- European defense one year on: bold commitments, but is delivery keeping pace? One year into Europe's landmark rearmament announcements: defense spending has increased, financial commitments have expanded (e.g. SAFE loans, +60% commitments in 2028-2034 EU draft budget) and order books have reached record highs. But industrial investment and delivery have yet to catch up. Defense spending growth has been cut in half (9% vs. above 20% in 2024/2025), and is set to reach 2.6% of GDP by 2030 (3.1% of GDP by 2035), falling short of the EU 2030 target of 3% and the 2035 NATO target of 3.5% of GDP. This means a funding gap of EUR255bn and EUR575bn, respectively.
- In equity markets, defense companies are facing a painful reality check but the hype is not over yet. European defense has lost its magic (+5% YTD but -8% maximum drawdown) after three consecutive years of strong performance (35-60%), a clear reality check from investors as countries take diverging paths: Baltic and Nordic countries, as well as Germany and Poland are leading the effort while Italy and Spain are not using the available fiscal tools to boost spending. Capital has been mostly channeled into equipment, rather than long-term infrastructure projects (0.11% of GDP against NATO recommendations of 1.5% of GDP). In term of innovation, defense is lagging the AI and robotics conversion but rising interest from the private investment market (above EUR10bn vs. EUR2.6bn in 2025) suggests that the innovation cycle still has strong funding leeway.
- Money is not the constraint, conversion is. Governments have poured commitments into a sector where newcomers cannot quickly acquire what incumbents built over decades, so excess demand turns into production bottlenecks and postponed projects rather than output. Backlogs stand at more than five times revenue while the capex ratio has stalled near 5%. Diverging national interests, no supranational steer and the absence of conditionality mandatory clauses in public financial support give the industry little reason to invest at a time when higher interest rates and material costs from the Iran conflict have cut margins (from 10% to 8%). The shortage of skilled labor adds to the pressure as firms compete for engineers with civilian sectors that pay more, and cannot quickly transition their workforce into new complex programs. The shortage is sharpest where Europe started late: drones, space and cybersecurity segments account for 26%, 16% and 13% of open defense vacancies.
- The ongoing depletion of US interceptor stocks is another warning for Europe: external dependence is both a security risk and a capital-efficiency problem. To fill urgent gaps, Europe buys from abroad, and the import ratio has risen from 20% in 2021 to 45% in 2025. The US’s share in European imports has fallen from 71% to 48% but it still supplies almost half, and aircraft and missiles make up 82% of US purchases, with few alternatives for air defense and long-range missiles. We estimate it could take up to five years to rebuild some US stocks; until then, US domestic demand will come first, and Europe will wait in the queue behind it. Dependence is also expensive: Missile import prices are up 116% on the 2019-2021 average, so each euro buys less capacity than budgets assume.
- The way forward: Two horizons but one single industrial roadmap. In the short term, Europe needs to close the gaps in long-range missiles, air defense and cyber, and redirect idle automotive capacity to defense. Furthermore, it needs to back this with grants for infrastructure (a 0.5-1% of GDP corridor, or EUR760bn to EUR1.4trn cumulative to 2035) and fiscal flexibility conditional on results. In the long term, Europe needs to build supranational reserves and invest in drones, space, AI, robotics and quantum. These would spread benefits across the economy and protect the export model. Success should be judged on new capacity, spillovers, modernization and reliance rate, not on the share of GDP alone.