Ripple effect of Russia's invasion of Ukraine: How European countries forced to increase defense sector

INVASION OF UKRAINE: IMPLICATIONS FOR EUROPEAN DEFENSE SPENDING

 INTRODUCTION

 When it was time to wake up by Ukrainian to begin afresh new day, they were shocked by in discriminatory shelling and bombing, and to know that Russia invaded Ukraine meant complete direct war on the unlucky horror day of 24.02.2022. This war has been continuing and to date directly already destroyed Ukrainian human lives and livelihoods. The pictures of the destruction of properties, the mayhem of innocent irrespective of age, gender, race, etc., and inhuman cruelty. Millions of people were dislocated and took shelter as a refugee in nearby countries. Indirectly affecting the entire world intensity may be differed, but the most intensity in Russia too. This has disrupted the global supply chain, abrupt disruption of global trade, sanctions, and counter-sanctions – all termed as geo-political turmoil.  The global economy has been facing high volatility in pricing and uncertainties. Global experts have even predicted a sign of deglobalization. Their forecast of higher inflation, failure of any country's economy, and allocation of national expenditures on various sectors.  

 EUROPEAN NATIONS CONSTRAINED TO INCREASE THE DEFENSE SECTOR

 The above belligerent has compelled European nations to enhance defense spending. But, how do they capitalize on the impact and achieve optimal security benefits? They have to undertake a significant reappraisal of defense and security in Europe and a review of long-standing assumptions that large-scale hospitality on the continent was indeterminate in the 21st century. Following humanitarian, economic, and military aid responses, multiple NATO and European countries declared a strategy to increase their defense budgets. Still, the possibility of reappraisal of decisions is to be made about the actual scale of the increase, and the areas that will get the most funding. The 27-member European Union (EU) has implemented a wide range of policy responses to Russia’s war against Ukraine, launched in 2022. EU actions and coordination with the US are of interest to Congress given the EU’s role as an important. Providing aid to industry stakeholders, including governments and companies supplying emergent and essential products and services, we created a model to estimate how European defense budgets might evolve through 2026 and identified areas that might receive an influx of funds during this period. This model of potential spending scenarios could prove useful as European nations consider new strategies to ensure security while making difficult choices on budgeting priorities.

 EUROPEAN COUNTRIES OR EU RESPONSES, AND SANCTIONS

 The EU has imposed many times progressively punitive sanctions—or restrictive measures— envisioned to cripple Russia’s ability to finance the war against Ukraine, enact costs on Russia’s elites, and diminish Russia’s economic base. Imposing sanctions requires unanimity among EU members. As of December 2022, EU sanctions on Russia’s government and financial, business, defense, technology, and media sectors included the following:

  Freezing the assets of 171 entities (including key banks) and 1,386 individuals (primarily Russian officials and elites), to whom travel bans also apply.

Imposing debt and equity restrictions on certain banks and companies.

Restricting transactions with Russia’s central bank and blocking access to its reserve holdings.

Banning transactions with certain Russian state-owned military-industrial enterprises.

Disconnecting 10 leading Russian financial institutions—including Sberbank, Russia’s largest bank—from SWIFT (the world’s dominant international financial messaging system).

Broadening export controls on dual-use goods and technologies.

Banning certain exports in the aviation, maritime, and technology sectors (e.g., semiconductors) and the export of drone engines and luxury goods to Russia. Congressional Research Service Congressional Research Service prohibits imports of steel and other raw materials, spirits, seafood, and gold (including jewelry) from Russia.  Closing EU airspace, seaports, and roads to Russian aircraft, ships, and freight operators, respectively. Suspending the broadcasting activities of nine Russian state-owned media outlets. EU energy dependence on Russia has made targeting its energy sector challenging, but the EU has approved progressively tougher sanctions in this area, including Prohibiting most imports of Russian crude oil and petroleum products, with an exemption for crude oil delivered by pipeline. The EU expects these sanctions, which began taking effect in December 2022, to apply to around 90% of Russian oil imports.  Banning oil transport services. An exemption finalized in December 2022 allows EU companies to provide such services for Russian oil sold to non-EU countries at or below an agreed Group of Seven (G7) price cap of $60 a barrel (aimed at reducing Russia’s oil revenues while keeping global energy markets stable). Banning EU exports of oil refining technologies. Prohibiting Russian coal imports. Although the EU has not prohibited Russian natural gas imports, Russia has reduced gas flows to Europe and the EU is working to end its reliance on Russian energy. The EU may consider additional sanctions on Russia and using frozen Russian assets to support Ukraine.

