Higher defence spending brings forward hard fiscal policy choices and has an uncertain economic impact

By Ben Conigrave, OECD.

After falling relative to overall public expenditure and GDP in the three decades after the Cold War ended, military spending is rising again in many OECD countries. Among those that are also NATO members, a large step up in defence outlays has recently occurred in Central and Eastern European countries (Figure 1). A broader pick-up in defence spending has seen expenditures also increase in Japan, the Nordic countries and Israel.

Poland and the Baltic states (Estonia, Latvia and Lithuania) were among those quickest to increase defence spending following Russia’s invasion of Ukraine in 2022. All plan to keep military spending at high levels in the coming years, or even increase it. Earlier this year, all four countries pledged to lift their defence budgets to 5% of GDP. Spending on this scale could absorb up to 15% of their tax revenues based on outcomes for recent years (OECD 2024). In recent months, Czechia, Denmark, Finland, Norway and Sweden have also signalled ambitious goals for defence spending, as have larger European economies including France, Germany and the United Kingdom (Figure 2 panel A). In a NATO summit this week, members are expected to agree to a new, higher defence spending target.

Many countries plan to borrow more, at least in the near term, to finance higher military expenditure. Sweden and Germany have loosened their fiscal rules – changing the Constitution in Germany’s case – to make more room for higher future defence outlays. A larger group of countries (16 by the end of April) hope to make use of national escape clauses in EU fiscal rules (Council of the EU, 2025). If cleared by the Council, this would allow these member states to deviate from approved budget plans by spending an extra 1.5% of GDP on defence up to 2028 (compared with levels in 2021).

Financial market pressure may make it difficult to meet defence spending ambitions in high debt countries. While Germany and Sweden have fiscal space to let debt rise for a period of time, higher-debt OECD economies could face increased borrowing costs if they fail to cut non-defence spending or raise taxes. Tax increases have often accompanied past military build-ups after a temporary period of higher borrowing (Marzian and Trebesch, 2025). But in many of the OECD countries now promising to raise defence spending, tax burdens are already high (Figure 2 panel B). Postponing to the “long run” tough fiscal policy choices – already unavoidable for countries grappling with heavy costs from changing demographics and climate (OECD 2025) – may not be an option.

The broader economic effects of higher defence spending are uncertain and will vary from country to country. Near-term growth payoffs from increased defence expenditure are likely to be larger in economies with spare capacity and established local defence industries, particularly if monetary policy accommodates a fiscal expansion. But many countries could expect the positive gains from higher defence spending to be offset by some combination of higher imports and reduced private sector activity due to increases in inflation or interest rates.  

The impact of higher spending may also vary by type of spending. Defence infrastructure projects or spending on equipment could generate relatively high multipliers by boosting public sector investment directly, and if they generate domestic private sector activity and jobs, and rely mainly on locally-sourced materials. Raising the number of military personnel also contributes to domestic output – directly through public final consumption and indirectly via household consumption – and is likely to have larger net effects in economies below full employment.

To the extent that European countries are able to source defence equipment, inputs or services from each other, and stretched availability of supplies does not raise costs, regional multipliers from increased defence spending could exceed those in individual European countries. Recent analyses suggest that a collective 1.5% of GDP lift in military spending could boost Europe-wide GDP by between 0.5% and 1.5% (Ilzetzki, 2025; European Commission, 2025). Across all but the very top of this range, a combination of higher imports and some crowding out of private sector activity would mean a less than one-for-one translation of increased government spending to GDP.

Longer-run benefits might still come from defence investments that boost the economy’s productive capacity, for instance through better infrastructure or innovation to respond to the shifting technological demands of modern warfare. These benefits are hard to quantify, though there is good reason to expect defence R&D to eventually benefit other industries (Steinwender, Van Reenen and Moretti, 2019). Gains from innovation and higher productivity might be more likely to spill over national borders if allied countries coordinate strategic investments and military procurement. Such coordination could be a powerful lever for more efficient defence spending if it reduces the cost of achieving intended improvements in military capability.

References

Council of the EU (2025), “Coordinated activation of the National Escape Clause”, press release of 30 April 2025.

European Commission (2024), Opening remarks by President von der Leyen at the joint press conference with President Michel and Belgian President De Croo following the meeting of the European Council of 27 June 2024.

European Commission (2025), “European Economic Forecast Spring 2025: Moderate growth amid global economic uncertainty”, Institutional Paper, 318.

Ilzetzki, E. (2025), “Guns and Growth: The Economic Consequences of Defense Buildups”, Kiel Report, No. 2.

Marzian, J. and C. Trebesch (2025), “How to Finance Europe’s Military Buildup? Lessons from History”, Kiel Policy Brief, 184.

OECD (2024), Revenue Statistics 2024: Health Taxes in OECD Countries, OECD Publishing, Paris, https://doi.org/10.1787/c87a3da5-en.

OECD (2025), Economic Outlook, Volume 2025/1, OECD Publishing, Paris, https://doi.org/10.1787/83363382-en.