European nations are ramping up their defense spending in response to growing geopolitical pressures. NATO allies have committed to an annual defense investment of 5% of their gross domestic product (GDP) by 2035, with a minimum of 3.5% designated for essential defense needs. This strategy includes allocating at least 20% of the total investment to major equipment and research and development, while another 1.5% should focus on resilience and innovation. Analysts note that this heightened demand for defense resources could invigorate European manufacturing and enhance the continent’s defense capabilities.
Despite the ambitious plans, the funding sources for these increases remain uncertain. Many governments face tight fiscal conditions, which complicates the prospect of meeting these spending commitments. In the UK, for instance, the potential shift towards defense spending could benefit the robust manufacturing sector; however, the current public finances are under strain. Venture capital might help fill some gaps by providing necessary funding for defense technology and dual-use firms, but this would require a firm commitment from the public sector to a credible investment strategy.
Long-term Economic Growth through Defense
A successful defense investment strategy could transform the British industry by driving long-term economic growth beyond immediate fiscal benefits. According to a report by the Aerospace Defence and Space Group and Oxford Economics, defense currently contributes about 0.6% to the UK’s gross production, a figure that does not consider its broader impact on other sectors. With increased government spending targets, the defense market in Europe is expected to expand, benefiting countries with available industrial capacity.
Critics of increased defense spending raise concerns about potential cuts to civilian services, but a study by the Kiel Institute suggests little evidence for such reductions during military buildups. Historically, governments have financed such efforts through higher taxes and borrowing. The challenge lies in whether the industrial and productivity gains from increased spending surpass the economic implications of higher taxes.
European governments face mounting fiscal pressures as they seek to boost defense capabilities. The UK budget released in late October 2026 outlined plans to increase defense spending by 0.1 percentage points of GDP, reaching 2.6% for the current fiscal year and 2.7% in subsequent years. This plan involves £3.8 billion in additional annual funding, primarily drawn from cuts to other departmental budgets.
Looking to meet the more ambitious defense goals of 3% by 2030 and 3.5% by 2035 poses additional challenges. The Institute for Fiscal Studies estimates this will require approximately £11 billion annually, a significant burden given the current fiscal constraints. The government intends to provide a roadmap for these targets in next year’s spending review, indicating a need for budgetary reform.
Some nations are resorting to borrowing to address their defense funding needs. For example, Germany recently revised its constitutional debt limits to exempt defense spending, while the UK must carefully manage its high public debt, which stands at 93% of GDP, the highest since 1962. Relying on borrowing without a clear path to fiscal consolidation is not sustainable in the long term.
John Healey, the UK’s Chancellor of the Exchequer, has indicated that spending cuts may be necessary. Proposed reforms to the state pension system aim to generate savings, with estimates projecting potential cuts of £15 billion a year by the late 2030s. These reforms may assist in meeting defense spending requirements sooner.
Raising tax revenues presents another option, although the existing tax burden is already significant. The Office for Budget Responsibility has projected that tax revenues will exceed historical records in the coming fiscal year. As military expenditure often relies on income tax, raising this type of tax could provoke political backlash.
While the public sector remains the primary customer in the defense market, additional funding from private capital is essential. Venture capital has the potential to drive innovation and growth in Europe’s defense sector, particularly for start-ups focused on defense technology. However, many small and medium-sized enterprises face challenges in transitioning from grants to long-term financing, a shift that is critical for commercial success. Streamlining procurement processes could enhance opportunities for emerging technologies to be integrated into defense efforts.
The upcoming seminar hosted by OMFIF and EY on November 17 in London aims to gather leaders from various sectors to discuss how increased defense spending can bolster long-term economic resilience and competitiveness. This collaboration emphasizes the need to harmonize public and private investment to revitalize Europe’s industrial base while strengthening national security.
