ability: risks and problems of increases... 9 More money for defence: this was agreed by all member states at the NATO summit in The target is for all Allies to increase their defence spending and aim for 2% of GDP by Since Donald Trump has become President of the US, the pressure on Europeans to implement the goals they have set themselves has increased. According to current figures, for Germany this would mean to increase its annual expenditure by 6.8 billion euros in order to spend approx. 85 billion Euros on defence in this corresponds to a total increase of approx. 129% between 2017 and Germany would thus spend 27 billion euros more than France and 30 billion Euros more than the UK. It would have the second largest defence budget within NATO after the US. In fact, there are good reasons to increase defense budgets. Years of cost-cutting measures have meant that a large part of European armed forces equipment is only there on paper. The challenge in increasing the defence budget is not only to provide 2% of GDP (input), but also to spend the money sensibly (output). Ultimately, what counts most is how much more personnel, material and operational capability the armed forces receive. Increasing the defence budget for the sake of increasing it is not the right answer. Europe has the opportunity to use the push for additional expenditure to improve its own capacity to act and to strengthen the European pillar in NATO. At the same time, the additional expenditure would also benefit European cooperation initiatives such as PESCO. 1

2 1 The 2% debate: Come to stay Since President Trump took office in 2017, the US government has been putting pressure on European NATO members to honour their commitment to spend two percent of gross domestic product (GDP) on defence. This comes as no surprise: During the election campaign Trump had already threatened to withdraw support from NATO and thus its European members if they do not pay more for defence. While his predecessors had regularly criticised Europeans' low defence spending, the tone of this US president and the atmosphere of the unpredictable that surrounds him make the demand more insistent. That is why the Europeans fear more than before that the USA could actually draw consequences and reduce its support if the Allies do not comply with the demands. That is why not only those Europeans who feel directly threatened by Russia are prepared to take a serious look into their wallets, but also those, like Germany, who feel less directly threatened. In this sense, the US President was more successful than his predecessors. 1.1 The burden-sharing debate in NATO The idea of the 2% target is not only catchy, it also sounds solidary: all states contribute the same share of their economic performance to the security of the community by investing 2% in defence. In this way, the burden of collective defence is to be shared equally. The dispute over who has to bear which burden in NATO is as old as NATO itself. Money has always played a role. That is why in 2002 the NATO states agreed to spend at least 2% of their GDP on defence. Since then, US officials have insisted that the other members should now actually spend this 2%. This did not change much - until recently, the number of states that have overcome this hurdle has even fallen. It was not until the Ukrainian crisis in 2014, when a tangible military threat returned to Europe, that some countries increased their spending again. At the NATO summit in Wales, all member states made a political commitment to reverse the trend towards more spending by 2024 and to try to reach the 2% target. This is the so-called Defense Investment Pledge (DIP). "Effort", i.e. working towards the 2%, is the key word here. The DIP does not demand that states "achieve" the 2% target by In addition, the states are to invest 20% in new equipment. It is therefore a twofold objective: to spend 2% of GDP on defence and 20% of that on new equipment, research and development. 2

3 1.2 Current defence budgets: No turnaround, few model students Although this agreement is not legally binding, it unfolds an enormous de facto force. In fact, there have been changes in expenditure - but there is still no sign of a turnaround. Some countries actually spent more in 2017 (e.g. Estonia, Poland). Many, however, are stagnating at the approximate level of the previous year (Italy). Overall, Figure 1 shows that the vast majority of European countries fall well short of the 2% target. Figure 1: Defence budgets of European NATO members as a share of GDP (in percent, 2017) Defence budget as a share of GDP (in %) 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% Greece United Kingdom Estonia Romania France Poland Lithuania Latvia Norway Montenegro Netherlands 2 Three good reasons to increase budgets There are good reasons for a systematic increase in defence budgets. Croatia Italy Bulgaria Denmark Slovakia Portugal Turkey Germany Czech Republic Slovenia Spain Belgium Hungary Albania Luxembourg Iceland 2.1 Security policy environment and transatlantic protection Europe simply lacks alternatives to an alliance with the USA: in the short term, Europe cannot guarantee its security without the USA. Militarily, Europe is lost without the USA. But the political damage to transatlantic relations from a US withdrawal would also go far beyond NATO. It would concern the possibility of tackling global governance issues together, such as security in the Middle East. In the medium term (5-7 years), Europe cannot build credible capabilities that are not based on the US backbone. This applies to conventional forces. The situation is even more difficult in the nuclear dimension. Even a more self-determined European security policy cannot do without the military dimension. Despite Germany's defensive stance, the military is becoming increasingly important for world politics. Europeans cannot address the pressing non-military security problems without the ability to deter and control violence. The Ukraine crisis, the war in Syria and the flow of refugees from Africa have shown this in various ways. 2.2 Europe continues to shrink the legions A second reason for increasing defence spending is the desolate state of Europe s armed forces. It's true: Europe has long been a freerider of US security policy. The dismantling of the European armed forces since the end of the Cold War, and especially since the economic crisis in 2008, has gone beyond 3

