Merz defense push hasn’t revived German manufacturing

When Chancellor Friedrich Merz announced a dramatic increase in defense spending a year ago, many observers hoped that this would stimulate Germany’s stagnant industrial production. National champions such as Rheinmetall — a major producer of artillery shells as well as tanks and air-defense systems — had already expanded production massively this decade, supplying both NATO partners and Ukraine in the wake of the Russian invasion.

So far, Merz’s spending has had little wider effect. Unlike the beleaguered automotive sector, armament firms have limited supply-chain linkages to the broader German manufacturing base.

As our first chart shows, the arms component of the German industrial production index (IPI) has outpaced its EU equivalent. But overall German IPI continues to underperform the European average — despite Germany’s firmly entrenched status as a net exporter of weaponry (as our second chart shows).

The Ukraine war looms large in our subsequent charts, which delve into the international arms trade of the 2020s and the German budget. As Russia’s invasion fundamentally reshaped European security perceptions and Ukraine’s allies sent weaponry east, Germany replenished its stocks via imports in 2022-23 — led by US ammunition and missiles, as UN Comtrade figures show.

US supplies are popular with allies due to speed of production and interoperability. Italy also figures strongly as Germany’s no. 2 supplier, demonstrating the nation’s role in niche capabilities such as helicopters and integrated European production benefiting firms such as Leonardo SpA, a Rheinmetall partner.

Even before Merz’s defense plan (enabled by keeping this category exempt from the national “debt brake” rule that otherwise restricts German spending), budget figures reflect the post-2022 security reassessment.

Germany increased its military spending as a share of GDP to 1.9% in 2024 from about 1.5% a year earlier. Finance ministry projections show a continued increase through this year.

The outsized growth in the “capital transfers” segment, which includes military grants, is notable. By contrast, the “gross capital formation” segment, which would reflect the production of more military equipment or the construction of new bases, has grown much more slowly.

With global geopolitical tensions rising and President Trump demanding NATO partners take on a role in the confict with Iran, policymakers will still be hoping that the defense demand boom spills over to more German factories.

But our last chart demonstrates the nation’s lingering industrial challenge. Energy costs have remained high this decade, even before the Persian Gulf crisis sent oil prices soaring in March.