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Defence Industry Consolidation - Time for Political Action

01 December 2001

Over the last two years, cross-border consolidation of defence industries has been high on the agenda of European defence. However, public debate on this issue is often characterised by profound misunderstandings.
First, most analysts use the term "defence industry", when what they really mean is aerospace and, at the most, defence electronics. Only in aerospace and defence electronics, real cross-border consolidation has actually taken place, leading to the formation of sector specific transnational companies (TDCs), such as Eurocopter or Matra BAE Dynamics Alenia (MBDA), as well as, of course, to the creation of a truly European parent company, EADS. Land armaments and naval shipbuilding, in contrast, have gone through a national consolidation process, but have not as yet been greatly affected by transnational restructuring.
Second, even in aerospace and electronics, cross-border integration of companies has been limited up until now to the shareholder- and senior management levels. The major reason for this is that European governments clearly have difficulties in matching industrial processes. Whereas almost all industrial high-tech assets are now organised into TDCs, defence-related rules and regulations, R&D funding and procurement systems are still overwhelmingly national. EADS, for example, has to deal with three different national regulatory frameworks and procurement systems. This fragmentation makes it extremely difficult for TDCs to optimise their internal procedures and to rationalise their production in an economically efficient way. It is a major disadvantage for European companies vis-à-vis their American competitors, but it is also a major disadvantage for European governments because it creates costly duplications and weakens the customers purchasing power vis-à-vis TDC's.
This means that, in many ways, the ball is now in the court of governments. Industrial consolidation is one prerequisite for more cost-effectiveness, but the reorganisation of the demand side and the regulatory frameworks are at least as important. There is an urgent need for far-reaching reforms of procurement systems and defence-related regulations in order to help industry to become more competitive, but also to save scarce financial resources. The last point is particularly important : Given the general shortage of public finances, the absence of a common procurement system and a homogeneous defence economic space is a luxury that defies political and economic logic.
Granted, all major arms producing countries have started to reform their procurement systems, but these initiatives are purely national, which means that they will hardly be sufficient since more and more weapon systems will be built through international cooperation. At the European level, however, a common armaments policy is still a long way off. WEAG's results are extremely modest, and the fading away of WEU puts the group into a delicate institutional and political situation. On the hand, the EU's competence in armaments matters is still very limited.
The most significant progress has been achieved through intergovernmental ad hoc initiatives outside existing frameworks, namely OCCAR (Organisation for Joint Armaments Cooperation) and the LoI (Letter of Intent). However, these initiatives will hardly be sufficient:
both OCCAR and the LoI are limited in their scope. OCCAR’s competence is limited to the lower end of the procurement cycle. The LoI framework agreement signed in July 2000 covers six major areas, but is limited to cooperative projects, and its focus is on regulatory issues. This means that both initiatives might be important steps forward, but they will have to be completed by other elements. <br />So far, both initiatives have developed without real coordination, neither between the two or with other relevant bodies. This is indicative in the sense that there is no overall plan for a final armaments architecture, and nobody seems to know how the existing bits and pieces can be brought together. <br />Both LoI and OCCAR are exclusive arrangements. This is politically tricky, but it can also create economic problems. For example, suppliers from non-LoI countries will not benefit from a Global Licence that is granted within the framework of a cooperation between companies from LoI countries. This is a clear disadvantage for non LoI suppliers vis-à-vis their LoI competitors and hampers role specialisation among EU industries. <br />Neither is exclusiveness a guarantee for success. The idea that progress is easier to achieve if arms producing countries move ahead alone, is not necessarily true. For example, it took OCCAR five years just to get its legal status, and divergences among member states have blocked both the widening and the deepening of the organisation. As a consequence, OCCAR’s current structures are much weaker than was initially envisaged. As far as the LoI framework agreement is concerned, it remains to be seen whether the purely technical approach can cope with problems that are political in nature (see, for example, exports). Even among Arms producing countries, interests might be too divergent to achieve efficiency through purely intergovernmental methods. <br />So what needs to be done? The overall objectives are clear and generally accepted ; Europe has to cooperate more and better than in the past, and in order to do so, Europe has to create a more homogenous defence economic space and adapt procurement agencies and methods to the new industrial and technological realities.
