Germany set for trillion-euro defense and infrastructure splurge

But economists and defense experts have warned that for Germany and Europe to reap the full benefits, the wall of money would need to be flanked with ambitious—and not necessarily popular—structural overhauls, including tax, bureaucracy and labor-market reforms.

Germany’s spending plan, equivalent to around $1.08 trillion, has drawn cheers across a continent unnerved by signs that the U.S. is downgrading its security commitment to Europe and seeking a rapprochement with President Vladimir Putin’s Russia, which is seen as the region’s biggest threat.

“Berlin is breaking the piggy bank, and it’s doing it even before the next government is in office," said François Heisbourg, a Paris-based expert on strategy and defense who has advised the French president. “Germany is giving itself the means to become a military force to match its economic and strategic weight. That’s a sea change."

Friedrich Merz, winner of last month’s German election and the man in line to become chancellor, has pledged to focus on European cooperation after the departing government became increasingly distracted by internal frictions between the coalition’s three parties.

The German spending plan he developed marks a U-turn for Berlin, which for years preached fiscal discipline to its European neighbors while letting its military atrophy for lack of investment. The package’s scale dwarfs a €158 billion defense fund floated by the European Commission this month to support military spending in the European Union and fund future help for Ukraine.

The German decision is especially credible, Heisbourg said, because it would directly benefit German arms manufacturers, including Rheinmetall, an armored-vehicle and ammunition manufacturer, and others that have proven their ability to deliver large orders quickly on behalf of Ukraine.

The spending package is made possible by a constitutional amendment that effectively exempts defense-related spending from the provisions of Germany’s strict fiscal rules, which ban budget deficits bigger than 0.35% of gross domestic product. This exemption will apply not just to spending on military hardware but also on cybersecurity, intelligence and civil protection.

Because Germany has relatively low public debt, the upshot is that it will from now on be able to spend as much on defense as investors are willing to lend it—at least and as long as overall spending doesn’t breach the EU’s more lenient spending rules.

“The priority now is to make sure that the money is being spent efficiently and not only to plug gaps in hardware," said Ben Schreer, executive director of the International Institute for Strategic Studies’ Europe office in Berlin. “Now we have the possibility to think about the capacities that we need to build—in software, in artificial intelligence, in communications, in space—if we’re going to become less dependent on the U.S."

The amendment also creates a €500 billion investment fund to be spent on the country’s long-neglected transport, communication, digital and power infrastructure as well as on measures to combat climate change, over the next 12 years.

The legislation was designed so that only new investment is eligible for funding—a provision meant to prevent existing investments from migrating from the ordinary budget into the fund.

After the amendment gathered the necessary two-thirds majority in both houses of parliament on Tuesday and Friday, the package’s implementation will depend on detailed legislation that will be drafted when the next government takes office.

This is likely to happen at the end of April as Merz’s conservatives and their prospective center-left coalition partners are still locked in negotiations over the government’s policy agenda for the next four years. While the two buried their differences to push the spending package through, they remain at odds on issues ranging from how much should be done to combat illegal immigration to the merits of cutting income and corporate tax.

The spending package has caused some consternation in conservative ranks after Merz campaigned against relaxing the country’s fiscal rules. But most economists agree that the combination of rapid rearmament and much-needed infrastructure investments could be a boon for an economy that has barely grown since before the Covid-19 pandemic and has been in recession for the past two years.

The plan could help Germany’s GDP grow by 0.3% this year and 2.1% by 2027 if it is implemented quickly, according to insurer Allianz. While Germany’s public debt was set to fall rapidly on the previous spending trajectory, it could now reach 68% of GDP by 2027, Allianz said—still low by European and U.S. standards and likely without a sizable impact on the country’s funding costs.

But the group’s economists also warned that unlocking and maintaining this level of growth over time without rekindling inflation would require Germany to implement a number of structural overhauls, including fixing its unsustainable pension system, increasing incentives to work and innovate, and cutting taxes, not all of which would be popular with voters.

Likewise, the economic fallout from the extra military spending would be biggest if Germany ensures most of the money is spent at home and in Europe and a substantial share of it goes to research and development, according to the Kiel Institute for the World Economy. This would increase the likelihood that military innovations find their way into the private sector, thus boosting growth further.

“The planned defense spending can give Germany a structural boost if it is spent correctly," said Moritz Schularick, the institute’s president.

Analysts said the next government would also need to fix slow, bureaucratic and inefficient procurement processes at the Defense Ministry to ensure that the extra money borrowed on capital markets can actually be absorbed by the military.

Write to Bertrand Benoit at bertrand.benoit@wsj.com