4 what was necessary and acceptable. A substantial part of the damage has been caused because the states have not coordinated the reduction of their armed forces. Everyone kept what they deemed important - not what was needed in NATO. In addition, the inertia of the armed forces branches was high. So the armies shrank to bonsai format: all there, but much too small to be militarily powerful. 2.3 Defence inflation is steadily eating up the budget The main reason for a systematic increase in defence spending is the so-called defence inflation. Every year, it cuts the purchasing power of every defence budget by a great deal. Just in order to maintain the level of capabilities, defence budgets would have to grow constantly. This is because the value of money invested in new procurement and materials (the investment share) decreases by 5-10% per year. This is due to disproportionately high cost increases in the defense sector, e.g. due to monopolies and very low production volumes. Figure 2 shows how dramatic this effect can be over a longer period of time. The purchasing power of the investment volume is halved within 14 years. Even if all Europeans reach the 2% mark in 2024, their money will then only be worth around 314 billion euros instead of almost 380 billion euros - just under a quarter less. Without additional investments that go into equipment maintenance or new acquisitions that compensate for this loss, this means that an existing capability level cannot be sustained. Figure 2: The effects of defence inflation on European NATO members defence budgets Defene Budgets in Bln EUR Neccesary increase in defence budgets to reach 2% of GDP by 2024 Projected increase in defence budgets to reach 2% of GDP in 2024, adjusted to real values (defence inflation) 4

5 3 Prospects for defence budgets towards Required increase to achive the 2% target by 2024 The previously known plans for defence budgets in the coming years do not allow for enthusiasm: On the one hand, Figure 3 (blue) shows how the budgets of the European NATO states would ideally have to develop in order to reach the 2% mark in The yellow line shows the known plans of the states and extrapolations of developments until The gap between ambition and reality would therefore be around 110 billion euros by 2024: this European contribution is missing in order to reach the 2% target. Figure 3: Planned and necessary increase of European NATO members defence budgets to reach 2% in 2024 as a percentage of GDP (in percent, 2017) Defene Budgets in bln EUR Planned and projected defence budgets of the European NATO states neccesary increase in European NATO states' defence budgets to reach 2% of GDP by 2024 At the same time, the European countries would have to make very different efforts to reach the 2 % mark together by The countries marked green in Figure 4 would have to increase their defence budgets by up to 5% per year in real terms; the countries marked orange by between 5% and 15%. The red countries would have to increase their spending by 15% or more per year to reach the target. 2 1 Planned and projected defence budgets include budget plans of the states, as far as they are publicly available. If these are not available, we expect that the states will continue to spend the same GDP percentage on defence as they did in All figures here refer to inflation-adjusted figures, including defence inflation. 5

6 Figure 4: Required average real annual changes in defence budgets to spend exactly 2% of GDP in 2024 (in EUR) Legend Countries that will have to increase their defence budgets by less than 5% a year in real terms in order to spend 2% of their GDP in Countries that will have to increase their defence budgets by 5% - 15% in real terms each year in order to spend 2% of their GDP in Countries that will have to increase their defence budgets by more than 15% a year in real terms in order to spend 2% of their GDP in Germany's outstanding role becomes clear in Figure 5: Germany would have to increase its nominal expenditure by 6.8 billion euros each year and then spend around 85 billion euros on defence in a total increase of around 129% between 2017 and it would thus spend 27 billion euros more than France and 30 billion euros more than Great Britain. Germany would then have the second largest defence budget within NATO after the USA. Annual increase in bln EUR Figure 5: Required average annual changes in defence budgets to spend exactly 2% of GDP in 2024 (in EUR)) 3 3 Please note: Compared to the geographical illustration, these are NOT inflation-adjusted figures, but absolute values. Germany Italy Spain France Turkey Netherlands Belgium United Kingdom Poland Denmark Czech Republic Norway Portugal Hungary Romania Slovakia Luxembourg Slovenia Bulgaria Croatia Iceland Lithuania Latvia Albania Estonia Greece Montenegro 6

7 3.2 The magic of numbers What gets covered up by the 2 percent discussion: Small changes for large payers are more significant than large changes for small payers. Estonia reaches the 2 percent mark. As a total, however, less than 0.5 billion Euros come together in 2017 (in comparison, the German defence budget amounts to 2017, at just under 1.2 % of GDP 37 billion Euros). France and Germany do not pass the 2% mark at present, Great Britain just barely makes it. However, the three countries together account for the largest share of European budgets by far: approx. 130 billion Euros or 60% of European expenditure. An increase to 2% of GDP would mean several billion Euros more for defence in each of the three countries. Figure 6: Size of the European NATO defence budgets in 2017 Denmark Portugal Romania Belgium Greece Czech Republic Hungary Iceland Bulgaria Slovakia Slovenia Albania Montenegro Luxembourg Latvia Estonia Croatia Lithuania Norway United Kingdom Turkey Poland Netherlands Spain France Italy Germany 7

