How Germany Can Afford High Defense Spending Investing.com

Investing.com — Germany is struggling to finance more defense spending to meet NATO’s 2 percent of GDP goal, with some analysts at Commerzbank (ETR: ) saying they would support higher spending (up to 4% of GDP).

While historically common (1960s) and accepted in some countries (e.g. Poland), Germany’s current economic situation poses obstacles.

Germany’s slow economic growth is a key obstacle. The country is projected to grow at an average annual rate of only 0.5% in the coming years, which is below the level needed to accommodate substantial defense spending without impacting other sectors.

Historically, rapid economic growth has allowed Germany and other countries to effectively manage high defense spending, which in turn increases government revenue.

Without accelerating economic growth, Germany will need two decades to gradually increase defense spending to 4% of GDP, Commerzbank added.

Reducing costs in other areas of the federal budget provides a partial solution, but the scope for such savings is limited.

To close the gap through budget cuts alone, Germany would need to cut federal civilian spending by nearly 20% over four years.

Potential savings from social spending cuts and government efficiency improvements are insufficient to fully support defense spending.

While reallocation of funds from climate initiatives, such as through more efficient carbon pricing, can generate savings, this is likely to face significant political opposition.

Raising the defense through debt is another option, but raises legal and economic issues. Such an approach could double Germany’s budget deficit from 2% to 4% of GDP, violating European debt law and the constitutional debt ceiling.

The current reliance on shadow funds to support core government functions such as defence, is unsustainable in the long term, underscoring the need for expenditure to be integrated into the regular budget.

Germany’s rising risk of government bonds makes debt-based financing more complex. According to Commerzbank, weak economic growth has led to a significant increase in financing costs for government bonds.

Structural reforms are essential to ensure sustainable debt levels and boost economic growth and tax revenue.

Increasing productivity and investing in growth sectors will reduce the pressure on government finances and improve the country’s ability to afford higher defense spending.