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European Union countries are going through what might be called a ‘defence transition’. Against the background of the war in Ukraine and a heavily deteriorated geopolitical situation for Europe, they are recording big jumps in the size of their defence budgets ¹ See European Defence Agency news of 30 November 2023, ‘Record high European defence spending boosted by procurement of new equipment’, . .

However, under the recently reformed EU fiscal rules, countries must reach a fiscal position that ensures that debts in excess of 60 percent of GDP are put on a declining trajectory and deficits stay below 3 percent of GDP over the medium term. Government balances in most countries currently fall short of the levels that would allow for the required decline in debt, often by large margins. Governments therefore need to carry out sustained reductions in (non-interest) expenditure or to permanently increase taxes. Greater military expenditure raises the burden of the adjustment on the rest of the budget.

This is causing tension. Poland’s finance minister, Andrzej Domański, has criticised the rules for imposing reductions in government deficits when the country faces strong pressure to increase defence spending ² Raphael Minder, ‘Poland pushes EU to exempt its defence spending from fiscal rules’, Financial Times, 13 October 2024, . . Poland is going through an unprecedented peacetime military build-up, with defence expenditure nearly doubling from 2.5 percent of GDP in 2022 to almost 5 percent in 2025, values on par or above those of the United States ³ Armida van Rij and Melania Parzonka, ‘Poland could be Europe’s rising star on defence and security’, Expert Comment, 19 July 2024, Chatham House, . . 

Domański’s statements may serve a dual purpose. In the short term, he may seek to pre-empt negative consequences for Poland, in the form of an escalation of EU procedures to rein in countries’ deficits, with attendant penalties. In the longer term, he may want to re-open the discussion on fiscal rules, specifically on special treatment for military expenditures. The former is likely to succeed in the light of experience (see the annex for details of Poland’s specific situation), but the prospects for the latter are decidedly less favourable, though arguably more deserving of reflection.

A golden rule for military investment?

Could the military build-up in Poland and in other EU countries lead to a change in the EU fiscal rules in the form of some exemption for military investment? Two main considerations militate against such a change:

First, the EU fiscal framework has just been reformed, with countries now facing the first test of its application. The idea of a golden rule, ie allowing investment to be financed without debt limits, remains excluded because it is difficult to reconcile with the EU deficit and debt limits. But also and more fundamentally, it is incompatible with the notion of debt sustainability, which is at the core of the reform and which the reform operationalises through the tool of debt sustainability analysis (DSA) ⁴ In the context of the reform, the DSA serves the purpose of verifying whether the adjustment path would result in a declining debt trajectory in the medium term, including under a range of fiscal stress scenarios. .

High-debt countries are required to put their public debts onto a declining path in the medium-term. Limited flexibility is allowed with regard to the adjustment timeline, which can be extended up to seven years in exchange for commitments on reforms and investment. But flexibility is not allowed in terms of the scope of the rules, which must ultimately encompass all the operations affecting the size of public debt. Note also that investment proper, the deferred returns from which over time provide the main justification for the golden-rule idea, represents less than 20 percent of military expenditure in the EU (Cepparulo and Pasimeni, 2024).

Second, even if a ‘golden rule’ in the standard meaning of the term is excluded and only a temporary and ultimately self-correcting allowance is permitted for military investment, the issue of what control the EU should exercise over the quality and composition of the investment in exchange for the exemption still has to be addressed.

This issue has arisen in the context of discussion about whether and how the fiscal framework should be changed to accommodate green public investment – for example if a “fiscally responsible green golden rule” could facilitate the green transition by “exempting well-specified Council-approved public investments” (Darvas et al, 2024) from the application of minimum adjustment requirements other than those derived from the DSA. The objective of fiscal sustainability would therefore be preserved, as the exemption could only apply to temporary increases in investment, and at the end of the investment programme the country should have reached a primary balance allowing for the repayment of the extra debt.

However, effective implementation of this proposal would still have to reckon with the reluctance of national governments to being steered by the EU in their expenditure choices. Governments are likely to be especially resistant to any perceived EU interference with decisions on national defence, which lie at the core of sovereignty and thus remain largely outside EU competences. Alternatively, governments may accept a pro forma steering, in the knowledge that there would be little effective scrutiny of their choices. This would however call into question the rationale for offering exemptions from the common rules in the first place.

