Europe’s Defence Surge Will Squeeze Social Spending Once the Escape Clause Expires

The European Union has entered a period of structurally higher defence spending. Russia’s war against Ukraine and growing uncertainty over security relationships with the United States have intensified the pressure on EU member states to expand military expenditure. In a study prepared at the request of the European Parliament, we analyse what this shift means for public finances and for macroeconomic developments.

The European Commission has introduced several measures to create fiscal space for higher defence spending, including a coordinated invitation to activate the so-called national escape clause (NEC), which allows a temporary deviation from the fiscal path agreed between an individual government and the Commission.

The deviation permitted under the NEC for additional defence spending is capped at 1.5 per cent of GDP per year, relative to the spending level in the reference year 2021 (and for some countries, the reference year 2024), and applies over the period 2025 to 2028. Defence procurement contracts concluded during this period remain eligible, even if the payments occur later. As of October 2026, 18 member states had activated the NEC: Austria, Belgium, Bulgaria, Croatia, Czechia, Denmark, Estonia, Finland, Germany, Greece, Hungary, Latvia, Lithuania, Poland, Portugal, Slovakia, Slovenia, and Spain.

Since June 2026, flexibility under the NEC may also cover certain measures that reduce dependence on imported fossil fuels. These are capped at 0.3 per cent of GDP annually and 0.6 per cent cumulatively over 2026 to 2028.

Defence spending had already begun to rise before the Commission’s invitation to activate the NEC. On average across the EU27, it increased from 1.3 per cent of GDP in 2021 to 1.5 per cent in 2024, with particularly large increases in countries geographically close to Russia: Estonia raised military spending from 2.0 to 3.7 per cent of GDP and Poland from 1.6 to 2.9 per cent. The increases were, however, concentrated in a relatively small group of EU countries. Defence expenditure over 2021 to 2024 remained broadly stable in countries such as Slovakia, Portugal, and Spain, and declined in countries such as Greece, Bulgaria, and Italy.

Defence expenditure is set to rise further over 2025 to 2028. Official data for defence spending in 2025 and 2026 using Eurostat’s statistical classification relevant for the NEC were not yet available at the time of writing. However, a recent analysis by the European Central Bank (ECB) using that classification points to an increase in military expenditure in the euro area from 1.4 per cent of GDP in 2024 to 1.7 per cent in 2026, with a pronounced rise in countries such as Estonia, Finland, and Germany.

The Escape Clause Only Delays the Reckoning

Our study) shows that activating the NEC postpones the fiscal consolidation pressures that come with higher defence spending. Once this flexibility expires after 2028, however, member states will face mounting pressure to undertake fiscal adjustments to comply with EU fiscal rules, with the largest consolidation requirements concentrated in countries with high public debt and deficits.

Over the medium term, sustaining higher defence spending while complying with the EU fiscal framework will require either higher taxes or lower non-defence expenditure, or a combination of the two. This creates future trade-offs with other budget priorities, such as climate and digital investment, and also with social spending.

There are already signs that member states with high public debt levels have either not activated the NEC at all (e.g. Italy) or make only limited use of the defence spending flexibility provided by the NEC (e.g. Portugal). A plausible explanation is that they expect any additional borrowing during the exemption period to weaken their fiscal position and increase the adjustment requirements once the clause expires. For member states that have activated the NEC while subject to an Excessive Deficit Procedure, such as Austria, higher defence spending may delay their exit from the procedure, as the additional expenditure continues to count towards the headline deficit, potentially prolonging the period needed to bring it below the three per cent of GDP threshold.

Furthermore, our study highlights that higher defence spending is likely to provide only modest macroeconomic support in the EU. Most of the evidence points to positive but limited short-term growth effects from the defence-related fiscal stimulus.

The European Commission considers a linear increase in defence spending of up to 1.5 per cent of GDP by 2028, relative to 2021, and finds that EU real GDP rises by around 0.5 per cent above baseline in its main scenario, while inflation remains about 0.2 percentage points above baseline until 2028. IMF simulations find a somewhat larger real GDP effect of 0.9 per cent by 2028 and an increase in inflation of about 0.25 percentage points.

Debt-financed spending has stronger short-term effects than tax-financed spending, but it also exerts upward pressure on the public debt ratio. The long-term effects of higher defence spending on public debt trajectories will depend on whether it has persistent effects on GDP growth and on borrowing costs. We show that when higher military expenditure does not boost GDP in the long run but does lead to higher government borrowing costs, it can substantially worsen public debt dynamics, especially in high-debt countries.

Fragmented Procurement Sends the Stimulus Abroad

At present, European defence procurement remains fragmented across national markets, with limited coordination and joint procurement among member states. European countries are also heavily dependent on imports of military equipment from non-EU suppliers. The arms imports of European NATO members in 2021 to 2025 were 143 per cent higher than in 2016 to 2020, and the United States supplied 58 per cent of those imports. Furthermore, most of the additional defence spending is directed towards personnel and operations rather than towards research and development (R&D) and other productivity-enhancing investment. These features limit the positive growth effects of higher defence expenditure, making it unlikely that the additional spending will finance itself to any substantial extent through stronger long-term growth, particularly if it crowds out public investment with greater growth-enhancing potential.

Stronger European production capacity, more coordinated procurement, and a greater emphasis on R&D, infrastructure, and advanced equipment could increase the share of defence spending that translates into domestic output and productivity gains. At the same time, common European financing of defence spending could limit the impact of the substantial disparities in borrowing costs across EU member states.

Selective use of the available flexibility for higher defence spending under the national escape clause helps contain future fiscal adjustment pressures, particularly by limiting the debt-financed expansion of poorly targeted defence expenditure. Sustaining structurally higher national defence spending while complying with EU fiscal rules from 2029 onwards, once the NEC has expired, will ultimately require higher taxation, cuts in other areas of public expenditure, or both.

Adjustment pressures may fall particularly on social protection spending, which accounts for around 40 per cent of total government expenditure in the EU. Financing higher defence spending through (large) spending cuts will not only dampen economic activity but also prove politically contentious, thereby increasing the risk of political instability.

The recent extension of the national escape clause to measures that reduce dependence on imported fossil fuels creates scope to support investment in energy security. Green public investment could trigger comparatively strong positive growth effects and increase productivity. By reducing dependence on imported fossil fuels, it could also lower exposure to future inflationary pressures arising from fossil fuel price shocks.

Historically, rearmament episodes have often been financed through a combination of higher taxation and increased fiscal deficits, with tax revenues and tax rates frequently remaining elevated for many years. This suggests that if European governments seek to accommodate structurally higher defence spending while preserving other major budget priorities, including education, health, climate action, and social protection, sustained increases in taxation are likely to be part of the fiscal response. Ensuring that economically well-off groups bear a greater share of the additional tax burden can help limit the negative economic impacts.