By Paweł Suszczak
The ongoing conflict in Ukraine shows no signs of slowing down, with little indication of resolution in the near future. Estonia, Lithuania, Latvia, and Poland, like every country in Europe and the European Union today, feel the need to arm themselves due to the proximity of the conflict in Ukraine. The threat from the east cannot be underestimated. Defense expenditure represents the fastest-growing portion of national budgets across Europe, constituting approximately 2-3% of a country’s GDP. In 2022, there was an uptick of nearly 6% in European defense expenditures compared to the preceding year. This raises the question of where to acquire the funds for this purpose and where the world sources these funds.
Kaja Kallas’s strategy
Estonia’s Prime Minister Kaja Kallas emphasized the necessity of EU defense bonds in countering Russia’s aggression in Ukraine. In February 2023 she suggested an amount of €100 billion. Since then, she has emerged as a prominent advocate for defense bonds, garnering support from influential figures such as French President Emmanuel Macron. However, the French leader expressed his support for the proposal, only under the condition that the money issued through debt would remain within Europe, specifically earmarked for the acquisition of military equipment from European firms. Kallas’s proposal is intriguing not only because it pertains to the contentious issue of warfare, which naturally elicits strong emotions, but also because the European Union has been reluctant to issue common bonds for many years. Kallas, in an interview with Bloomberg said: “We are in a place where we need to invest more and [explore] what we can do together…”.
The EU bonds
This occurred only once previously, during the pandemic, when the European Union issued bonds worth €800 billion. These funds were allocated to recovery efforts aimed at assisting EU member states in rebounding from the economic impacts of the COVID-19 pandemic. Why is a bond proposal so hard to sell that it happened only once? Well, in the past, numerous richer European nations staunchly resisted the idea of issuing EU public debt during economic crises due to concerns that it would disproportionately penalize wealthier countries. Simply put, they feared being burdened with the responsibility of servicing the debt incurred by other countries.
Many countries in Europe desire these bonds because everyone faces the same problem: the need to spend more on defense. One could consider raising taxes, but borrowing serves as a more politically favorable maneuver for governments. As a consequence, the idea of managing this at the EU level emerged, as servicing such debt individually by each country would be more expensive than the costs associated with servicing public debt issued by the European Union. This is because the EU’s credit standing is higher compared to individual states. In simpler terms: the European Union enjoys greater trust from foreign investors than individual countries, perhaps except for Germany and France, where the difference is marginal. Estonia or Poland, for instance-countries very near Ukraine and Russia- would significantly benefit from this approach. When the European Union issued bonds post-pandemic, it secured extremely favorable market conditions, signifying low interest rates. Other countries issuing their own bonds would never obtain such advantageous terms. The demand for these bonds was immense, despite the considerable quantity. Thus, EU debt is essentially as secure as U.S. debt.
Why is this needed?
War comes with substantial expenses; for instance, fighter jets, frequently used in conflict, can carry a price tag of around $90 million each. This number can give a perspective on how expensive war can be. If this proposal is accepted by the EU, subsequent decisions would revolve around how to allocate and spend these funds among member states. And this issue, of course, will raise additional controversy. Right now, the biggest supplier of weapons and ammunition to Ukraine is the United States.
Throughout history, nations have often resorted to indebtedness to finance warfare. A closer examination of history reveals that those countries who managed their finances efficiently and effectively often emerged victorious. A great and interesting example from history is Napoleon’s wars. Napoleon’s struggle to sell bonds due to France’s lack of credibility (as it turns out, the public execution of kings during the French Revolution did not encourage other countries to lend them money), contrasts with the British, who faced no such hindrance in financial markets and ultimately prevailed in the war. Of course, during WWI and WWII many examples of financing warfare by bonds can be found as well.
Indeed, augmenting defense expenditures, and investing in armies, can be likened to an insurance policy – something everyone desires and values having but which may never be utilized in practice. It’s an expensive insurance policy indeed. However, an extremely crucial policy, for the safety and security of Europe.