THE COSTLY END OF EUROPE´S "PEACE DIVIDEND" / THE FINANCIAL TIMES

The costly end of Europe’s ‘peace dividend’

Defence spending at 3.5% of GDP would have cost EU an extra $387bn a year since finish of cold war

Valentina Romei, Sam Fleming and Alan Smith in London

© FT montage/Getty Images

European countries collectively saved hundreds of billions of euros a year in recent decades — a postwar “peace dividend” — as they drove down defence spending and freed up resources for other priorities including their welfare states.

They now face a brutal reckoning as they embark on a dash for re-militarisation after President Donald Trump threatened to scale back US support for the continent.

While the EU spends slightly less than 2 per cent of its GDP on defence today, European leaders are openly debating lifting spending to as much as 3.5 per cent of GDP or higher in the coming decade, a level not seen in continental Europe since the late 1960s.

Spending at this level between 1995 and 2023 would have required EU member states to allocate an extra $387bn a year to defence, according to Financial Times calculations based on 2020 purchasing power parity (PPP) dollars. 

The uplift for the UK, which spent 2.3 per cent of GDP on defence in 2023, would have been $35bn a year over the same period — roughly equivalent to annual public spending on housing and local amenities.

Mark Zandi, chief economist of Moody’s Analytics, said Europe had enjoyed a peace dividend in recent decades that “freed up economic resources for private investment and allowed governments to increase support for social welfare and financial safety nets”.

This benign state of affairs is now over — and the choices for Europe are stark. 

Europe enjoyed its years of low military spending thanks to a prolonged period of protection from the US, allowing it to build one of the most generous social security systems in the world for an ageing population.

Across the EU, social protection has grown as a share of total government spending, rising from 36.6 per cent in 1995 to 41.4 per cent on the eve of the pandemic, according to Eurostat.

German government spending on social protection, which includes welfare spending and pensions but excludes healthcare, is more than double that of the US relative to GDP. 

The difference is even starker for France. 

To significantly reverse the long-term trend in military spending — which relative to GDP halved between 1963 and 2023 in most large European economies, according to data collected by the Stockholm International Peace Research Institute — would require paring back existing spending or higher borrowing that many capitals would struggle to afford.

Across Europe, attempts to rein in social security spending have largely proved wrenching and difficult. 

France’s efforts to tackle pensions spending have repeatedly sparked mass protests, including in 2023, when President Emmanuel Macron rammed through a two-year increase in the retirement age that aimed eventually to save about €18bn a year.

Yet a debate is now under way on repealing the change, under pressure from unions and the opposition — even as ministers discuss targets for raising the defence budget that would dwarf the pension savings.

Trump’s pivot towards President Vladimir Putin’s Russia and threats of disengagement from Nato have pushed Europe to respond. 

It has begun shifting to a more independent defence policy.

But Claus Vistesen, economist at consultants Pantheon Macroeconomics said the gap in capabilities was great, and “progress remains too slow”. 

“A long, rushed and panicked transition awaits,” he said.

“Europe hasn’t had armed forces able to take on an equal adversary since arguably the 1970s and 1980s with the persistently elevated defence posture during the cold war,” he added.

The UK’s armed forces personnel plunged by more than half between 1985 and 2020 to 153,000. 

The total number for the EU shrank from 3mn to 1.9mn over the same period.

The defence spending trend has in recent years begun to tick upwards.

In 2024, EU defence spending reached an estimated €326bn — about 1.9 per cent of EU GDP, up from €214bn in 2021. 

That is higher than an average of about €150bn in the 15 years to 2019, according to the European Council.

But estimates of the required step-up are of a different magnitude, from €160bn per year over the next five years estimated by Goldman Sachs to a range of €230bn to €460bn per year estimated by Pantheon Macroeconomics.

While higher borrowing can cover some initial outlays for countries with the fiscal space to do so, the cost of rearmament will ultimately be shouldered by taxpayers and beneficiaries of the continent’s social security nets.

Guntram Wolff, a senior fellow at Bruegel, said the “new world” is one in which Europe comes closer to 1980s military spending levels, as a share of GDP. 

“That of course means more trade-offs in public budgets.” 

Foreign aid programmes are likely to be among the immediate casualties, — the UK has already announced steep cuts — while harsh decisions lie ahead for welfare budgets. 

Vistesen said the equivalent of “war” taxes may also be needed. 

German chancellor-in-waiting Friedrich Merz has unveiled a plan to remove limits on national borrowing when it is used to fund defence spending. 

European Commission president Ursula von der Leyen has proposed exempting €800bn in additional borrowing by EU governments from the bloc’s rules on debts and deficits.

The UK government has committed to spending 2.5 per cent of GDP on defence by 2027, funded by cuts to overseas aid, and will then target a further increase to 3 per cent. 

Poland has already sharply increased its military spending, backing Trump’s demand for Nato countries to put 5 per cent of GDP on defence as it earmarked 4.7 per cent this year, the highest in the US-led alliance.

While Germany has scope to issue more debt, other European countries are far less well-placed. 

Italy, for example, has seen its public debt to GDP rise from 31 per cent in the 1960s to 137 per cent in 2024, according to European Commission data. 

France and the UK also have public debt exceeding the size of the economy, along with large budget deficits. 

The EU now spends about 2 per cent of GDP on interest payments.

Italy’s figure is double that.

Cutting government spending on pensions and healthcare will be particularly challenging, as Europe’s population is the oldest of any continent, meaning social spending will grow and revenues fall as the working age population shrinks. 

“Governments will either need to borrow more, which risks upsetting bond investors, or make offsetting budget cuts, which risks upsetting voters,” said Jack Allen-Reynolds, economist at Capital Economics.