  Russia’s War Against Ukraine:  Military Assistance through its European Peace Facility (EPF), the EU has committed €3.1 billion to date in military assistance financing for Ukraine, including for lethal equipment (€2.8 billion) and nonlethal supplies (€180 million). The EPF also is providing over €100 million for an EU training mission for Ukraine’s armed forces. Member states may be reimbursed from the EPF for assistance provided since the start of 2022. EU members’ bilateral military assistance to Ukraine totals an estimated €8.6 billion (as of November 2022). Financial and Other Aid In 2022, the EU, its member states, and European financial institutions collectively mobilized €19.7 billion in financial, humanitarian, and emergency assistance for Ukraine (with €9.2 billion from the EU budget, €3.2 billion from European financial institutions, and €7.3 billion in member state contributions). The EU has approved €18 billion in financial assistance for 2023 (in the form of favorable loans). The EU also coordinates the delivery of in-kind emergency supplies to Ukraine. A temporary protection mechanism provides Ukrainian nationals who have fled with immediate residency rights and access to benefits throughout the EU.  Addressing Energy Dependence Russia’s war in Ukraine has heightened long-standing concerns about EU dependence on Russian energy imports, in particular natural gas. Russia substantially reduced gas pipeline deliveries to the EU in 2022. By the end of 2022, pipeline gas from Russia accounted for roughly 9% of EU gas imports   40% in early 2022), although EU imports of Russian LNG  increased somewhat during the same period. The EU has pledged to phase out Russian fossil fuel imports before 2030.

 A new perspective and viewpoint on European defense expenditure

The scheduled increase in European defense spending does not characterize a setback in long-term trends. Defense funding has been mounting in recent years in many European countries, partially due to   NATO sounds for enhanced spending and NATO members’ resolve in his respect, subsequent in a compound annual growth rate of 6% between 2015 and 2021.  In spite of this growth, several countries did not trail NATO’s standard that each nation should expend 2% of its GDP on defense—a mark set in 2006.

From the date of the above invasion, many European nations have committed to attaining or surpassing the NATO aim in certain cases, years before they initially decided to do so. For example, Germany declared in February 2022 about spending an extra €100 billion on defense. This is a radical turn, in view of the country’s military spending, as a percentage of GDP, averaged 1.3% between 2008 and 2021. Other European NATO countries have also made similar plans. Poland, for instance, set a defense budget of 2.4% of its GDP for 2022 and proposes to raise it to 3% in 2023. The country may possibly add additional funding, which could bring the 2023 defense budget to above 4% of GDP. Some countries outside the NATO fold have also reevaluated their security postures and relationship with the alliance. Austria is considering establishing a near-term, fixed GDP spending target for the defense that would be higher than previous levels. This might involve a noteworthy funding raise, as the country has had one of the lowest European defense budgets in terms of GDP percentage since the Cold War ended. Similarly, Sweden now plans to expense 2% of its GDP on defense. It has also applied for NATO membership, as Finland. These are sea change moments for Europe and for the alliance.

Large expenditure and bold initiatives and hard resolutions

Comprehending the actual scale of extra defense spending, and the areas to which it will be allocated is significant for multiple stakeholders. For European nations, a common perception of country-specific funding resolves can help them optimize resources and ability of funds’  in the shared pursuit of more security. In the defense industry, this information can help companies focus on critical needs, efficiently allocate resources, and increase capacity to meet demand.

