Defense spending can no longer be separated from financial and innovation policies. Countries that align public investment with private capital will be better positioned to develop technologies on which both security and prosperity depend. Those who do not will find that larger defense budgets alone are not enough to bring about economic prosperity or national security.
After years of underinvestment, Europe is finally starting to increase its defense spending. Few put the situation more bluntly than former NATO Secretary-General George Robertson, who warned that decades of “eroding complacency” had left the UK “at risk”.
Based on data from the European Defense Agency, European Union (EU) spending on defense-related research and development totaled just €13 billion in 2024 — about 0.07 percent of GDP — compared to $149 billion, or about 0.5 percent of GDP, in the United States. Closing this gap will require not only more public spending on research and development, but also a fundamentally different approach to capital mobilization. But money is not the main constraint. The immediate challenge is the conversion of expenditure into technological capacity.
Modern defense is not so much about troop numbers as it is about controlling advanced technologies, such as semiconductors, Artificial Intelligence, quantum computing and clean energy. Military capability now depends on how quickly these technologies can be developed and scaled. Countries that move fast will be both safer and more prosperous, while those that lag behind will be forced to rely on external providers at a time when geopolitical fragmentation makes dependence ever more costly.
The challenge becomes even more urgent as competition over strategically important technologies intensifies. The US combines deep capital markets with large-scale public support, while China directs state resources into rapid deployment. Europe, struggling to translate its research lead into industrial capacity, risks falling behind both.
The problem is not a lack of talent. Europe has no shortage of world-class universities or highly skilled workers, but there are very few innovative firms that manage to grow into large, globally competitive companies, and most of them are either acquired or developed abroad.
Europe’s weakness is financial and institutional. While the continent has abundant savings, it lacks sufficient risk-taking capital. This is no longer just a problem of growth; it is a matter of defense, since the ability to expand new technologies increasingly defines military capacity.
Europe’s pension systems are among the largest untapped sources of financing for the expansion of strategic industries. But while pension funds manage large amounts of long-term capital, particularly in defined contribution schemes that now dominate retirement savings, they allocate only a small share to innovative, high-growth firms (mainly outside Europe), favoring safer assets over riskier equity investments.
Administrators and asset managers often view equity investments as illiquid, uncertain and difficult to compare with each other. Performance is assessed over relatively short horizons, while liabilities span decades. This disparity creates strong incentives to favor liquid assets with low volatility, even when long-term returns would justify taking greater risk. The result is a structural bias that makes it harder for innovative firms to access the capital they need to expand.
While policymakers are increasingly identifying this problem, existing measures remain extremely limited. Initiatives, such as the UK’s Defense and Security Accelerator, demonstrated the viability of public-private joint investment, but did not significantly change institutional allocation decisions or build the confidence needed for wider participation.
A more effective approach would treat public spending as a catalyst rather than simply a source of funding. If governments were to secure private investment in strategic sectors, then they could create powerful incentives for the development of new technologies. Potential risks would be shared, while the selection of projects would remain in the hands of the private sector.
Such an approach would have two main effects. First, it would reduce the risk faced by institutional investors, making it easier for them to direct capital towards illiquid and uncertain assets. Second, it would accumulate additional investments, in which case each euro of public money would mobilize an equivalent amount of private capital. Thus, public spending would be used and not just distributed.
Over time, such arrangements can fundamentally change institutional behavior. As investors gain experience, develop expertise and build success stories in these asset classes, perceived risk would decrease. What starts as a joint venture can then evolve into a more sustainable ecosystem in which private capital plays a larger role, even without ongoing public support.
Ultimately, Europe’s strategic autonomy depends on whether it can mobilize capital on a large scale and direct it to domestic companies in critical sectors. Without this capacity, Europe will remain dependent on foreign providers. Today, this dependence means costly risks, ranging from supply disruptions to reduced impact on standards and production.
The bottom line is that greater exposure to high-growth assets does not necessarily conflict with savers’ interests. It can improve diversification and long-term returns, provided risks are well managed. The main obstacle is not a lack of will, but the way institutional incentives and portfolio rules are structured.
To achieve the necessary scale and predictability, co-investment mechanisms must be large enough to influence institutional portfolios and be integrated into sustainable, multi-year public commitments to research and development, such as those implemented by France and Finland. Without this consistency, investors are unlikely to develop the necessary expertise and commit capital over the long term.
Moreover, the shift towards non-necessary joint investments requires a marked increase in public borrowing. Europe already devotes significant resources to innovation policy, but not in ways that effectively mobilize additional private investment. Tax incentives such as the UK’s Patent Box, for example, are often costly, disproportionately benefit large incumbents and often reward activity that would have occurred anyway. Reorienting these resources towards joint investment and competitive funding for research and development would support innovative firms, especially late-stage startups, for which capital constraints are most pronounced.
The broader lesson is clear: defense spending can no longer be separated from financial and innovation policies. Countries that align public investment with private capital will be better positioned to develop technologies on which both security and prosperity depend. Those who do not will find that larger defense budgets alone are not enough to bring about economic prosperity or national security.
(Paolo Surico is a professor of economics at the London Business School. This review was written exclusively for the global journalism network “Project Syndicate”, of which “Koha Ditore” is also a part).