8 4 The 2% target as an ambivalent measure Although increases in defence spending are now widely accepted, the 2% target remains controversial. In fact, it is unhelpful for several reasons. Firstly, efficiency (output), i.e. how much benefit the input achieves (an increase in expenditure), does not play a role in the 2% target. This is all about increasing input. But if the objective is to equip NATO effectively, then the necessary contributions, such as aircraft or tanks, should be the criteria. The investments are a bad measure, because the NATO states operate differently well with the money. Secondly, states pay different things with their defence spending: France its fire brigade, Germany the pensions of its Bundeswehr employees. A high budget does not therefore mean an efficient military. It is not even particularly solidary when the funds are spent on national objectives that can only be used NATO tasks on the side. Thirdly, the 2% target is based on an observation from the past: that more input into the defence apparatus always achieves a visible increase in output. But this is particularly true in countries where armies and defence industries already make a significant contribution to the economy. Due to their size, more investments and the economies of scale associated with them greater military performance can be the result. This was the case for Germany, France, Italy and Great Britain until the end of the Cold War and for the USA until today. This is no longer the case in the majority of countries. Fourthly, the arbitrary relationship between the two expenditure values, namely GDP and defence budgets, sends politically questionable signals. Greece has long been a prime example because it met the 2% target. However, this was only because Greece's GDP fell faster than defence spending as a result of an economic downturn. The military was contractually forced to spend (e.g. on procurement). If Germany were to meet the 2% target, it would have to make an additional investment of currently approx. 6.8 billion euros per year. The defence budget would rise from the current 37 billion to 85 billion euros. All this because Germany's GDP is predicted to grow enormously. Conversely, in the future, the UK could possibly stay at the 2% mark with less of an effort than today, if the country's economic performance and thus the GDP were to fall in the context of the Brexit. 8

9 5 More money does not equal more ability: risks and problems of increases The simple recipe for additional expenditure carries risks. Spending 2% of GDP on defence does not automatically lead to more fighting power. There are those, such as Greece, who spend a large proportion of their GDP on defence but do not make a significant contribution to NATO operations. On the contrary, the main drivers of Greek defence spending are the fear of an attack by Turkey and the role of the army as an employer. In some states, the trend towards creative accounting could rise in order to overcome the 2% hurdle, for example by partially "militarising" state expenditure, for example for the fire brigade or the police. 4 In addition, it changes the logic in the defense sector from "what to spend on" to "how much to spend". In 2017, Poland, which has the 2% mark in its constitution, asked itself whether the army would still get new tanks because not all the money had been spent. A pledged amount can therefore lead to money being spent, but not to the creation of security. In addition, the defence sector is traditionally known for wasting taxpayers' money. It would therefore make sense to ensure that every Euro invested produces more military performance than before. Waste of taxpayers' money would call into question an increase, especially in Germany. The scandals that may result from this could significantly discredit spending and arms efforts. It is also necessary to place defence expenditure in the context of state expenditure and in the context of the specific situation of the country. The isolated view only of the defence dimension ignores other aspects of security. Indeed, Germany could reach the 2% mark. For many other countries, however, this is not only far away, it is even risky. Attempts to increase defence spending could be at the expense of the health of the economy as a whole. The 90 % mark represents a magic limit: Long-term studies show that the states cause themselves economic damage to their domestic economies if the national debt rises above this level. The chart below shows that there are NATO states for which an increase in the defence budget could jeopardise economic security because they are already so heavily in debt that an increase in the budget could destabilise them through higher national debt. 5 Figure 7 shows the countries facing this dilemma: Greece spends too much on defence because it is seriously overindebted. Italy would face the same fate. It is already heavily overindebted, but is far from reaching the 2% target. The situation is similar in Portugal. Poland and Estonia, on the other hand, appear to be rock-solid regarding public finances and also reach the 2 % target. This raises the question of responsibility for NATO too: should it insist on the 2% target and NATO solidarity, knowing well that meeting the criterion can drive some countries into serious economic problems, which in turn will raise other security issues? 4 Great Britain, for example, has been suspected of doing so in recent years, see Royal United Services Institute ( ): 2% defence spending target will be met thanks to combination of real-terms increases andaccounting rules changes, 5 We are not looking at the positive effects higher defence spending could have on the economy in total. 9

10 Figure 7: Government debt and defense spending of the eur. NATO countries Authors: Dr. Claudia Major, Research Divison Security Policy, Stiftung Wissenschaft und Politik (SWP), claudia.major@swp-berlin.org Dr. Christian Mölling, Research Director, German Council on Foreign Relations (DGAP), moelling@dgap.org Torben Schütz, Associate Fellow, German Council on Foreign Relations (DGAP), schuetz@af.dgap.org Alicia von Voß, Resarch fellow "Security, Defense, Armament", German Council on Foreign Relations (DGAP), vonvoss@dgap.org 6 Data on government debt and GDP are taken from the IMF World Economic Outlook