Facing a Moment of Crisis, Europe Rewrites Its Economic Playbook

During the first week of March, a major transformation in European economic policymaking took place within the short span of 48 hours. It started in Brussels, where European Commission President Ursula von der Leyen announced an €800 billion "ReArm Europe" plan that would include the suspension of the European Union's fiscal rules for additional defense spending of up to 1.5 percent of GDP by member states as well as €150 billion in loans to supplement national defense budgets.
The funding for the loans would be borrowed by the commission on capital markets and passed on to national governments, only the second time in the nearly 70-year history of the EU that collectivized debt, or Eurobonds, has been used to finance common objectives. The first time it happened, during the COVID-19 pandemic, was supposed to be a historic one-time exception rather than a precedent for future action.
On its own, ReArm Europe would have signaled a major shift in thinking about the role of economic tools in advancing the EU's global interests.
Yet a second striking contribution to this sea change in European fiscal policy came the following day in Berlin: Friedrich Merz - the leader of Germany's center-right Christian Democratic Union and likely future German chancellor after winning that country's elections in February - called for exempting all national defense spending above 1 percent of GDP from Berlin's constitutionally anchored "debt brake," which strictly limits government borrowing.
To accompany this surge in defense outlays, Merz also proposed a €500 billion special fund to finance infrastructure investments.
Both plans must still be approved by EU member states and Germany's parliament, respectively, with the latter looking likely to pass as soon as tomorrow. But if they are, they will usher in the emergence of a European defense industrial ecosystem and bring to an end a decade and a half of austerity and underinvestment in Germany in sectors ranging from high-speed internet and telecommunications to rail, road and energy networks.
To be fair, this new approach in both Berlin and Brussels does not come out of nowhere. Momentum for reform had been building, albeit slowly, for some months now. Most recently, two major EU reports by former Italian prime ministers released last year were already pointing to the need for increased political courage to break policy taboos that were holding back everything from finance for tech start-ups to more efficient defense spending.
The first from Enrico Letta called for further integrating the EU single market while the second from Mario Draghi, who also served as president of the European Central Bank, focused more broadly on EU competitiveness.
If there is one lesson that Europe already seems to be learning from this new economic nationalism coming out of Washington, it is that it can no longer afford to anchor its own economic strategy in the institutional status quo.
The backdrop to these calls was a combination of internal and external factors that were becoming hard to ignore.
While the first "China Shock" immediately after the Beijing's entry into the World Trade Organization in 2001 primarily affected manufacturing industries in the United States, there is growing concern about a second shock that is already hitting German industries like automobiles, machine tools and renewable energy, where Chinese companies are now strong competitors and in some cases - like electric vehicles, or EVs - industry leaders.
In response to Chinese-government subsidized overproduction of EVs, the EU has already imposed countervailing duties last year, and it has a number of new trade tools available to deter or respond to similar actions in the future.
Beyond competition from China, the move to break Europe's dependence on affordable supplies of oil and gas from Russia since its invasion of Ukraine in 2022 has raised costs for German industry, where energy-intensive sectors saw a decline in production of appr...