A new question is coming to the fore as European NATO members and Canada move on a pledge to spend 5 percent of GDP on defence by 2035. The issue now is less whether the money is coming and more whether Europe can turn that money into military capability. A proposed Defence, Security and Resilience Bank, coordinated by Canada, is a serious response to this problem, but may also be a distraction.
Europe’s rearmament problem is not simply that defence companies need more capital or that banks have been too reluctant to lend. It is that governments continue to generate weak, fragmented and nationally biased demand. The supply problem is real. But it is mostly the consequence of a deeper failure on the demand side.
Europe’s defence market is fragmented by national procurement, home bias, low order numbers and technological gaps. If governments raise budgets while continuing to buy nationally, they will bid up prices, duplicate platforms, preserve small production runs and reinforce the industrial fragmentation that has left Europe dependent on United States strategic enablers.
For defence SMEs wanting to build production lines, hire engineers or invest in capacity, the underlying cause of lack of finance is the absence of credible, pooled, long-term demand. A public bank in itself will not fix this. Companies will invest when they can see binding orders, common standards, predictable procurement schedules and large production runs. Repair the demand signal and capital will follow – but if capital is subsidised without repairing demand, Europe may simply finance more fragmentation.
For this reason, the DSRB should not be treated as an answer to Europe’s defence investment shortcomings. The bank could be useful. EU defence firms face an estimated equity financing gap of up to €2 billion and a debt financing gap of around €2 billion. A specialist lender or guarantor could help crowd in private capital, reduce stigma around defence lending and support firms in dual-use technologies, cyber, drones, electronics and critical components.
And if designed badly, the DSRB could reinforce Europe’s defence-procurement problem. Europe already has numerous mechanisms and initiatives to promote defence cooperation. None has overcome the political economy or juste-retour thinking of national procurement. Governments still want contracts for domestic firms. Defence ministries still protect national champions.
This could be made worse if the DSRB lends to national suppliers without disciplining demand. It would mobilise more capital into the existing structure rather than change that structure. It could finance more national production lines, more politically protected SMEs, more duplicative projects and more off-the-shelf purchases dressed up as resilience: not overcoming fragmentation but subsidising it.
The test for the DSRB will not be raising cheap money, which multilateral balance sheets can do, but whether its lending is tied to common procurement, open competition and NATO capability priorities. If it finances projects because they serve pooled demand, common standards and multinational orders, it could be useful. But then the real innovation is not the bank. It is the demand framework behind it.
That is why Europe needs a demand-led institution: an intergovernmental European Defence Mechanism (EDM). This would be a common vehicle to procure and own strategic defence assets, issue debt against collective commitments and force scale, standardisation and competition into procurement. The logic should not stop at the EU border. The security problem is NATO-wide, excluding the US. The relevant perimeter includes the United Kingdom, Norway, Canada and other non-US allies, whose capabilities, industries and fiscal resources are vital to European security.
An EDM would convert higher NATO spending commitments into common demand. It would identify capability gaps, aggregate orders, procure through open competition, prohibit discriminatory national preferences and finance joint assets. Its balance sheet would serve procurement discipline, not replace it.
The money is coming for defence investment. The danger is it will be spent through the same national channels that created the shortfalls in the first place. The DSRB may help at the margin. But unless subordinated to common demand, it risks becoming another elegant financial wrapper around Europe’s oldest defence problem: everyone agrees to rearm together, then insists on buying at home.
About the author
Gene Frieda is a Non-resident Fellow at Bruegel. His work focuses on the interaction between macroeconomic policy, capital flows and systemic risk.