NATO rearmament will stimulate Europe’s domestic demand

At the 2025 NATO summit in The Hague, NATO members agreed to increase annual defence and security spending to 5% of gross domestic product (GDP) by 2035, committing 3.5% to core defence spending and 1.5% to critical infrastructure needed to support military capabilities. As a result, European and Canadian annual defence spending is expected to reach $1.3 trillion by 2035, according to GlobalData. NATO’s plan aims to reduce Europe’s reliance on the US’s security guarantee. Simultaneously, it seeks to revitalise European industrial manufacturing and domestic demand through government-led defence and infrastructure spending. Long-term prospects for European economic growth hinge on increased research and development (R&D) spending and the modernisation of military technologies.

The question is: will it work? In reality, defence spending will have a minimal impact on European economic growth in the short term, as much of the spending will go to US defence manufacturers. Only in the long term, as Europe builds up its defence capabilities, will government-led investment stimulate domestic demand and grow manufacturing capacity across the continent.

Europe plans for defence expansion

NATO’s commitment came after prolonged criticism from US President Donald Trump regarding the European Union (EU) ’s reliance on the US for security and trade. European leaders, including French President Emmanuel Macron, have also urged the region to reduce its dependence on the world’s largest economy. Europe has long relied on the US security guarantee for defence assurances and on US demand for economic growth. As long as that demand remained high, Europe had no real incentive to pursue new market opportunities or stimulate its low domestic demand.

But today, Trump’s tariff policy is changing security and trade dynamics. US protectionist policies will force European governments to revitalise domestic demand for economic growth. A return to Cold War levels of defence expenditure could help Europe revitalise its industrial and manufacturing capabilities. European governments have already introduced plans to increase defence spending. In March 2025, Germany announced it would amend its constitution to allow for an additional €1 trillion ($1.2 trillion) in defence and infrastructure spending. The UK also committed to purchasing 12 new attack submarines as part of AUKUS, the trilateral security partnership between Australia, the UK and the US.

The ReARM Europe plan was proposed in March 2025 by EU Commission President Ursula von der Leyen and supported by member states, allowing EU member states to spend an additional €800 billion on defence. As part of ReArm Europe, the Security Action for Europe (SAFE) loan instrument will allow EU member states to borrow up to €150 billion for spending on European-manufactured defence capabilities. SAFE illustrates one of the many ways Europe plans to use increased defence spending to bolster European demand.

Short-term challenges

Attempts to kickstart a new age of European reindustrialisation through rearmament will face challenges. Europe’s defence industrial base is small and fragmented, representing only a third of the US’s as a share of GDP, and the EU’s defence supply chain is compromised by more than 2,500 specialised small to medium-sized enterprises (SMEs). This fragmentation prevents companies from benefiting from the economies of scale the US defence ecosystem enjoys. Simply put, Europe does not have the industrial capacity or expertise to service a sudden increase in defence spending.

In the short term, much of this additional defence spending will leak into imports. Between 2020 and 2024, around 64% of European NATO countries’ defence procurement came from the US. US defence imports to Europe will likely remain high, as EU spending on US defence products was a preliminary condition for tariff leniency in the phase one EU-US trade deal. However, none of the spending commitments in the trade deal are yet legally binding.

Developing proper defence industries and capabilities within European NATO states will require years of defence industrial buildup and focused investment. Regulatory obstacles within and across states may further hinder this process. To address capability gaps, it will be essential for both industry and policymakers to align defence planning at the national and multilateral levels, facilitating the coordination of investment and commercial activities across borders.

Long-term opportunities

While the prospect of European demand revitalisation may look bleak in the short term, the defence sector can become an important growth catalyst for Europe over time.

European armies must adopt new technologies and modernise to close the gap between Europe and the US. This will require significant investments in defence R&D to upgrade necessary skills. US defence research, development, testing and evaluation pending in 2024 reached $141 billion, representing 16% of the US defence budget. European R&D spend in 2024 was around $14 billion, or 5% of the European defence budget. NATO’s rearmament plan could increase EU R&D spending from 2.3% of GDP in 2024 to 2.9% in 2035, or an additional €100 billion.

Military innovation is concentrated in small companies that struggle with delivery timelines and financing. Creating a collaborative ecosystem that bolsters innovation and streamlines national procurement processes will be necessary to mobilise the European defence sector efficiently. In the short term, Europe will have to rely on superior US intelligence and equipment while building its defence capabilities. The US leads the defence technology market on both quality and price. The US economy will reflect this influx of European defence investment before Europe can build its defence industrial infrastructure.

Eventually, European defence projects will bolster European industries and domestic demand. However, there will be controversy and trade-offs. Funds will likely be disproportionately spent across the larger militaries. For example, the EU can allocate up to 60% of the loans under SAFE to just three member states.

Increasing defence spending will also be controversial amongst the electorate, as numerous European economies struggle with ongoing cost-of-living crises. In theory, funds going towards weapons could be spent on healthcare, transport and social housing. European electorates may not perceive increased arms spending as investments that will directly benefit their daily lives. Pedro Sanchez, the Spanish Prime Minister, fought for an exemption from the 5% pledge, stating: “If we had accepted 5%, Spain would have to spend by 2035 an extra €300 billion on defence. Where would it come from? From cuts in health and education.”