The EU’s defence industrial policies – walking the walk with Euro-defence bonds

Over the last two years, the war in Ukraine has prompted the acceleration and multiplication of EU initiatives to enhance the European defence industry, and Europe’s ability to defend itself and support Ukraine’s defence.

Besides spending better, spending together and getting private equity onboard, the next frontier for EU defence spending must be the issuance of joint debt to provide ample political incentive for EU Member States to de-fragment the EU defence market.

From recent initiatives…

Recent initiatives from the European Commission have mainly sought to encourage Member States to transfer military equipment to Ukraine and assuage their concerns about dwindling stockpiles. This has been made possible by incentivising them to aggregate demand for certain products such as ammunition, ramp up production capacities in Europe and jointly procure to fill capabilities gaps.

Results have been mixed. Allocating EUR 17 billion under the European Peace Facility to reimburse bilateral arms transfers has certainly been significant. The rapid launch of the Act in Support of Ammunition Production (ASAP) has been a good example of quick decision-making but hasn’t been groundbreaking for industrial production in Europe.

Other initiatives have lagged or weren’t up to the task. Namely, the European Defence Industry Reinforcement through common Procurement Act (EDIRPA) was launched with a budget of a mere EUR 310 million over two years, with very little real impact in a procurement realm that features programmes in the magnitude of 12 figures. Not to mention that this ‘emergency response’ took 1.5 years to finally see the light of day.

And, overall, collaborative procurement remains low, with EU Member States preferring to grab whatever is available on the market according to a zero-sum logic—and often from non-EU suppliers.

As such, the European Commission and EEAS published its European Defence Industrial Strategy (EDIS) in March 2024. This longer term outlook on EU defence industrial developments is meant to remedy these shortcomings, build upon the 2022 Strategic Compass and help set the next Commission’s agenda.

…to low-hanging fruit…

Against this backdrop, the new Commission’s mandate is an opportunity to accelerate the implementation of existing initiatives, follow through on EDIS commitments and introduce a few, tailored novelties to free up necessary resources. This relies on three pillars: demand-side aggregation, supply-side industrial transformation and synergies, and the involvement of private investment.

First, the European Defence Investment Programme (EDIP) envisaged by the Strategy should be fully implemented. Outfitted with EUR 1.5 billion to merge EDIRPA’s incentives of demand aggregation with ASAP’s incentives to ramp up production, EDIP aims to increase collaborative procurement and boost European production capacity.

Second, the cost of capabilities to be procured under the EDIP could be reduced by eliminating some of the administrative burdens placed on EU-funded industrial programmes, such as ex-post intra-EU arms transfer authorisations. In tandem, EDIP and administrative easing could also generate the type of industrial consolidation necessary to create economies of scale.

Third, EDIS’ call to change European Investment Bank lending policy to favour the defence industry and encourage the mobilisation of private capital should be genuinely heeded. Innovative SMEs focused on emerging and disruptive technologies would also stand to benefit from administrative easing and an injection of private capital.

…and a potential breakthrough

But, most significantly, the foundations of a legit EU defence industry rests on proper resourcing. That means a conversation about Euro-defence bonds must move forward.

European Commissioner Thierry Breton, the EU’s outgoing defence industry chef de file, has stated that EDIP requires EUR 100 billion for effective implementation. This figure stands in stark contrast from the EUR 8 billion currently allocated under the EDF and from where EDIP’s EUR 1.5 billion portfolio has been drawn and repackaged.

EDIP funding should not be at the EDF’s expense and the precious role it has played in financing joint research and development—which should continue under the EU’s next multiannual financial framework (MFF). Considering that capabilities development and production requires a different order of magnitude of resourcing, EUR 1.5 billion is mere peanuts and the EDIP 2.0 budget should be revised to at least EUR 42 billion.

Spread across the 2028-2035 MFF, this would amount to about EUR 6 billion/year to cover part of the costs for the joint production and procurement of four-six high-end capabilities development programmes. This would allow the EU to co-fund at least one flagship European project in each physical operational domain (land, naval, air and space) and joint endeavours such as integrated air and missile defence.

Against this backdrop, the EU’s true ‘Hamiltonian moment’ in defence would be a decision to issue joint debt to properly fund the ambitions set out in its Defence Industrial Strategy.

Based on Art. 122 TFEU and implemented in accordance with Articles 173-174 TFEU, such bonds—possible under the EU’s Financial Regulation—could provide the backbone for grants to Member States to bolster the Union’s defence production capacity if paired with existing incentives for joint capabilities research, development, production, and procurement. This would avoid the two-speed logic and weaker conditionalities surrounding proposals to use the European Stability Mechanism (excluding key countries such as Poland, Sweden and Denmark) to issue loans to EU Member States for defence spending.

Like how the Covid-induced Recovery and Resilience Facility stabilised European markets and sustained demand during and after the pandemic, Euro-defence bonds are a potential game-changer for the EU’s defence ambitions due to the potential speed and scale of resource mobilisation, and the potential impact on market de-fragmentation. And, fortunately, the German Constitutional Court should have nothing to object to this time around.

According to our proposal, major defence manufacturers in typically frugal countries such as the Netherlands, Sweden, Denmark, Germany and Finland would surely stand to benefit from targets to jointly procure from Europe’s defence industrial base. The USD 50 billion loan guaranteed by the interest generated by frozen Russian assets could also be freed up for the European Peace Facility to focus on Ukraine’s imminent battlefield needs.

Above all, the strategic imperative could not be more self-evident. Russia’s full-scale invasion of Ukraine is a clear threat to European security and the EU must explore all avenues to fund its ability to deter Russia from expanding and escalating the conflict to fully deliver on its joint security commitments with Ukraine. With great ambitions comes a great responsibility to table ambitious solutions – and the funding that comes with them.

About the Authors:

Dylan Macchiarini Crosson is a Researcher in the EU Foreign Policy Unit at CEPS. His main expertise relates to the areas of EU foreign, security, and defence policies, transatlantic relations, and EU institutional and political dynamics in these areas.

Alessandro Marrone is Head of Defence Programme at the Istituto Affari Internazionali (IAI), where he manages research projects and publications related to European and transatlantic security as well as to Italy’s defence policy.