Yahoo Finance

The internet, GPS and Silicon Valley

It is indeed homegrown weapons and advanced military technologies that hold one of the keys to translating higher government spending on defense into a meaningful economic boost, experts say.

The reason is twofold. Firstly, ordering weapons from local firms, rather than mostly importing them as the EU has been doing, would increase domestic production, lifting GDP, as well as create jobs, with the salaries spent in the European economy.

Secondly, when cutting-edge military equipment is designed locally, the knowledge gained in the process spreads locally too, rather than staying abroad, generating so-called technological spillovers across the economy.

“Historically, the defense sector has been the origin of diverse innovation that has now been mainstreamed in the civilian world,” Mario Draghi, a former European Central Bank president and Italian prime minister, wrote in a landmark report on European competitiveness released in September.

Draghi pointed to numerous examples, including the internet, GPS positioning, satellite imaging, the ubiquitous three-point seat belt — derived from harnesses designed for military jet pilots — and the early growth in the 1950s and 60s of what became known as Silicon Valley, supported by government investment in defense.

Another example, from more recent history, illustrates broader productivity improvements that can follow from higher military spending. An increase in military research and development in the US after the 9/11 attacks led to a “significant” rise in productivity in the overall economy, according to research published in January, based on a working paper from the National Bureau of Economic Research.

And productivity growth matters, as it’s what drives improvements in living standards over the long run.

Building up defense industry capacity will take time and so Europe will probably continue to rely on imports for the bulk of its military needs in the short term. That initial period will last about five years, with at least another five needed to achieve self-sufficiency, Frank Gill, a sovereign credit analyst at S&P Global Ratings, told CNN.

But even with imports, “it’s not necessarily a zero (economic) effect,” argued Ethan Ilzetzki, an economics professor at the London School of Economics and Political Science, who wrote a report for the Kiel Institute on the economic consequences of defense build-ups, published last month.

He said Poland, for instance, had imported a lot of military aircraft since the Russian invasion of Ukraine. “This has also led to construction of airfields, which creates employment, which creates economic activity,” he told CNN.

Another way to ensure higher defense spending generates economic growth is to contract local companies that make products that can be used both for military and civilian purposes — something that’s currently more common in the US than Europe — rather than choosing specialized defense suppliers.

Technological advances by “dual-use” defense contractors spread quickly into the private economy, the Kiel Institute said in a press release on Ilzetzki’s study.

Europe’s defense industry is also different from its US counterpart in how fragmented it is, split along national lines.

“National defense procurement (in Europe) favors national champions rather than seeking economies of scale and efficiency,” S&P said in a report last month, co-authored by Gill. “Further inefficiencies arise from Europe’s excessive diversity of weapons systems.”

All big countries in Europe tend to develop their own military aircraft, their own tank, their own warship, noted Cingolani at Leonardo. This means they are not as fast at designing and making new military equipment as they would be if the EU operated as a single entity, he suggested.

Pooling resources would help European nations move away from reliance on defense imports sooner, Gill told CNN. That, in turn, would usher in the positive economic side-effects of domestic weapons production.

Those effects could be large. Ilzetzki has estimated that raising defense spending from 2% to 3.5% of GDP and shifting to domestically designed and made weapons could translate into a boost to Europe’s economic output of about 1%.

Borrowing for defense

That benefit won’t materialize, however, if the higher spending is financed with tax hikes rather than government borrowing, Ilzetzki wrote in his report.

Jack Allen-Reynolds, a senior Europe economist at Capital Economics, agrees. “If governments cut spending in other areas or raise taxes, there might not be much of an overall fiscal stimulus,” he wrote in a note last month.

More borrowing does appear to be on the cards. On Tuesday, the head of the EU’s executive unveiled a plan to enable governments to borrow more to increase their defense spending, as well as military support for Kyiv. And the parties hoping to form Germany’s next government agreed to overhaul borrowing rules to inject more money into the military, although this must still be approved by parliament.

Some economists are skeptical about the scale of the potential economic uplift from higher defense spending in Europe.

Claus Vistesen at Pantheon Macroeconomics said in a recent note that the splurge “is unlikely to be the fiscal panacea that markets and many observers are hoping for,” noting that building up the region’s defense industry would take time.

But, according to Ilzetzki, Europe can afford to pace itself.

“Hopefully, war in Europe, aside from the war in Ukraine, is not imminent, and so there is a little time for Europe to do this right and plan for the future,” he told CNN.

CNN’s Joseph Ataman in Paris and Niamh Kennedy in London contributed to this article.

For more CNN news and newsletters create an account at CNN.com