Bending the rules

None of this is to say that the EU fiscal rules won’t bend under the pressure of military expenditure decisions justified by the worsening geopolitical situation. Poland could face a lenient application of the excessive deficit procedure – the disciplinary procedure aimed at getting its deficit below 3 percent of GDP as soon as possible – should it deviate from the fiscal adjustment path on grounds of increases in military expenditure (see the annex). The European Commission, which polices the fiscal rules, might even eventually put forward a creative interpretation of the rules along the lines of the above-mentioned fiscally-responsible green golden rule. Under a so-called investment clause introduced into the previous version of the fiscal rules without an explicit legal basis, temporary deviations from the adjustment path toward the medium-term budgetary objective were allowed under certain conditions, in order to finance selected investment programmes ⁵ The investment clause was proposed by the Commission in 2015 and subsequently codified in the so-called Stability and Growth Pact Code of Conduct (see ). To be activated, it required that a country’s forecast GDP growth be negative or the output gap below 1.5 percent. These restrictive conditions resulted in very little use being made of the clause, but it is interesting to note that the legal basis for the clause (the provisions of Art. 5 of Regulation 1466/97 (the so-called preventive arm of the SGP)) referred only to the possibility of a temporary deviation from the adjustment path for structural reforms, and did not contain any mention of investment. .

Taking into account other pressures bearing on the implementation of EU fiscal rules (Pench, 2024a), the new fiscal framework may also suffer a progressive erosion in practice, of which the ongoing military expenditure surge may become a major driver. Rather than resigning themselves to this prospect, EU governments and the Commission may wish to take a proactive approach consisting of two elements:

1. Explore the possibility of introducing by way of interpretation of the reformed fiscal rules a DSA-compatible responsible investment golden rule, to cover investment programmes linked to the green and defence transition. While implementation of this may be challenging – in particular identifying the investment eligible under the new rule – this approach may be preferable to flexibility effectively granted ex post, ie via non-enforcement of the normal rules, on a case-by-case basis.

2. For those areas of defence investment, for which the distinguishing economic features of public goods – externalities and scale effects – are particularly strong across borders (eg air defence against possible attacks from Russia) arrangements could be envisaged for the financing of common projects through recourse to EU debt outside fiscal rules (Steinbach and Wolff, 2024).

References

Cepparulo, A. and P. Pasimeni (2024) ‘Defence spending in the European Union’, European Economy Discussion Papers 199, Directorate-General for Economic and Financial Affairs, European Commission, available at 

Darvas, Z., L. Welslau and J. Zettelmeyer (2024) ‘The implications of the European Union’s new fiscal rules’, Policy Brief 10/2024, Bruegel, available at /policy-brief/implications-european-unions-new-fiscal-rules

Pench, L. (2024a) ‘Three risks that must be addressed for new European Union fiscal rules to succeed’, Policy Brief 08/2024, Bruegel, available at /policy-brief/three-risks-must-be-addressed-new-european-union-fiscal-rules-succeed

Pench, L. (2024b) ‘The new Stability and Growth Pact: Innovation and Continuity in the light of Next Generation EU’, in F. Fabbrini (ed) Research Handbook EU Economic Law, Edward Elgar

Steinbach, A. and G. Wolff (2024) ‘Debt Financing European air defence’, Analysis, 27 June, Bruegel, available at /analysis/debt-financing-european-air-defence

Annex: Poland’s deficit

Poland is subject to two concurrent surveillance procedures at EU level, corresponding to the two ‘arms’ of the recently reformed Stability and Growth Pact ⁶ The Stability and Growth Pact (SGP) is the ensemble of the legal provisions of two EU regulations, initially adopted in 1997, on the eve of the launch of Economic and Monetary Union, to substantiate and specify, respectively, the principle of multilateral surveillance of national economic policies and the obligation to avoid excessive government deficits established by the Treaty (Art. 121 and Art. 126): Council Regulation No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies, and Council Regulation No 1467/97 on speeding up and clarifying the implementation of the excessive deficit procedure. The two regulations are referred to as the ‘preventive’ and ‘corrective’ arms of the SGP. The SGP was reformed in 2005, 2011 and 2024, the latest reform being a comprehensive overhaul of the preventive arm and hence including the repeal of Regulation 1466/97 and its replacement by Regulation 2024/1263 on the effective coordination of economic policies and multilateral budgetary surveillance. The corrective arm, meanwhile, was amended and therefore continues to be referred to as Regulation 1467/97 as amended. For a detailed analysis of the legal provisions of the reformed SGP, see Pench (2024b). :