McKinsey recently analyzed current and projected European defense spending from 2021 through 2026. First, we modeled the spending trajectory that likely would have occurred if Russia had not invaded Ukraine. With a model based on publicly available data, we then modeled two spending scenarios that show how the war and other considerations might prompt nations to increase spending over this baseline. One scenario shows the highest potential increase, while the second shows the lowest. It is outlined in the case of in spite of Russia had not sensitive security concerns by invading Ukraine, European defense spending would have risen from €296 billion in 2021 to €337 billion in 2026—a raise of 14%. In the mild scenario, which factors in the invasion’s effect on defense funding, expending raises by 53% over the same duration to touch €453 billion. In the acute scenario, which accepts a bold defense funding response, spending increases 65% from 2021 to 2026, reaching €488 billion. Rising funding pledges are envisioned to share advanced security. This will mean securing allocation to the right areas based on governments discreetly deciding their investment priorities. However, considering the potential volatility in accessible funds and purchasing power, connected with ever-increasing demands, proposed funding increases may not materialize.

Any spending increases are estimated to happen gradually rather than instantly. If inflation keeps rising, it could immensely prune or even negate the impact of any planned spending increases. For example, as estimated in March 2022 that the US Department of Defense could lose some $480 billion in purchasing power over five years if the economy goes back into a period of high inflation and low nominal top-line increases in the defense budget. For Europe, the cumulative loss of buying power could be close to €300 billion in such a scenario where inflation averages 5% from 2022 to 2026; in a more conservative scenario, with inflation averaging 3 % over this period, the collective loss of buying power would be about €185 billion. Hard resolves might be required, as further funds may be needed in several categories. To fix which areas stakeholders may decide to flag as priorities, we examined a few historic spending trends. As part of the “peace dividend” at the end of the Cold War, military equipment inventory was reduced massively, especially in the areas of major capital platforms: main battle tanks (MBTs), combat aircraft, large-surface warships, and submarines. For example, the number of submarines went from 107 in 1992 to 57 in 2022 as per an analysis of particular European countries.

In some categories, such as ammunition or armored vehicles, inventory supplies have been sent to support the Ukrainian armed forces, decreasing their count among other European nations. Although procuring new equipment will be a prime part of defense ministry spending plans, defense leaders may also have another major concern: the accessibility of current equipment. In Italy, France, and Germany, for example, less than 50% of old equipment is accessible in some major types, such as helicopters, because of the need for maintenance and repairs. In some cases, accessibility is even below 40%. Although some equipment categories have higher availability rates, overall readiness is a persistent risk and could profit from more attention as spending rises. Beyond improving the upkeep of the current fleet, nations might also attain new platforms to increase keenness.

 Achieving great investment

European nations have stated goals to offer security as a normal good and prevent their citizens. To reach this goal and spend their increased defense funding effectively, they might benefit from focusing on the following moves:

Increasing scale. Europe now has become “oil in the machine” in the context of greater funding, but this is not enough to secure the continent’s defense policy goals. To drive down costs and help their funding go further, nations might want to secure higher alignment and collaboration to widen the scale. If they consider making joint orders for equipment, not individually ordering an assembly of diverse designs, the greatness of the purchase might be enough to enjoy real economies of scale. It could also drive efficiencies in maintenance and sustainment for operating equipment, which normally has a long-life cycle. As Europe operates above 5 times as many weapons systems as the US across certain types, this would also help to reduce division and advance interoperability (a characteristic of a product or system to work with other products or systems).  

Combating inflation. Defense agencies are even now grappling with the impact of inflation as materials and other goods rising price. As such, defense agencies would benefit by factoring inflation into their counting, if they are not already doing so, to control if their funding will have the desired impact.

