For decades, the US has not only been Europe’s preferred weapons partner, but also the main research and development center for advanced weapons systems. Now, with Readiness 2030, Europe is not only increasing its defense spending but also focusing on prioritizing European defense contractors.
On the positive side, this could boost productivity growth in Europe and create numerous new jobs in the defense industry. On the negative side, this large boost to fiscal spending could crowd out private investment, a common problem in government investment programs.
John Antolin Diaz and Paolo Surico They managed to compile a comprehensive data set of 125 years of government spending and its impact on the US economy, allowing them to look at the very long-term impact of such increases in government spending on defense and defense R&D in particular.
The key insight is that the long-run budget multiplier is greater than one, meaning that every dollar spent on defense increases the size of the economy by more than one dollar. Most conventional studies estimate that the budget multiplier for US defense spending is about 0.5, while some studies find multipliers as high as 1.0. But this new study shows that the budget multiplier continues to grow over time, reaching 1.77 after fifteen years. Investing in defense is a long-term investment that only pays off after five to ten years or more.
Fiscal multiplier of defense spending stimulus
Source: Antolin-Diaz and Surico (2025)
Interestingly, the benefits of higher defense spending appear to come in two waves. The graph below shows the simulated increase in US defense spending at the top left.
The top right graph shows the boost to real GDP growth. There is an initial boost to GDP growth from higher defense spending, mainly driven by the government buying more equipment and hiring more soldiers.
But a second impulse comes after about 8 to 10 years. The graph below right shows that this is mainly caused by an increase in productivity. This productivity boost is due to increased spending on defense R&D. While this is typically only a fraction of defense spending, it significantly increases productivity growth in the defense sector, which then flows through to the economy as a whole.
Long-term response to the 1% of GDP increase in defense spending
Source: Antolin-Diaz and Surico (2025).
As I said above, the biggest concern with these types of fiscal spending programs is that they may crowd out private investment, because when the government spends more, it usually has to borrow more, raising borrowing costs for everyone and thus reducing private investment.
The graphs below show that this is the case in the short term for the first few years after the government increases defense spending. But crucially, after eight quarters, private investment and consumption begin to recover, and in the long run productivity increases as increased government spending on R&D ‘crowds out’ private R&D spending, helping to increase productivity in the wider private sector, not just the defense industry.
If this American experience extends to Europe – and I believe it does – the boom in European defense spending will be a key driver in pushing the continent out of its crisis. pitfall of low productivity of the past.
The impact of defense spending on the private sector increases by 1% of GDP
Source: Antolin-Diaz and Surico (2025).
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