Sunday, March 16, 2025

The Forecast: Defense could boost Europe’s productivity

Plus, the Fed and TikTok.
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Welcome back to The Forecast, where we help you think about the future — from next week to next decade.

This week we're looking at how European defense spending could boost its private sector, as well as how Jerome Powell will address the market selloff when the Fed meets next week. Plus, a check in on TikTok.

Will Defense Spending Boost Europe's Productivity?

In 1937, the US produced just 3,100 airplanes, mostly for private use. Over the course of World War II, it would be forced to produce 325,000, with a peak of 96,000 made in 1944 alone. In the face of unprecedented demand, sharp resource constraints and the urgency of war, US aircraft manufacturers had to invent and adopt new processes and become much more productive. Ethan Ilzetski, an economist at the London School of Economics, called it "learning by necessity."

As Europe commits to spend more on defense, Ilzetski thinks the same dynamic could be in play, albeit at a much smaller scale. And he thinks the productivity gains from defense spending could translate into higher European productivity overall.

"A transient 1% of GDP increase in military spending could increase long-run productivity by a quarter of [a] percent," he writes in a recent literature review titled "Guns and Growth." His logic is two-fold: Defense research can spark technological progress with civilian applications. And increasing the scale of defense spending means more "learning by doing" — like with US aircraft — which will improve production methods, again with spillovers to the rest of the economy.

That's good news for Europe, which has pledged hundreds of billions of euros in new defense spending over the several years. But several facets of Europe's defense procurement would have to change to secure these productivity benefits, starting with buying less from the US. 

"Right now, the main impediment to defense spending buoying the economy is the fact that about 80% of military hardware comes from outside the EU, and much of that from the US," write Martin Ademmer, Jamie Rush and Antonio Barroso of Bloomberg Economics (Terminal subscribers only). European defense stocks have surged in recent weeks, suggesting markets think Europe will increase its domestic procurement — though it may take a while.

Europe also needs to direct more procurement towards smaller companies, says Ilzetski. And it needs to find a way to centralize its efforts; it makes no sense for every EU country to have its own domestic procurement strategy, he says. 

Ilzetski suggests the EU could strike a balance between centralized, efficient procurement and spreading the benefits of spending around member countries. The US employs "dual sourcing," a policy of buying the same product from two separate companies. He suggests the EU employ a version of this, procuring products from at least two of its member countries. Ilzetski also thinks Germany needs to rethink its restrictions on universities' participation in military research.

The benefits of defense spending also depend on what it replaces. Some climate advocates worry Europe's defense buildup will come at the expense of investment in clean energy. And there is some research suggesting that World War II ultimately hurt US productivity — because the military buildup meant fewer resources spent on roads, bridges and other domestic infrastructure. 

The EU has indicated awareness of these dynamics: A 2024 white paper highlighted the benefits of R&D that has both military and civilian applications.

But while defense spending could boost European productivity, the dynamic works in reverse, too. A long line of research finds that wars are usually won by the country with deeper pockets. One way or another, Europe's security will depend on its competitiveness.

— Walter Frick, Bloomberg Weekend Edition

Predictions

"American exceptionalism is probably dead," at least in the sense of "consistently… higher earnings growth to fuel US market outperformance." — Edward Harrison, The Everything Risk

Investors surveyed in the Bloomberg Market Pulse survey agree:

Russia will return to global financial markets. That's the bet some investors are quietly making, in response to Donald Trump's overtures to Moscow. — Bloomberg News

"Researchers will do less bold science, ask fewer questions, make fewer discoveries" because of funding cuts at the National Institutes of Health. — Lisa Jarvis, Bloomberg Opinion

"Forever chemicals" won't last forever. "A wave of startups are offering potential solutions that won't cut the chemicals out of the [semiconductor] supply chain but can destroy them." — Aaron Clark, Bloomberg Green

Robots are about to become more dexterous: "Alphabet Inc.'s artificial intelligence lab is debuting two new models focused on robotics, which will help developers train robots to respond to unfamiliar scenarios." — Julia Love and Davey Alba, Bloomberg News

Disney could be coming to Fortnite. Its parks chief is "betting on a more virtual future" though Disney and Fortnite's parent company Epic Games "have been vague about what this means in practice — saying only that they're working on games and social experiences connected to Disney's brands." — Thomas Buckley, Bloomberg Businessweek

Gamers will buy "boatloads" of the new Nintendo Switch 2, "almost regardless of the price," according to Tokyo-based industry watcher Serkan Toto. Analysts predict a price tag of $400 or more. — Takashi Mochizuki, Bloomberg News

Keep an Eye on

Jerome Powell's Tightrope

Federal Reserve Chair Jerome Powell faces a tricky task this week of assuring investors the economy remains on solid footing while also conveying that policymakers stand ready to step in if necessary.

The Fed is widely expected to leave interest rates steady when they meet March 18-19, but traders now see high odds of three rate cuts this year, beginning in June. 

Even as Powell has touted resilience, uneasiness sparked by President Donald Trump's rapidly escalating trade war has sent stocks tumbling over the past month. Bond yields are down, too, as is consumer sentiment as worries about the economic outlook mount.

Some investors caution that if officials continue to signal only two reductions in 2025 and Powell reaffirms his favorable economic outlook at his press conference, it will be all the more important for the Fed chief to emphasize the central bank's willingness to adjust borrowing costs if the labor market stumbles.

— Jonnelle Marte and Liz Capo McCormick, Bloomberg News

What Are the Chances...

6%
The chances that Elon Musk buys TikTok by April 30, according to Polymarket and as of 3 p.m. ET on Friday. 

Larry Ellison, the founder of Oracle, has the highest chances at 29% — followed by Oracle itself at 28%. (If both were investors in a deal, both markets could resolve Yes.) Microsoft is at 14%; MrBeast is at 7%.

Weekend Reads

There Are Plenty of Reasons to Be Optimistic About Europe
The Real Threat to American Soft Power
Estonia's Startups See Opportunity in Europe's Rush to Rearm
The Left's New Rallying Cry: Move Fast and Build Things
Poland's First Abortion Clinic in Decades Is a Challenge to Parliament

Week Ahead

Sunday: Baidu, the Chinese tech company, is expected to launch a new AI model called Ernie 4.5.

Monday: China releases its activity report for Jan-Feb; Chinese officials are expected to announce new measures to boost consumption; the US reports retail sales; the OECD releases its interim economic outlook.

Tuesday: Canada reports CPI; Chile reports GDP.

Wednesday: The Fed is expected to hold US rates steady, as is the Bank of Japan; the central bank of Brazil is expected to hike rates by 1 percentage point; Argentina reports GDP; Tencent reports earnings.

Thursday: The UK publishes labor market data while the Bank of England is expected to leave rates unchanged; Nike, FedEx and Accenture report earnings, providing clues into US consumer, business and government spending, respectively.

Friday: Japan reports CPI; Russia and Chile are expected to leave interest rates unchanged. 

Have a great Sunday and a productive week.

— Walter Frick and Katherine Bell, Bloomberg Weekend Edition; Jonnelle Marte and Liz Capo McCormick, Bloomberg News

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