Fast-tracking modernization.  Several nations may view replenishing and recapitalizing their fleets, and some have already announced equipment orders to complete this. This trend, combined with current inflation levels, may make a situation in which limited funding is obtainable to invest in future technologies. If nations decide to focus on innovation, they might inspire strong collaboration between the defense and commercial sectors. And if their fund in R&D is relatively undeveloped, they might later appear as leaders in those industries. Despite inflation and the recent attention on restocking and recapitalizing fleets, an intense focus on innovation may now be more viable because of the higher defense funding. These strategies may help European nations achieve their defense goals, even if inflation cuts into their buying power. They could also allow Europe to reinforce a defense industry that supplies many leading products and services.

 Integrated profit management during inflation: Lessons for aerospace and defense

As nations drive scale and pursue innovation, choice and focus will be critical. Based on publicly acknowledged capability gaps and opportunities, there are four areas of focus emerging from which European nations may benefit from strategic investment:

• Defense capacity and stockpiles: stocking ammunition to levels in line with NATO guidelines; upgrading or maintaining existing platforms and armor; firming prevented mobility, airlift, and naval platforms; and increasing electronic warfare competencies.
• Enhanced capacities: new/enhanced air and missile defense and artillery; 5th and 6th generation combat aircraft; and unmanned systems
• New defense technologies: consolidating digital command, control, and communications; backup multidomain (Multi-domain MDM manages all different types of master data in one place, bringing the multiple data domains) integration of systems (digitally enhanced and cyber protected); supporting cybersecurity and state-of-the-art intelligence/surveillance/reconnaissance (ISR) assets
• People: retaining and recruiting highly trained military talent, including additional staff with technical expertise, to encounter new risks, such as those in the digital domain; securing enough trained and talented employees to run the additional influx of equipment and capability.
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EXAMPLE OF ONE OF THE BEST COLLABORATIONS ACROSS EUROPE

Even after several European nations may need to ground new equipment rapidly, its possibility succeeds only if industry and defense-obtaining ministries or agencies can fulfill demand. Supply chain disruptions, which have been aggravated by the COVID-19 pandemic and the invasion of Ukraine, are a major issue and could likely slow production, and upkeep. Many businesses have run into hitches in speedily sourcing some materials and electronic parts, including titanium and semiconductors, which are also desired for defense procurement.

Some defense companies may need to discover how to increase capacity by opening new production lines, accelerating new development programs, and enhancing shop-floor productivity. These steps may not be easy, however, due to several factors:

• Defense demand had been falling over the past decades, and companies have scaled down their production capabilities in response.
• Workforce scarcities have increased post-COVID-19, and new working preferences may hinder work on the production line.
• The defense industry is facing additional challenges in attracting, training, and retaining skilled workers in light of demographic factors, such as an aging workforce population at many businesses within the sector.
• Some companies may be scarce the hangar, depot, or yard space required to increase the production of platforms and spare parts.

To remove obstacles related to procuring new equipment or increasing availability through enhanced maintenance, multinational efforts could be critical. By considering co-created and co-owned solutions, European countries could maximize financial proficiencies. There are already precedents for defense collaboration launched within the past five years in Europe, including the EU’s Permanent Structured Cooperation Framework and the European Defense Fund, among others. Beyond EU initiatives, there are positive examples of international collaboration. For instance, the US/European Strategic Airlift Capability has enabled the pooling and sharing of expensive defense assets and helped European countries, including nations with smaller defense capabilities, develop their security. Within NATO, members have volunteered national aid to shared alliance assets, such as those related to ballistic-missile defense, to further NATO’s integrated air and missile defense capabilities.

