French navy Rafale jet fighters sit on the bridge of the French aircraft carrier Charles de Gaulle with the UK Royal Navy’s aircraft carrier HMS Queen Elizabeth in the background during a joint exercise off the coast of France (Photo by CHRISTOPHE SIMON)
AFP via Getty Images
By Roberto Scaramella, Oliver Wyman partner and head of Aerospace and Defense in Europe
Political tensions are higher in Europe than they have been at any time since the Cold War, given the escalating Russia-Ukraine conflict, recent drone and MiG incursions into European air space, and cyberattacks against major European airports. In June, European members of the North Atlantic Treaty Organization (NATO) committed to a historic expansion of the region’s defense investment — raising contributions to 5% of each nation’s gross domestic product. With most currently contributing between 1.5% and 3.5%, this represents a near-doubling of Europe’s contribution to NATO’s defense, rising from €400 billion annually to over €800 billion by 2030.
Two questions loom: Will it be enough, and can the expansion be achieved, given Europe’s current industrial infrastructure and capabilities?
Spending on military tech innovation rather than armies produces growth
Building a significantly larger industrial and engineering footprint for aerospace and defense (A&D) and pursuing a national industrial strategy would create a long-term competitive advantage for Europe. Nurturing regional industry champions in technology and defense is likely to galvanize central European economies like Germany and France where annual growth has slowed to below 1%.
But for that to happen, Europe also must spend smarter when it comes to defense. Europe’s historical pattern shows that less than 30% of the total defense budget has been invested in new equipment and technology, with the majority used to sustain standing armies, manage infrastructure and operations, and for training and logistics. The new higher defense budget would begin to reverse those spending priorities with more than 40% buying hardware and the latest tech for the region’s military services.
This new priority is of paramount importance for Europe if it is to get the full economic value out of the investment. According to our study, spending on European A&D had a historical multiplier effect of 1:2 — meaning every euro spent on defense generates two for the economy. With new tech-driven priorities, the multiplier will be almost double (1:4), which should mean more economic growth.
To translate a higher defense budget into a strategic power lever and economic engine, each nation in Europe also needs to address the sociopolitical fallout from prioritizing defense and security over other equally relevant national priorities. Convincing the public will not be easy, given the region’s sluggish economy and escalating political divisiveness, which threatens EU unity at a time when it already is getting less support from its longtime ally, the United States.
How defense spending will realign European economies
Based on the EU’s Readiness 2030 plan, the European Commission has identified key investment priorities for the region’s defense. They include air and space defense systems, tactical unmanned aircraft systems and mechanized combat capabilities, information and spectrum dominance in areas like electronic warfare, integration software and secured communications, and cybersecurity as priorities.
The EU could also play a role ensuring that resources are effectively used by limiting the number of platforms. For instance, the US supports three military tank platforms, while Europe has no fewer than 15. One potential way to optimize spending would be to encourage specialization by identifying the companies, partnerships, and even nations most advanced in specific defense equipment and channeling investment for those specialties to them.
An additional bounce from European defense spending could be achieved through another anticipated change in the procurement strategies of European nations. With the exception of France, European countries have historically bought more than half (65%) of their equipment import from US-based defense contractors. Our analysis shows that the new European commitment to “Made in Europe” defense production will gradually cut the US share to less than 30% by 2035.
That said, a significant chunk of the increased defense spending on cyber, unmanned vehicles and weaponry, electronic warfare, air defense, space surveillance, and underwater applications will continue to come from strategic partnerships between North American and European players. These will grow because of commitments made as part of recent EU-US tariff agreements and the attractive long-term return on investment these partnerships tend to provide, but we may see European players controlling larger shares of the ventures.
The overlap between defense industry and commercial supply chains
But can European industry even meet the new demand, given the extensive overlap between the industrial supply chains of commercial aerospace and other manufacturing industries and defense? The short answer is no: The European supply chain is exponentially smaller than what is required to accommodate the proposed growth in defense equipment production and the anticipated expansion in commercial manufacturing. To expand enough to satisfy both would require a long-term industrial vision for both the region and each nation — as well as setting priorities on how to allocate and expand production capacity.
Take the global aerospace industry. The potential for conflicting demands on the industrial supply chain is already materializing — especially in Europe, where Airbus, the world’s largest airframe maker, is based and there have already been difficulties meeting aerospace production schedules. The global commercial fleet is expected to expand to more than 38,000 aircraft by 2035, requiring global production to grow more than 7% per year over the next decade. Add new pressures from defense, and it becomes clear that new investment in capacity will be needed. The capacity shortfall is further complicated by instability injected by fluctuating tariffs and exchange rates.
Meanwhile, our military fleet forecast estimates annual deliveries of military aircraft will skyrocket from around 800 to 1,400 over the next decade. A similar surge in demand is projected for land (the highest growing domain), naval, and space-based capabilities. Our study of the industrial market in Europe indicates that the sector will require more than 250,000 additional engineers and skilled technicians (more than 25% of the current total) across the continent within the next five years to handle the increasing market demand.
Currently, the sector is subject to national golden power rules — regulations that allow governments to control foreign investments in critical industries like aerospace to protect national security and strategic interests. As a consequence, not all international investors can participate.
Governments can make sufficient capacity expansion more likely
One of the biggest contributions governments could make would be the simplification of regulations around investment and the removal of some risk in corporate investment in capacity expansions. This could be accomplished through long-term agreements and financing schemes that increase the appeal of such investments for external investors.
The key to ensuring adequate European capacity for defense and civilian industries is to develop policies that reflect priorities for the next decade, not just the next year or two.