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European and Transatlantic Defense Industrial Strategies: A European perspective

01 January 2002

The history of transatlantic armaments cooperation goes back to the beginning of the Cold War. Since then, however, the nature of cooperation has changed considerably, from simple licensing of US systems to Western Europe in the 1950s and 1960s to co-production arrangements in the 1970s, followed by government-to-government joint development programs in the 1980s and 1990s. In recent years, industry-led cooperation has become the most prominent feature.
The changing nature of cooperation reflects the changing motivation of the two sides. During the first decades after World War II, the US helped to rebuild an exhausted or destroyed West European defense industry in the face of the Soviet threat. The more European NATO allies recovered economically, the more they sought a more balanced partnership with the US. After the end of the Cold War, interoperability became a major argument for enhanced cooperation. Since the late 1990s, the technological and financial consequences of globalization have pushed industry towards transnational consolidation and closer transatlantic ties, whereas governments have had difficulties matching industry-led initiatives.
In spite of many good reasons for more transatlantic cooperation and numerous initiatives to achieve that objective, the record is rather poor. Arms trade across the Atlantic has remained primarily a one-way-street from the US to Europe, with few cooperative projects having actually been set up and even fewer having been considered as a success. There are several reasons for failure:<br />· Since the strategic and force planning processes are conducted independently, harmonization of military requirements is almost impossible, <br />· Market access for foreign companies remains difficult: Whereas the openness of European defense markets differs greatly from country to country, the US market is well protected against both foreign investments and sales. Moreover, complex rules and procedures for defense exports represent major hurdles for industrial cooperation.<br />· In the US, both the political leadership and the armed forces are extremely reluctant to rely to any extent on foreign suppliers. On the other hand, in Europe there is widespread anxiety in many arms producing countries about the possibility of US market hegemony. Both attitudes make it very hard to create a positive political climate for transatlantic armaments cooperation.
Even more important, transatlantic cooperation is hindered by a fundamental imbalance of power between the US and Europe: <br />· The US is by far the biggest defense market of the world. In 2001, the DoD spent more than twice as much on defence as all EU members combined. With an increase in US defence spending of $48 bn for FY 2003, and further increases planned from $396.8 bn in 2003 to $469.8 bn in 2007, the transatlantic financing and procurement gap will continue to grow over the next few years. <br />· There also fundamental structural market differences. Due to fragmented defence markets and disparate procurement policies, European countries pay a high price for costly duplications and face great difficulties in efficiently combining their resources. As a consequence, the EU as a whole gets less value for its money than the US. Moreover, the investment profiles are different, the US spending not only in absolute, but also in relative terms more on procurement and R&amp;D than Europeans. <br />· The US has such enormous financial resources, defense-industrial assets and military capabilities that they simply do not need armaments cooperation or arms imports. From the US perspective, the potential benefit of transatlantic cooperation is, at best, the cohesion of the Alliance. This argument, however, is hardly sufficient to overcome bureaucratic and political resistance. The same is true for interoperability: For many in the US, interoperability within the Alliance could best be achieved if Europeans simply bought US products. The fact that the US can conduct the whole spectrum of military operations without any allied contribution does not help to convince the Administration, Congress and Armed forces that they need to suffer the trials and tribulations of transatlantic cooperation. <br />· In Europe, the situation is, again, completely different: Even the most important arms-producing countries cannot afford to maintain a purely national Defense Industrial Base (DIB). With the exception of certain technological niches, they need international cooperation to develop and produce hi-tech weaponry. In this context, access to US technology is in general considered as highly attractive. Moreover, there is a strong European interest in interoperability as the prerequisite for coalition building and therefore for political influence in Washington. However, the lack of financial resources, national industrial interests and the difficulties involved in transatlantic ventures greatly reduces European interest in cooperating with the US.<br />· Last but not least, the US pursues an explicit and coherent strategy for defense-related industries, aimed at technological superiority in all relevant sectors. European countries, in contrast, do not have the means to implement such a strategy individually and lack the political consensus to develop one collectively. In consequence, Europeans have difficulties in developing common positions towards the US on armaments issues.
