Peace in Europe: Its Economic Consequences
By Hans Hoogervorst, Skytop Contributor / March 20, 2025
Hans is a distinguished Dutch former minister and public policy expert with a notable career in both the public and private sectors. He served as the Chairman of the International Accounting Standards Board (IASB) from 2011 to 2021, where he played a pivotal role in shaping global accounting standards. Prior to this, Hans held various significant positions in the Dutch government, including, Minister of Economic Affairs, and Minister of Health, Welfare, and Sport. His leadership extended to the Netherlands Authority for the Financial Markets (AFM) and the International Organization of Securities Commissions (IOSCO) Technical Committee, where he served as Chair, contributing to the regulation and oversight of financial markets.
Throughout his career, Hans has been recognized for his expertise in economics, finance, and governance. His work at the IASB was instrumental in promoting transparency and accountability in financial reporting worldwide. Hans's extensive experience and dedication to public service have made him a respected figure in the world of finance and accounting. Known for his strategic vision and commitment to high standards, he has left a lasting impact on the institutions he has led and the global financial community.
Increasing Defense Expenditures
It has become abundantly clear that Europe can no longer blindly rely on the postwar American security guarantee. Faced with an unchained Russia, Europe will have to increase its long-neglected defense expenditures and quick. Raising defense outlays to a level of 3.0-3.5% of GDP is probably what it takes. Given that the current average level in Europe is about 1.9%, this means increasing defense expenditures by approximately 1.1-1.6% of GDP.
Exhausted Systems
Since many European governments easily devote around 50% of GDP to public expenditures (compared to 36% in the United States) carving out 1.1-1,6% for defense should not be too much of a problem, or so you would think. No so. The truth is that in many European countries both public finances and the political system are exhausted. In practice, increasing the defense budget in a responsible way is politically a Herculean task, so it is more likely to happen in an irresponsible way.
Strained Public Finances
The main reason why public finances are under so much strain in Europe is the size of its welfare arrangements. They were developed during the postwar baby boom when the number of pensioners were few and social security could be provided on the cheap. Now the baby boomers are retiring en masse and costs are ballooning.
Massive Outlays
In France and Italy, the EU’s second and third-largest economies, the government spends 15-16% of GDP on pensions alone. In the big EU-member states total spending on welfare adds up to 20-25% of GDP, crowding out spending on infrastructure and education. Moreover, the high level of taxation funding these massive outlays serves as a drag on growth which, in turn, further undermines public finances.
Freeing Up Resources
Freeing up resources to bolster defense spending should not be all that difficult. Would it really be impossible for the French to survive a rise of the retirement age from 64 to 67, like the Dutch and the Scandinavians have already done? Is it really necessary for German workers to work a mere 1350 hours per year, 25% (!) less than their American counterparts? Does the UK National Health Service really need to be 100% tax funded? Asking these questions is answering them.
Convince the Electorate
As a former politician, I know how difficult it can be to convince the electorate of painful measures. But I also know that it can be done, if properly explained. If protecting the integrity and safety of our nations does not raise sufficient urgency to take painful measures, then what is?
Unaccustomed to Painful Measures
The problem is that in the past decades of easy money our politicians have unlearned the art of taking unpopular measures. The fallout of the Great Financial Crisis in 2008 was smothered by massive money printing by the Central Banks, followed by an even more extreme reaction to the COVID-19 pandemic. Central Banks bought up such massive quantities of government debt, that it became silly for politicians to worry about the budget deficit. Why bother about unpopular decisions when central banks were willing to buy up more debt than the government could produce? Both politicians and their electorates have grown unaccustomed to painful measures.
Rise of Populism
Another factor explaining the paralysis of our political systems is the rise of populism. In almost all European countries the established parties failed to get a grip on mass immigration, while all opinion polls show that the large majority of our populations are deeply worried by it. As a result, we saw the rise of populist parties everywhere in Europe, with the exception of Denmark. Denmark is one of the few countries where the political elite undertook firm measures to stem mass immigration. It is also one of the few nations where the social democratic party has not been wiped out by populists. In the rest of Europe, the unaddressed concerns about mass immigration led to an almost unstoppable rise of populism.
Economic Policy Making
Populist parties are usually labelled ‘far-right’, but the truth is that their economic policies are mostly traditionally socialist. Under pressure from populist leader Marine Le Pen, the French government is currently discussing lowering, instead of raising, the retirement age. In many countries (including my native The Netherlands), populist parties have become so large that sane economic policy making has become very difficult.
Borrow Money Again
Given these circumstances, it is not surprising that Europe’s gut reaction to the challenge of raising money for defense is to yet again borrow more money. Soon after the public quarrel between President Trump and President Zelensky, Europe announced an 800-million-euro Defense Fund, financed by joint borrowing and by allowing countries to yet again flaunt the fiscal rules of the Eurozone.
Raising Germany’s Debt
More surprisingly, this time the charge towards more borrowing was led by Friedrich Merz, the conservative Prime Minister in waiting of Germany. While he ran his recent election campaign on a message of fiscal discipline, he quickly closed a deal with the left to allow for massive borrowing to finance big investments in infrastructure and defense. While such investments are necessary, relying on borrowing alone could raise Germany's debt close to Southern European levels. Fiscal discipline, never strong in the Eurozone, is now definitively dead and buried. It is unlikely that Merz will be able to negotiate meaningful reforms of the German welfare state with his social democratic coalition partners to be.
Facing the Consequences
The European Union regularly congratulates itself with the fact that its average public debt is lower than that of the United States, which stands at a staggering 124% of GDP. While true, this is hardly a reason for self-satisfaction. The U.S. will have to face the consequences of its gigantic debt sooner or later too. The American government already pays 4.7% of GDP on interest on its debt and there is more to come. But at least the U.S. combines unsustainable debt with a dynamic and flexible economy, while most European debtor nations combine huge debts with stifling regulation and failing incentives in the labor market. This is the main reason why the US has experienced much more economic growth than Europe in the past decade.
Further Stagnation
The truth is that by yet again resorting to borrowing, Europe will likely condemn itself to further stagnation. Rather than reforming their social security systems, countries like Italy and France are now allowed to further increase their already unsustainable public debt. Europe is starting to look more and more like Japan, with an ageing population, low growth and massive debt that can only be sustained by a central bank that keeps interest rates too low and turns a blind eye to inflation.
European Central Bank
A mild stagflation scenario is probably the best Europe can hope for. Yet when Germany actually starts borrowing on a big scale, the markets could also react by demanding much higher interest rates on French and Italian bonds, which could trigger a new European debt crisis. Most likely, the European Central Bank would then step in with new rounds of quantitative easing. But this would likely come at the cost of rekindling inflation to levels that even the dovish ECB cannot tolerate.
Borrowed Time
Historically, war efforts have always been the main reason for massive sovereign borrowing. In the past decades, however, our debts have reached wartime levels while defense expenditures reached a historical low! If Europe is serious about arming itself to the levels necessary to maintain peace, it had better make some real choices. The time for easy fixes is gone. Europe cannot continue living on borrowed time.