Richard Barfield / Mar 2025
Photo: Shutterstock
UK defence spending is going up and the best way to pay for it would be to grow the economy rather than cut public expenditure, raise taxes or borrow more. To achieve the level of growth required, there is only one option: a major reset of the UK’s trading relationship with Europe.
The Trump administration’s actions on Ukraine and tariffs, and its threats to Europe’s security umbrella have focused European minds. Sir Keir Starmer has decisively reaffirmed UK support to Ukraine and committed to raising defence spending from 2.3% to 2.5% of GDP by 2027 (implying an increase of about £6 billion).
In simple terms, the 0.2% GDP increase in defence needs an extra 0.5% of GDP to fund it (aggregate UK tax revenues are about 40% of GDP). Extra GDP would enable the government to avoid further unpopular cuts to public services.
A new trading relationship would boost both the UK and EU economies. This matters because the EU’s poor economic performance is already a critical issue. Even without Trump tariffs, the EU economic model has been spluttering with weak growth in the Eurozone. The latest OECD forecasts expect growth in France, Germany and Italy to lag the UK in 2025 and 2026. On top of that, they face the challenge of significantly increasing defence spending from a lower proportion of GDP than the UK.
In January 2025, in response to the comprehensive Draghi report on the future of EU competitiveness, the European Commission’s “Competitiveness Compass” sets out a road map to boost competitiveness and productivity including reducing internal trade barriers, simpler EU regulation and stronger coordination between member states. Although the single market is one of the EU’s greatest achievements, its internal trade barriers are still high compared to the barriers for intra-US trade.
The pressing need for defence collaboration has pushed the UK and the EU much closer politically. The UK’s relatively strong defence capabilities now give it a unique opportunity to seek reduced UK-EU trade barriers to facilitate cross-border procurement and free up supply chains. For example, a customs union between the UK and the EU would cut through customs red tape. This alone would increase UK GDP by at least 1% but would also have consequences.
In a customs union, the UK would have to levy the same tariffs on US imports as the EU, but these would be a small cost compared to the greater benefits of freer UK-EU trade. The US is an important trading partner (15% of UK goods exports worth £60 billion in 2023) but much less important than the EU (49% of UK goods exports). Note that tariffs do not apply to services trade and the UK exported £126 billion of services to the US.
The UK would have to renegotiate the trade agreements that were not rollovers of previous EU agreements: Australia, New Zealand and membership of the CPTPP. Again, the economic cost would be small: the government’s central estimate of the long-run benefit of each agreement is less than 0.1% of GDP.
The economic benefits to the UK of a US trade agreement would also be small. The Johnson government estimated the value of a trade deal with the US at just under 0.2% of GDP after 15 years. Trump’s willingness to renege on trade deals makes any potential economic benefits less certain.
Aside from a customs union, there could be other big mutual economic gains with the EU. A recent report from Frontier Economics found that deep regulatory alignment, even while staying within Labour’s ‘red lines’, could increase UK GDP by 2.2% (about £60 billion a year, that could fund defence spending of £24 billion). Indeed, the same study found that the economic cost to the UK of Trump tariffs should be small, mainly because most of the UK’s trade with the US is in services.
Reduced UK-EU trade barriers could also deliver significant economic benefits to the EU – an estimated first-year increase in EU exports of USD 30 billion with long-term benefits of an extra 0.2% to 0.3% of EU GDP (or USD 40 to 60 billion).
The UK’s economic and political interests lie heavily with Europe. To head off domestic political opposition to a closer EU relationship, Labour can rightly argue that a government’s first responsibility is to protect its citizens through strong defence. This core patriotic duty eclipses concerns about following certain EU trade rules or accepting the European Court of Justice as the final arbiter.
As UK and European allies ramp up defence manufacturing, their shared need for additional, sustained economic growth makes a compelling case for relaxing red lines and radically resetting the trading relationship.