The imbalance between the US and Europe can also be seen at the corporate level. The enormous consolidation process that took place from 1993 to 1997 within US Industry reinforced European anxieties about the threat of US market hegemony. Facing competition from giants such as Boeing-McDonnell Douglas, Lockheed-Martin and Raytheon, Europe’s national champions and their respective governments (finally) began to accept cross-border integration as the only way to avoid being squeezed out of the market and/or forced into unbalanced subordinate partnerships. The main result of the restructuring process that followed was the creation of three big groups, EADS, BAE Systems and THALES, each of them linked to each other and to the remaining groups by numerous international joint ventures.
This industrial movement, in turn, triggered the so-called Letter of Intent (LOI) process between the governments of the major European arms-producing countries (France, Germany, Great Britain, Italy, Spain, Sweden). In July 2000, the six partners signed a Framework Agreement covering 1) Security of Supply, 2) Transfer and Export Procedures, 3) Security of Classified Information, 4) Research and Technology, 5) Treatment of Technical Information and 6) Harmonization of Military Requirements. In these six areas, the partners committed themselves to create a more homogenous regulatory framework in order to improve market conditions for an increasingly transnational industry.
However, and in spite of all its potential virtues, the Framework Agreement does not actually establish a common armaments policy. On the contrary, armaments remain in the national domain, with defense industrial interests and strategies still diverging. <br />· Among the six LOI countries, France is traditionally the most ambitious about Europe becoming an autonomous political actor (although its partners often suspect the real objective is simply to use Europe as a means to achieve national ends). In the 1990s, France accepted both privatization and internationalization of its defense industry as indispensable, combining market orientation of companies with the politico-strategic objectives of the government. Therefore, France has been a driving force behind the restructuring of Europe’s Aerospace and Defense Electronics sectors. Aérospatiale-Matra was brought into EADS and THALES (formerly Thomson-CSF) transformed into an international player with strong links to the UK (through the acquisition of Racal). In the future, the French government will probably try – again – to bring Dassault into a wider European structure and to find a new reference shareholder for THALES. The main challenge, however, will be land armaments and naval shipbuilding, where the privatization of GIAT and DCN is still pending. The poor shape of the two former arsenals represents not only an important financial burden upon the French government, it is also a major obstacle to greater openness of the French defense market and makes it de facto impossible for Paris to push for European mergers (since both companies are rather unattractive as potential partners). <br />· The UK’s industrial policy is characterized by a “value for money” policy, which includes relative openness of its defense market for foreign competitors. This openness also compensates for a growing lack of competition in the national market. In fact, after the take-over of GEC Marconi by British Aerospace and the recent acquisition of Vickers by Alvis, there are two national champions left which distorts the market-led approach that the British claim to champion. To counterbalance this dominance and to create a second “national” defense electronics supplier competing with BAE Systems, London accepted, for example, the take-over of Racal by THALES. Competition may also come from American companies that regularly team-up with British firms for bids in the UK. Transatlantic cooperation in general is welcomed not only for political reasons, but also as a means to benefit from US technology.<br />· In Germany, the largest part of the aerospace industry is now integrated into EADS. The government has failed, by contrast, to convince land armament and naval shipbuilding industries to follow the same approach – first national consolidation, then European integration. Germany’s leading land systems companies – Krauss-Maffei and Rheinmetall – continue to resist any political pressure to merge. In naval shipbuilding, government plans have also failed. Instead of joining forces with Thyssen Krupp Industries, Babcock Borsig sold its 75 per cent share in HDW to the US investment fund Equity One Partners. Since HDW is a world leader in conventional submarines, this deal has stimulated a debate about a sell-out of German key technologies. Many observers now fear that Krauss-Maffei could become the next candidate for a politically incorrect take-over.<br />· Italy, Spain and Sweden have all tried to integrate their defense industrial assets into wider international structures, without pursuing a clear European preference. The Spanish government has integrated Casa into EADS, but preferred General Dynamic’s bid for Santa Barbara over Rheinmetall’s offer; the Italian government has pushed Finmeccanica – with more or less success – to integrate its units into European joint ventures, but left the A 400M program and joined the F-35 program. In Sweden, certain industrial elements have been linked to European networks (see Saab), whilst others have been sold to US investors (Bofors).
Industrial policy is only one aspect of largely divergent armament policies in Europe. Another example is the somewhat uncoordinated way in which the LOI countries have embarked on bilateral negotiations with the US on regulatory issues. In fact, industrial consolidation in Europe, together with the LOI process and the development of ESDP, alarmed Washington about the possibility of an emerging “Fortress Europe”. The perceived threat of a closed European market, combined with the risk of the lack of any true competition in the US market, pushed the Clinton Administration to launch two initiatives: a) the Defense Trade Security Initiative (DTSI) aimed at streamlining the US export control system, and b) bilateral negotiations with certain allies on a “Declaration of Principles on defense equipment and industrial cooperation” (DoP).