The question is how to get there. The most logical approach would be to develop a concept for a comprehensive armaments policy defining the various policy objectives and the means to achieve them. For the time being, such an approach would be politically unrealistic and therefore pointless. Under current circumstances, progress can only be achieved on the basis of a pragmatic step by step approach. However, it is essential to promote efficiency by overcoming bureaucratic and political hurdles.
Within this context, the following, very general points could help to improve armaments cooperation in Europe :
More transparency would be helpful. The financial implications are too important to deal with armaments cooperation only at the working level between specialised MoD branches. There should be at least a systematic supervision of existing cooperative bodies in order to evaluate performance and shortcomings. <br />In order to develop a systematic and comprehensive approach, there should be much better coordination between the various actors. This is true for armaments organisations stricto sensu, but coordination should also imply the involvement of other actors like the EU Commission in the field of R&amp;T, for example, or ministries of economy or finance. <br />It is very difficult to develop a coherent strategy and to get satisfactory results if the people in charge spend only 10 % of their time on cooperation and meet only once a month. A coherent procurement policy underpinning ESDP cannot be created with panels that only meet twice or three times a year. Cooperation should therefore be handled through permanent bodies. <br />Today, few phases of the procurement cycle are actually covered by European bodies. There should be permanent bodies throughout the procurement cycle, starting from the harmonisation of capability needs all the way down to in-service support and logistics. These bodies should have strong links with each other and with their national counterparts. An important first step could be to give the Military Committee the mandate to develop a systematic comparison of capability needs as a starter for better and more effective harmonisation of military requirements. <br />Equally important would be to find ways to stabilise the funding of cooperative projects. One way to achieve this aim could be to create a specific EU defence budget line and / or to give OCCAR financial autonomy. <br />Two further points are crucial:
1) Reforming procedures and mechanisms is useful and necessary, but it can not replace politics. The LoI framework agreement, for example, defines a decision making process for the establishment of permitted export destinations for cooperative projects. However, the problem is not the mechanism as such, but the political consensus needed to come to an agreement. So long as a European consensus concerns only general principles but not their practical interpretation, the traditional disagreements will probably reappear when it comes to concrete decisions. In this specific case, would it not be possible to establish, at least among the LoI countries, a system regime for defence items along the lines of the dual-use regime? Or, to put it another way, a regime which allows the free movement of items within the Union because all member states recognise each others authorisation for exports to third countries?
2) Any institutional setting has to be both coherent and flexible. Fulfilling these criteria is more important than the need to establish a single European 'customer', which should not be an end in itself. Since membership of current organisations is not symmetrical, any future collaborative framework will have to allow flexible integration. The further upstream in the procurement cycle, the broader membership should be: harmonisation of military requirements should be dealt with at 15, whereas membership will automatically decrease if you go down to the project level. Concerning the regulatory framework, it seems also logical to include as many EU-members as possible in common arrangements.
To sum up: Following the consolidation wave in aerospace and defence electronics, the ball is now in the court of governments. OCCAR and the LoI framework agreement have been important steps, and the new &quot;European Technology and Acquisition Program&quot; (Etap), signed in November 2001, is another encouraging initiative to harmonise military requirements and join forces in the field of aerospace R&amp;T. However, Europe will have to move beyond the classical intergovernmental approach if it wants to organise its armaments cooperation in an efficient way. There is an urgent need to create a homogenous defence economic space and to develop a common procurement policy, both to improve the competitiveness of European industries and to save taxpayers money. The last point is key; even though it is difficult to calculate, one can assume that the current fragmentation of Europe's armament sector is a major cause of waste. Or, put in positive terms, a major source for cost saving. There is an obligation vis-à-vis European tax payers to find the most cost-effective way to equip our armed forces, in particular if governments want public opinion to support the ESDP project.