The economic shock: a ‘Hamiltonian moment’ for the next EU budget?

This article is part of a series putting forward bold ideas for how the EU’s next Multiannual Financial Framework (MFF) could look. In this piece, Daniel Dăianu sets out the geopolitical and economic rationale for a more ambitious, resilient and strategically focused MFF by strengthening EU fiscal capacity to better hedge against global volatility and invest in economic resilience. It is part of a two-part contribution on building a more strategic, resilient and fiscally empowered EU budget to face today’s economic and security challenges. Find the first part here.

The across-the-board trade war and erratic measures adopted by the US Administration (huge rises in tariffs, followed by temporary freezes in some instances, or some de-escalation) amplify uncertainty and unpredictability in markets, and may lead to higher inflation, economic stagnation (stagflation), or even recession. Central banks could find themselves in the difficult position of raising interest rates again, while economies lose momentum.

Time will tell whether increased defence spending (a form of ‘military Keynesianism’) can offset the factors slowing down economies – given the uncertainty and the risk aversion in the private sector. Moreover, higher defence spending diverts resources away from addressing civil needs, which may exacerbate social and political tensions. Borrowing could be an option, but there are limits to this approach when public budgets are under enormous strain.

Germany’s decision to rescind its debt brake to allow for increased spending on defence and infrastructure may help the EU’s economic growth, but how significant its impact will be remains to be seen. The suspension of EU fiscal rules, be it temporary and only for the increase of defence expenditure, threatens to dilute their relevance again. This raises critical questions for the European Commission’s upcoming proposal for the 2028–2034 Multiannual Financial Framework (MFF), where balancing fiscal flexibility with long-term sustainability will be paramount.

Could the blow dealt by US measures to Europe lead to a greater EU cohesion in certain areas? It could, especially if Europeans advance along the path towards a joint fiscal capacity, if a ‘European defence community’ becomes a reality, and EU markets become more integrated. However, many uncertainties persist, and it is important to note that the EU is not a federal state – and it may never be. Coordination of national policies and common decision-making continues to represent huge challenges in the Union, which the upcoming budget cycle will need to address carefully.

Simply adding up the EU states’ GDPs and their military capacities (tanks, aircraft, military personnel, etc.) is a simplistic exercise that cannot project a joint deterrent force against potential aggression. More is needed, particularly combined capabilities, joint actions and deeper integration for this purpose.

The euro could gain more weight in international transactions (where it currently holds around 20% – according to ECB data), if the eurozone becomes more cohesive and a common fiscal capacity is set up. Economic growth in the EU could be stimulated if the increased defence spending would generate significant multiplier effects, a prospect that should be reflected in the strategic priorities of the forthcoming EU budget proposal.

A new wave of financial deregulation, combined with the lack of proper AI regulation, could cause serious turmoil in financial markets. There is pressure for deregulation in financial markets in Europe as well and a push toward using stablecoins as private money, against the backdrop of economic difficulties. However, lessons from the 2008 financial crisis are too easily forgotten.

A trade war could trigger a currency war, with dire implications for financial market functioning and investment dynamics. A similar episode caused an earthquake in the international financial system in 1971, when the Nixon Administration announced the abandonment of the dollar’s linkage to gold, thus delivering a fatal blow to the Bretton Woods system. After the breakdown of the Bretton Woods System, the world shifted to floating exchange rates and capital movements surged very rapidly.

The general sentiment within the Trump Administration is that its economic policy must reshore critical industries (e.g., microprocessors) back to the US, otherwise the American industrial and technological power will be endangered in a confrontation with China. It is worth mentioning that, decades ago, Clyde Prestowitz advocated for strategic protectionism, considering the economic rise of Japan. However, today’s situation involves China, which has economic, technological, and demographic assets that make it a much stronger competitor for the U.S. than Japan was many years ago.

Some analysts try to describe the competition between the US and China in terms of ‘geoeconomics’, by referring to Albert Hirschman’s 1945 book, “National Power and the Structure of Foreign Trade”^[1], in which protectionism, autarky, and phenomena characteristic of wartime periods are explored. However, such analyses should take into account that today’s world is far more interconnected economically and technologically, even though fragmentation and regionalisation have intensified in the last decade, partly as a result of deep crises and security concerns.

The trade war can lead to major disruptions at the international level, economic contraction, and inflationary surges, which might have a boomerang effect worldwide. One of the unintended consequences might be a stronger euro in international relations, especially if the eurozone develops better functioning mechanisms and tools.

In this new economic and geopolitical context, the EU will be forced to mobilise its internal resources. All this would be part of an updated industrial policy that the Union has been considering for years in order to survive in the global economic and technological competition. Nevertheless, military security concerns play a much more significant role nowadays. The next MFF proposal provides a critical moment to align budgetary priorities with these evolving realities, enabling the EU to strengthen its strategic autonomy and economic resilience. A larger EU budget is arguably needed.

The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.