Whereas the DoP is de facto a bilateral version of the European LOI, covering a broad range of defense trade issues, the DTSI is comprised of 16 procedural reforms to the US export control regime. Moreover, it includes the possibility for certain qualified countries to enter into negotiations aimed at granting ITAR-license exemptions for unclassified exports to the government and to companies identified as reliable.
Up until now, the DoPs have been signed with the UK; Australia, Norway, Spain and the Netherlands, whilst negotiations with Italy seem to be will advanced, whereas discussions with Germany and France are, at best, at an early stage. So far, the UK is the only LOI-country with whom the US has begun to negotiate a binding export control agreement. ITAR-talks with additional partners are envisaged only after negotiations with the UK have been completed. However, under the Bush Administration these transatlantic discussions have apparently lost momentum, their future therefore being unclear. Even with the UK, negotiations on export controls seem to be experiencing difficulties. However, in general, the different stages of negotiations with the partners suggest that Washington still makes a distinction between “reliable” and “less reliable” allies.
Sooner or later, this distinction might create problems for the compatibility of the multilateral LOI system and the bilateral DOP approach. It remains to be seen how transatlantic arrangements would interact in practice with the LOI Framework Agreement. However, at least in certain areas, bilateral agreements with the US might complicate a system whose purpose is precisely to simplify and facilitate European cooperation. For example, could a European Transnational Defense Company qualify for an ITAR exemption if only one of its home countries has an export control agreement with the US? Or, would the ETDC be obliged to create new Chinese walls between its different sites, thereby limiting its internal integration and acting against the philosophy of the LOI process?
To operate in such an uncertain and fluid environment is certainly not easy for European Industries. As has been seen, a European Armaments Policy and a common defense market, are still a long way off, and defense budgets in Europe remain flat The enormous difference between budgets in Europe and the US represents an irresistible incentive for European companies to attempt penetration of the US market. Indeed, access to the US has become a major strategic goal for all big industrial players in Europe.
There are different ways to achieve that objective:<br />· Given the predominant Buy-American policy, direct sales of European products to the US armed forces will probably remain extremely rare exceptions;<br />· Jointly developed defense systems under a government-to-government agreement will remain exceptions as well; European budget constraints on the one hand, and difficulties to harmonize the military requirements across the Atlantic on the other, will continue to limit the possibilities for intergovernmental projects.<br />· Teaming Arrangements with US prime contractors for specific US programs will be politically easier, in particular if the European contribution is limited to sub-systems and components. However, the cost-effectiveness of these industrial arrangements depends to a considerable degree on the regulatory framework that governments agree on.
Another possibility to penetrate the US market is to buy an American company and to become a “national” supplier to the Pentagon. British companies, in particular BAE Systems, have pursued this strategy extensively and with a lot of success. For continental European companies, however, this option has been politically unrealistic so far, and there are no signs that this might change in the near future. What we have seen, by contrast, is a multiplication of joint ventures (Raytheon-THALES) and strategic alliances (EADS-Northrop Grumman).
In land armaments and shipbuilding, the situation is different. By contrast to Aerospace and Defense electronics, trans-European consolidation has failed in these sectors, leaving European companies in a rather weak position vis-à-vis their US counterparts. As the Santa Barbara and the HDW take-overs have demonstrated, US investors have therefore a good chance simply to “cherry-pick” the European Defense Industrial base.
To conclude, there are not many reasons to be overly optimistic about the future of transatlantic armaments cooperation. Cooperation will certainly continue, but its intensity will probably remain limited by persistent political obstacles. Moreover, cooperation will be mainly industry driven. If they have a commercial and / or a technological interest, companies can be quite innovative in dealing with bureaucratic and regulatory hurdles. In particular at the less visible - and therefore politically less sensitive - sub-system and component level, closer ties are indeed probable. On the other hand, even the big European companies will only be able to cooperate on an equal footing with their US counterparts if they maintain their capacities as system-integrators and if they remain at the cutting edge of technology – not in all, but in specific key areas. This, in turn, will only be possible if European governments keep at least a certain level of R&amp;T funding and if they – finally – come to a common European strategy for their defense-related industries.