Title: Collective Finance for NATO’s Collective Security

To achieve this goal, the United States should work with NATO to collectively finance its security. Here is how to start: NATO’s more creditworthy countries, which are mainly located in Western Europe, and which often spend less than two percent on defense, should guarantee more defense spending by other NATO members. As it turns out, many of these other members are in Eastern Europe and have worse credit. They are also rightly wary of nearby Russia after its wars in Ukraine and Georgia. These more creditworthy, western members include France, Germany, Luxembourg, and Canada, none of which is expected to spend more than two percent of its GDP on defense in 2019. Among the less creditworthy, eastern members are Estonia, Poland, Latvia, and Lithuania. Each of them is estimated to spend more than two percent on defense this year.

To a lender, a Western European NATO member, for example, with a high sovereign credit rating of AAA represents a safe investment. It probably has a large, developed economy and is relatively secure from outside threats. As a consequence, its borrowing costs are low. In contrast, an Eastern European NATO member with a lower rating of BBB pays a marginally higher interest rate on borrowed money, including for defense spending. Yet the AAA ally may be short by $100 million of meeting its two percent spending pledge. Meanwhile, the BBB member already might have exceeded its Wales commitment by $100 million to meet current threats.

Collective financing proposes that the illustrative AAA western member use its higher credit rating to guarantee excess defense spending by the BBB eastern member. Armed with its ally’s AAA rating, the eastern member can now borrow for more defense on better terms, so it is more likely to do so. Because the eastern member has spent $100 million more using its ally’s AAA rating, NATO should recognize the western member for honoring its Wales pledge by that amount. In the same way, a group of more creditworthy members could pool their credit ratings to collectively guarantee one or more members with lower ratings.

Put plainly, collective financing acknowledges that Western Europe is more secure and therefore less eager to spend on defense, yet more able to do so because it is richer. The situation in Eastern Europe is generally the opposite. Of course, the higher cost of borrowing for eastern members owes partly to their insecurity in the looming shadow of Russia—the very kind of threat NATO’s commitment to collective defense is meant to deter. By moving credit from the West to buy arms in the East, NATO would complement the individual strengths and motivations of its members to strengthen the alliance as a whole.

Empowering NATO’s less secure members to borrow cheaply would amplify the Wales Summit’s two percent goal in several ways. First, credit support would reassure NATO’s East, bolstering the alliance’s credibility and muscle where they are needed most. In fact, more spending in the East, where some countries already exceed the two percent goal, may be better than in the West, where many do not. After all, eastern members are closer to Russia, the principal threat. Plus, guarantees could nimbly adapt to a future threat elsewhere, because threatened members, no matter where, could use credit support to help to meet it. Granted, guarantees by those western members with larger economies to eastern members with smaller ones would only increase overall defense spending within NATO incrementally. And NATO’s eastern members–traditionally averse to debt–might not avail themselves of the better terms. Even so, guarantees would position NATO members as a whole to spend more on defense than they do now.

Second, NATO’s more creditworthy members should prefer contributing through guarantees instead of paying upfront. True, credit support represents a liability, but it only results in real loss if an eastern member doesn’t make good on a guaranteed loan. Despite their pledge, some of NATO’s most secure members might never spend two percent of their GDP on defense. Collective financing recognizes this stagnant situation and offers a compromise. If NATO credits guarantors against their Wales pledge, they should be motivated to participate in collective finance.

Third, more lending and spending by NATO countries could stimulate the defense sector. Because Europe’s major defense companies are in the West, guarantees by members there would help their own economies, not to mention that of the United States, since U.S. defense companies supply NATO, too.

Fourth, investing NATO’s West in its East would give all members a greater stake in the alliance’s success. Unfortunately, NATO’s ledger divides members into security consumers and producers. That is partly unavoidable, but guarantees can blur this division by harnessing consumers’ credit to improve production. Or, as Alexander Hamilton recognized in the United States, where the federal government’s assumption outright of the states’ debts and creation of the First Bank of the United States helped to solidify a new union, a collective debt–if not excessive–is a collective “blessing.”

Indeed, today’s guarantee could develop into tomorrow’s institution. A NATO bank, for instance, could lend to NATO—and even nonmember—allies to finance their defense spending. Just as a collective guarantee would let a member borrow closer to the rate derived from the guarantors’ pooled credit rating, a NATO bank could borrow based on a rating that approximates the sovereign credit ratings of the bank’s guarantors. Once funded, the bank could then lend at a marginally higher rate to allies that is nevertheless lower than their own borrowing cost. Sure, NATO’s Security Investment Program pools member funding for common projects, but it does not finance members’ defense spending. A NATO bank would be an enormous undertaking but is worth consideration. For one, examination should be given to how it would work alongside the laws and institutions of the European Union. Still, a NATO bank could achieve much, broadening the current, short-term focus on individual member spending into a long-term, strategic one.

NATO is history’s most successful alliance, but it must evolve. If the United States and its NATO partners can compromise, then smart financing can strengthen common security.

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Dillon Guthrie is a counsel at the Federal Reserve Bank of New York. Dillon previously practiced at Ropes & Gray LLP and at Skadden, Arps, Slate, Meagher & Flom LLP, where he focused on mergers, acquisitions, shareholder activism, and capital markets. Earlier, Dillon served as a Europe policy advisor on the U.S. Senate Committee on Foreign Relations and, before that, as a legislative aide to then-Senator John Kerry. The views expressed in this article are his own and do not necessarily reflect the views of the Federal Reserve Bank of New York.