Around 800 billion euros should be set aside for the "re-armament of Europe", said representatives of European Union countries at an extraordinary summit on March 6, 2025 in Brussels. Ursula von der Leyen, President of the European Commission, will soon outline details on how everything should be financed.
For now, it looks like most of the €800 billion package, €650 billion to be precise, will be raised through new borrowing by individual EU countries, rather than through joint debt. The remaining €150 billion should come through loans secured from the EU budget - which is already approaching the concept of joint borrowing.
Unlimited borrowing
Friedrich Merz, the likely future Chancellor of Germany, has already set a precedent. Although he has long been against new borrowing, he now advocates unlimited borrowing for armaments. "Whatever it takes," said Merz.
To get other EU countries to act in a similar way, von der Leyen plans to activate the "exemption clause." "This will allow member states to significantly increase their defense spending," she said at the Munich Security Conference in February this year.
"The exception clause helps to bring these expenditures into line with the Stability and Growth Pact," explains Jürgen Mates, an expert on international economic policy and financial markets at the Institute for German Economics (IW).
The pact sets clear limits on government debt (60 percent of gross domestic product - GDP) and budget deficit (3 percent) for the 20 eurozone countries. However, many eurozone countries are already significantly more indebted.
If these countries soon take on additional debt, Brussels will "turn a blind eye" instead of threatening sanctions as before. Let's remember Portugal and Greece.
Interest rate differences as a warning sign
Within the EU, this policy gives countries more room for maneuver. However, the question is how financial markets will react.
Investors monitor countries' credit ratings, which are assessed by specialized agencies. A worse rating means more expensive loans.
In the eurozone, Germany pays the lowest interest rates on its debt. The difference in interest rates compared to other countries is called the "spread." Italy currently pays 1,2 percentage points more than Germany. During the debt crisis of 2010, the difference was even smaller, but it quickly grew to almost 5 percentage points. For Portugal and Greece, the difference was even greater.
The higher the interest rates, the less funds the state has for other priorities, such as investment, education or pensions. These differences can threaten the stability of the eurozone, as happened during the aforementioned debt crisis.
It is not yet clear how new defense borrowing will affect the spread, says Mates.
Lessons from the debt crisis
The risk still exists. Mates therefore refers to an instrument from the time of the debt crisis. The European Stability Mechanism (ESM) was created at that time as a buffer fund worth several hundred billion euros to help the eurozone weather the storm.
Mates sees the ESM as a "safety reserve" in the future as well. "Therefore, its free funds must not be used inappropriately for defense costs."
Time for Eurobonds?
Big expenses, big risks - is now the right time for joint borrowing, i.e. Eurobonds?
The principle is this: if Europeans borrow jointly, the terms are more favorable for most countries than if they borrowed individually. They benefit from the good creditworthiness of the "richer" countries - which would ultimately take responsibility for the entire debt.
This issue has divided the EU for years. Northerners (Germany, Austria, the Netherlands, Finland, etc.) blame southerners (France, Italy, Spain, Portugal, Greece, etc.) for indiscipline in budgetary policy and refuse to provide guarantees for their debts.
EU law also prohibits one country from being liable for the debts of another. This is stated in the "Treaty on the Functioning of the European Union", Article 125.
So if Eurobonds were to be used to finance defence, a change to the EU treaties would be required. That would not only take a long time, but would also require unanimity. The question is whether that is realistic.
Joint debts already exist
However, there are already tried and tested forms of joint borrowing, albeit with limited liability.
For example, the €750 billion stimulus package that the EU put in place during the coronavirus pandemic. That was the first time the EU had borrowed as a community in 2021. Individual countries' liability is limited to their share of the EU budget. For Germany, that would be about a quarter of the sum.
Also, the aforementioned ESM and its predecessor EFSF were forms of joint debt.
Necessary, incredible, purposeful?
"Whether joint borrowing will become necessary remains to be seen," says financial expert Mates of IW.
Economist Clemens Fuest, president of the Munich Ifo Institute, however, considers it "highly improbable" that defense costs will be financed through joint debts.
This instrument is "inappropriate, because defense spending is a national expense and because a concept for a European Union defense policy should first be developed, and now it is necessary to act quickly," Fuest told DW in an email.
Jens Boissen-Hogrefe, deputy director of economic analysis at the Kiel Institute for the World Economy (IfW), believes that joint debts would be "purposeful" if they were used to finance joint military tasks. However, "it is not clear whether all EU countries would meet their joint defense obligations, or whether they would do so in the coming years."
It would be advisable to create a mechanism in which non-EU countries, such as the UK or Norway, could also participate. Also, decisions should be made without the requirement of unanimity, so that, for example, Hungary could not block everything with a veto, says Boysen-Hogrefe. The European Development Bank (EIB), which belongs to all EU countries, could play a "significant role" in financing defense projects.
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