Germany's Emerging War Economy

Germany’s Emerging War Economy

Dalia Marin,

MUNICH – On February 27, three days after Russia invaded Ukraine, German Chancellor Olaf Scholz stood before a special session of the Bundestag and declared the invasion a “turning point” (Zeitenwende) in German history.

In his speech, Scholz also pledged to increase defense spending by €100 billion ($98.5 billion), reversing Germany’s decades-long aversion to rearmament.

Scholz further clarified the meaning of “turning point” in an hour-long speech at Charles University in Prague in August.

There, he outlined his vision for the “militarization” of Europe under German leadership and called for a stronger, more “sovereign” European Union that is more effective at defending itself and competing against the influence of foreign powers.

For decades, Germany spent little on its military. Much to the chagrin of the United States and other NATO partners, it preferred to rely on the US for protection.

But in the wake of Russia’s aggression, it is clear that Germany cannot continue to fall short of NATO’s 2%-of-GDP target for military spending. Policymakers must commit to bolstering the country’s armed forces.

But what would Germany’s newfound commitment to national defense spending mean in practice? If it is to assume a leading role in Europe’s remilitarization, it would need to transform its economy to meet the challenges of a geopolitical era in which war is an ever-present threat. The German government can take several steps to adapt to this new reality.

For starters, Germany and Europe must establish an EU-level military research and development agency modeled on the US Defense Advanced Research Projects Agency (DARPA), which boasts a decades-long track record of promoting high-tech innovations.

Germany should take the lead in creating the European DARPA, which would be essential to keeping pace with technological competition from the US and China.

Germany has already taken small steps in this direction in the past three years. In 2019, the government created a new agency tasked with funding breakthrough innovation.

But the new agency is too small and, unlike DARPA, is not linked to the military. Its ability to make groundbreaking discoveries is thus more limited than an EU-level agency, which would have access to a far larger pool of innovators.

Establishing a military research institution is a necessity during wartime. In countries like the US and Israel, the defense sector is a major driver of innovation, and it is military-funded research in both countries that has brought us technological innovations like GPS, Siri, and the touchscreen.

But war requires a different kind of innovation, and Europe needs to be able to develop its own sophisticated military equipment.

Germany must also take the lead in securing the supply of critical inputs like semiconductors and green batteries, both of which are vital to European security.

The market, left to its own devices, will not make global supply chains more resilient, so the US and European governments must diversify away from Asia by ensuring that alternative suppliers are available on both continents.

That way, if supplies from the Taiwan Semiconductor Manufacturing Company are disrupted, the production of cars or machinery around the world would not grind to a halt, as it did during the COVID-19 pandemic.

In a time of war, however, merely strengthening global supply chains is not enough. For example, if China invaded Taiwan tomorrow, how would Germany and Europe meet the demand for batteries and chips? China currently produces 80% of the world’s batteries and controls the processing of key minerals and metals – including 80% of rare-earth elements and nearly 60% of lithium and cobalt – while Taiwan (along with South Korea) dominates the production of semiconductors.

To protect itself against future supply-chain shocks, Europe must align the chains with the goal of greater strategic autonomy.

Moreover, achieving strategic autonomy would help Europe avoid the trap Russia walked into when it invaded Ukraine.

For years, Russia neglected to build up its military’s technological and economic foundations and instead relied heavily on imports from Germany’s Rheinmetall.

The multilateral sanctions imposed on Russia in the past seven months have rapidly depleted its arsenal and left it unable to rebuild its capabilities.

Russia’s technological weakness should serve as a warning to Germany and the rest of Europe. In a wartime economy, European governments need to increase publicly-funded military research and development, encourage public-private partnerships and startups in the defense area, and secure the uninterrupted supply of raw materials.

The proposed EU Chips Act – which sets an ambitious goal of producing 20% of the world’s chips in Europe by 2030 – and the European Battery Alliance are both steps in the right direction. But much more needs to be done to meet the challenges of these dark times.

Dalia Marin, Professor of International Economics at the School of Management of the Technical University of Munich, is a research fellow at the Centre for Economic Policy Research and non-resident fellow at Bruegel.

Copyright: Project Syndicate, 2022.