Collaboration might engage in making bulk joint purchases of defense equipment in the short term or working together on new designs in the medium to longer term. Additionally, to pruning costs, such projects might assist nations to avoid duplicative development efforts and decrease the fragmentation that happens when countries have multiple through-life support infrastructures that lack interoperability. Collaboration may also help relieve some pressure on the industry to produce duplicative assets and allow countries to divide and conquer on capabilities they target for investment, creating the possibility for accelerated time to field. Some examples of successful cross-Europe collaborations already exist, such as those related to the A400M transport plane or the Eurofighter combat aircraft. Other transatlantic or foreign efforts have also shown the benefits of collaborating on new capabilities, including those related to the F-35 Joint Strike Fighter and K9 self-propelled howitzers. Collaboration also enables interoperability to be baked into the needs requirements, as multinational efforts require systems to be interoperable across nations and services. The benefits, in terms of less fragmentation, could be significant. Collaborations may also enable shared sustainment capabilities across the continent, as the F-35 or the Leopard 2 MBT sustainment cooperation already do, and the Future Combat Air System, Future Air Defense System, and Future Cruise/Anti-Ship Weapon multinational abilities may actually do.

To empower more effective collaborations, countries may benefit from improving their acquisition and maintenance processes, as well as from revisiting their risk and approval methodologies. Prior and ongoing bilateral and multinational acquisition programs have been stymied by delays, cost overruns, and challenges, as multiple countries, ministries/services, and industry counterparts must set and harmonize requirements and give approvals. Streamlining and maximizing acquisition processes may require a strong commitment from decision-makers, but it will help nations deliver programs in a time frame that supports deterrence. The expanded use of digital solutions can also help accelerate timelines within collaborations. The Russian invasion of Ukraine has led NATO and other European nations to readjust their plans to keep n defense and security in Europe. Although the pan-European increase in defense spending can enable long-needed boosts in capabilities, these potential gains could be stalled by ongoing inflationary pressures, challenges in coordinating European capabilities, and interoperability issues. Through existing frameworks and initiatives, European nations may decide to coordinate defense procurement more tactically to increase their strategic autonomy. While the war in Ukraine has created humanitarian challenges and economic headwinds that will remain for years to come, Europe’s defense spending could enable the continent to reinforce its defense capabilities and industrial competitiveness. More important, it could help support peace through dissuasion and readiness.

CONCLUSION

When war hits, some degree of analytical humility is required. No one knows how – or when – Russia’s war on Ukraine will end and the effects on European security over the medium to longer-term (i.e., the next five to ten years) are unknown. Naturally, close to these countries and business transactions, they could not avoid the ripple effects of war Despite the analytical fog that shrouds Russia’s war, discussions increasingly focus on how European countries should support Ukraine, how Europe and the US should view and engage with Russia during and after the conflict and to what extent Europe should bolster its own defenses. Such questions have already found material form. Think of the wide-scale provision of weapons and lethal equipment to Ukraine, the enhanced military presence on the EU’s and NATO’s eastern flank, the announcements of increased defense spending in Europe, the sanctions designed to disable the Kremlin’s war machine, or the calls for Ukraine to be speedily brought into the EU. Finland and Sweden have also formally announced their intention to join NATO in response to Russia’s actions. So far, Europeans have shown a high degree of unity in the face of Russia’s war – forces have been deployed to the eastern flank and, despite the difficulties of agreeing to an oil and gas embargo on Russia, political unity has ensured that heavy sanctions are in place. However, this unity is likely to be challenged over the coming months and years by a fundamental question that has so far not received sustained and serious attention. Some elites may desire a détente with Putin, especially with economic interests at stake. Others, however, reject any notion of a diplomatic settlement with Russia and instead call for preparations for a long-term political stand-off with the Kremlin. How Europe politically adapts itself to the Russian threat in the coming months and years will be a test of its credibility, unity, and autonomy. Indeed, Russia’s war on Ukraine is already giving rise to questions that will have long-term implications for European security, including: to what extent should European countries increase their defense expenditure?  European countries presently face those that may appear on the horizon. To this end, the paper explores how defense expenditure in Europe may evolve after Russia’s invasion and how defense investments may be shaped in the coming years. More specifically, we look at the interplay between geostrategic and investment choices.