• The assessment and eventual endorsement of Poland’s national medium-term fiscal-structural plan (MTFSP) 2025-2029, under the so-called preventive arm, ie the fiscal rules applying to all member states, to ensure that debts in excess of 60 percent of GDP are put on a declining path and deficits stay below 3 percent of GDP over the medium term;

• The Excessive Deficit Procedure (EDP), under the so-called corrective arm, ie the fiscal rules applying to EU countries found in breach of the deficit or debt criteria, to put an end to the situation as soon as possible. 

The EDP was officially opened by the EU in July 2024, on grounds of the deficit criterion – because of the large excess of Poland’s government deficit relative to the 3 percent of GDP reference value ⁷ The 2024 SGP reform redefined the breach of the debt criterion in terms of deviation from the net expenditure path in the national medium-term fiscal-structural plan (MTFSP). As the first round of MTFSPs will be submitted and endorsed in autumn 2024, covering at least the subsequent four years, deviations can be established at the earliest only based on 2025 data (officially available in 2026), and therefore an EDP based on the debt criterion in principle cannot be opened before 2026. . Contrary to what the rules would normally require, the opening of the EDP was not accompanied by a recommendation for the correction of the deficit. This is expected to come when Poland’s MTFSP is endorsed, in November 2024 at the earliest.

Poland presented its MTFSP on 9 October. It plots a gradual reduction of the deficit below 3 percent of GDP by 2029. The corresponding figures for the structural adjustment also appear to be in line with the ‘reference trajectory’ provided by the European Commission for the growth of the new ‘net expenditure’ aggregate (government expenditure excluding interest payment, discretionary revenue measures, cyclical unemployment benefits and expenditure co-financed by the EU), introduced for monitoring compliance with the rules. It seems reasonable to expect that the EU will endorse both the deficit correction path and the medium-term spending plans put forward by Poland, even if bringing the deficit below 3 percent of GDP as late as 2029 may appear to clash with the spirit, if not the letter, of the EDP ⁸ Reflecting the frequent practice of EDPs extending over several years, the reformed corrective arm of the SGP no longer contains the prescription that the correction of the excessive deficit should be completed in the year following its identification, unless there are special circumstances. .

Although Poland, not being a member of the euro area, is not subject to financial sanctions for not complying with the adjustment recommendations under the EDP, the establishment of such non-compliance by the EU may still carry costs, including the possibility of a suspension of transfers under EU regional policies and the post-pandemic Recovery and Resilience Facility. Historically, however, the Commission and the Council have been reluctant to escalate EDPs, even when the balance of the evidence suggests that the country did not carry out the prescribed adjustment (France in 2015, for example). The Commission and Council have been even more reluctant to impose penalties in case of escalation of the procedure (eg Spain and Portugal in 2016) ⁹ The only case of suspension of transfers under the Cohesion Fund following an escalation of the EDP was Hungary in 2012. The suspension was lifted the same year after the Commission concluded that additional measures taken by Hungary amounted to the ‘effective action’ required under the EDP. Since the suspension concerned commitments, not payments, and was swiftly lifted there were no practical consequences for the flows of funds to Hungary. Note that the suspension was adopted under a conditionality framework (Regulation (EC) No 1084/2006)) that was less stringent than the one subsequently adopted and currently in force (Regulation (EC) No 1303(2013) and Regulation No 1060/2021), as the current rules on principle leave no alternative but to activate the suspension in case of escalation of the EDP. In spite of this, no suspension effectively took place when the EDP was escalated in the case of Spain and Portugal in 2016. .

These precedents suggest that Poland can expect a lenient attitude from the EU if it fails to carry out in full the adjustment recommendations, especially if military expenditure is the main or a contributory reason for it. In this connection, one should note that the reform of the SGP included “the increase in government investment in defence” among the “relevant factors” that the Commission and the Council should take into account before deciding on each step of the EDP ¹⁰ Articles 2(3) and 2(5) of Regulation 1467/1997 as amended, available at . .