Joint EU debt for defense is the way to go, says Lithuanian central bank chief

SINTRA, Portugal — The European Union should continue to issue joint debt to finance the revival of armed forces across the bloc, the head of Lithuania’s central bank said in an interview. 

Speaking to POLITICO on the sidelines of the European Central Bank’s annual conference in Portugal, Bank of Lithuania Governor Gediminas Šimkus called joint EU debt “directionally right.” 

“We are Europeans: we have a single market, we have a single currency,” he said. “We should have more unity in defense because this is our strategic priority — and it’s very natural to have this single financing via a certain level of debt.”

The EU has already approved plans to raise €150 billion in common loans to finance rearmament under its Security Action for Europe (SAFE) plan. The money will be disbursed to individual member countries as loans that are repayable to the Union. For more indebted countries, like France and Italy, the loans are provided at a more favorable interest rate than what the market would offer them if they borrowed in their own name. 

Šimkus, who heads the central bank of one of the countries most threatened by revanchist Russian ambitions, praised recent pledges to more than double the NATO defense spending target to 5 percent of gross domestic product (GDP).   

“It’s a very clear signal to the European allies and to the potential adversaries that Europe is serious about its commitment to increase its defense spending,” Šimkus said. “I think the time of peace dividends is over.”

Innovation benefit

But many European countries are already facing high levels of indebtedness, and are struggling to square the conflicting tasks of bringing down their budget deficits while also boosting military investment. Šimkus acknowledged the challenge, but also said that the spending could unlock economic opportunities. He pointed to countries like the U.S., Israel, and South Korea, which spend significant amounts on their militaries, and which also enjoy high levels of innovation. 

Research from the Kiel Institute published in February estimated that Europe’s long-term productivity could rise by as much as 0.25 percent for each 1 percent of GDP spent on military research. But crucially, the study underscored that the bloc will need to overcome national preferences for domestic manufacturing to derive the maximum benefit for overall productivity. Comparatively weak productivity growth has been one of the key reasons why the European economy has fallen so far behind the U.S. and China in recent years.

“The defense industry market — it is very fragmented in Europe. And a lot of governments are still buying from their domestically incorporated companies,” Šimkus said. 

He pointed to the continent’s struggling automotive industry as a possible beneficiary of more military investment. It is “more than prepared to satisfy the increased defense spending” by producing the necessary equipment. 

Šimkus said that issuing EU joint debt could also help channel European household savings — which amount to €1.4 trillion annually versus €800 billion in the U.S. — into more productive investment. In recent years, money looking for high returns has generally gone to the U.S., which is home to the world’s most innovative companies, but also home to the world’s most efficient capital market, underpinned by a huge and liquid market for ‘safe assets’ such as government bonds.

Economists such as former ECB chief Mario Draghi have called for Europe to create an analogous market for safe assets in Europe, arguing that it would make the capital market much more user-friendly, increasing the supply of collateral for loans and expanding the possibilities for hedging risks. A bigger market for EU debt could serve this purpose, Šimkus said. 

Lithuania hasn’t always been so supportive of joint EU spending: along with the other Baltic states, which suffered the deepest recessions in the EU after the 2008 financial crisis, it had little enthusiasm for the bailouts of Greece and other southern European countries between 2010 and 2014.

But the revival of the Russian threat has led to a major rethink on the EU’s eastern flank, embodied by former Lithuanian Prime Minister Andrius Kubilius, who, as the EU’s Defense Commissioner, has played a large role in getting the SAFE program up and running.

That change of heart has chipped away at the bloc of countries that consistently resisted a bigger role for EU debt in the past. However, as Šimkus acknowledged, significant obstacles still remain. The project continues to be regarded with suspicion by countries like Germany and the Netherlands. 

“It's a very political question and it's a very complex question,” he admitted.