Joint EU borrowing presents the perfect storm for the centralisation of the EU

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BrusselsReport.eu
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By Samuel Martin, Editor-in-Chief of The Mallard and freelance writer interested in immigration, trade, and European politics

You don’t need to be an economist to understand that none of NATO’s European member states can afford the new 5% defence spending target. 

Every EU-NATO country has been running a substantial deficit, and consequently accruing a sizeable debt burden, for several years at this point. Indeed, there was widespread doubt about the ability of members to reach a 3% target, an aim that has evaporated as suddenly as it was floated less than a year ago.

At present, the defence spending of EU-NATO sits at around 2% of GDP on average and total government expenditure sits at around 40-to-50%. As such, an increase of 2-to-3% of GDP equates to a 5% increase in overall government spending.

None of the options available to European governments are particularly appealing. Tax rates are already burdensome, austerity is politically toxic, and the suggestion that increased defence spending can pay for itself with increases in productivity is shaky at best; recent increases in defence spending haven’t boosted productivity so why exactly would future spending do so?

Nevertheless, EU-NATO states aim to meet this target by 2035. What appears like an attempt by leaders to pace themselves in funding this new endeavour is just a thinly veiled attempt to kick the increasingly hollow can down the proverbial road.

As such, further joint borrowing at the EU level is increasingly attractive. After all, national governments have continuously exceeded their means and therefore can’t expect to borrow their way out of this commitment. Besides, the EU can borrow at lower rates than most states, making the solution politically convenient and cost- effective, especially when compared to the alternatives.

Of course, it’s debatable whether this target is a sincere political objective or a ploy to satisfy Trump. However, there’s good reason to believe that Europe is angling to boost its defences. The EU Commission’s SAFE arms fund includes an additional €150 billion in defence spending, so it’s fair to assume EU-NATO countries are prepared to put their money where their mouth is. Overall, joint EU borrowing seems to be the only plausible way states can meet this spending target, having lost their ability to borrow their way at the national level.

Well, that’s that then. Let the EU pick up the tab. Crisis averted! Except not quite. While it’s possible that the nations of Europe could shoulder the cost of increased defence spending, it paves the way for further EU federalisation.

1871

Prior to World War I, Germany was composed of semi-autonomous states under the authority of the Kaiser and the Reichstag. While unified politically since 1871, the imperial government had limited taxation powers, relying primarily on tariffs and matricular payments. Although the Reich possessed powers of indirect taxation, it lacked direct control, which remained within the purview of individual states.

However, following the outbreak of the war, The Reich became Germany’s borrower of last resort, financing the war almost entirely through debt; a debt that the newly formed Weimar Republic inherited after the war ended. Consequently, the central government pushed through significant tax reforms which centralised income and corporate tax collection under federal authority.

Switzerland followed a similar trajectory. Throughout the early 19th century, it remained a loose confederation of largely autonomous cantons, joined under the Federal Pact of 1815. However, growing ideological divisions between liberal and conservative cantons—mainly over religion, but also education and trade—led to the Sonderbund War in 1847.

In the aftermath, the victorious liberals drafted the Federal Constitution of 1848, transforming the confederation into a federal state. The new central government acquired exclusive powers to levy customs duties; a power that was expanded to include federal income tax by the 20th century. While the post-war debt was quite minor, and centralising fiscal power was far from an initial objective of the liberals, it was nevertheless regarded as economically necessary and required to ensure the collective security of the cantons.

The pattern endures across the pond. Prior to the American Revolutionary War, the Continental Congress lacked the authority to impose taxes and relied on voluntary contributions from the states, many of which were irregular, insufficient, and even withheld.

When the Revolutionary War broke out, the Congress stepped in to fund the war effort, issuing continental currency and borrowing from domestic creditors and foreign allies. This wartime improvisation left the newly independent union with a vast debt and a dangerously inflated currency.

Under the Articles of Confederation, Congress still lacked powers of taxation, which severely hampered efforts to service its debt. It was in this context that delegates convened in 1787 to draft the U.S. Constitution, allowing the newly formed federal government to assume powers of taxation and responsibility for the national debt.

A related pattern emerged in Canada. Prior to 1867, British North America was a collection of separate colonies, each with its own capacity to borrow. Lacking any joint central body or shared borrowing mechanism, the colonies accrued separate debts, much of it driven by the construction of railways and other infrastructure projects.

At the same time, fears of U.S. invasion, along with political gridlock and economic instability, created a convergence of pressures that culminated in the British North America Act of 1867. This Act created a new federal government that assumed the debts of the colonies and centralised taxation and borrowing.

Wherever you look, the pattern is clear: a weak or functionally non-existent central body takes on debt during crisis, acquires taxation powers after the crisis to repay said debt and ensure security, resulting in deeper political union.

Given this, one should regard recent developments with some degree of hesitancy – if not outright hostility! Opponents of further EU federalisation should be digging in their heels right about now.

The Frugal Four

Alas, this doesn’t seem to have disturbed conservatives as much as it should. In fact, they are nowhere to be found. The Frugal Four is basically dead. Danish PM Mette Frederiksen has disavowed the group, the Netherlands has descended into turmoil following the collapse of its government, Austria’s ongoing recession has increased its economic reliance on the EU, and Sweden has far too much to gain from unified borrowing, being one of the largest defence exporters in the EU.

Moreover, representatives from Sweden, Denmark, and the Netherlands attended a secret meeting with counterparts from Finland, Poland, and even the UK, to plot the creation a new supranational defence bank.

Defence has always the intuitive, common-sense exception; the mere mention of more spending has the power to turn otherwise level-headed fiscal conservatives, supposed deficit hawks, into gluttons for borrowing.

Joint borrowing at the EU level presents the perfect storm for the centralisation of EU economic policy, and thus a threat to any hopes of ensuring the EU retains its dwindling number of confederal characteristics.

 

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