The European Aerospace and Defense Industry: A New Kind of Military Industrial Complex

October 2012 - By Major Michael Wise, US Army - disamjournal.org

The European Union (EU) is an institution founded upon the precept of shared economic prosperity to prevent conflict. The idea of increasing interdependence in the coal and steel industries expanded into a trade union that eventually led to a common currency for seventeen of the EU’s twenty-seven members. The economic benefits of this regional trade liberalization scheme are apparent, but what are the effects of integration and coordination on industries that are undeniably strategic in nature? One might expect that the efficacy of EU and European Defense Agency (EDA) would not transcend into the aerospace and defense industry, but it turns out that the EU and EDA have a positive effect on exports in this arena. The consequences of this phenomenon reinforce the foundation upon which the European project set out to accomplish. There are lessons to draw from integration of the aerospace and defense industry as well as indicators that the US government and defense firms alike should consider.

The EU

European integration is an endeavor that has failed throughout the ages, often resulting in competition and bloody wars. As Adreas Staab puts it, “From the Roman Empire of Julius Caesar to Napoleon, Hitler, and Stalin, European history is marked by many attempts to organize the multitude of nations and ethnicities into a more or less coherent political entity with competing views of how the different states should be related and the degree to which autonomy and sovereignty should be preserved.“¹ But something encouraging has transpired in Europe since the end of WWII. A few forward thinking elites gathered together to establish an economic union that would bind the war-making industries of coal and steel production among the usual states perpetrating war. Jean Monnet, a French entrepreneur and functionalist, presented a plan that would sow the seeds to what would develop into the EU. While there was always disagreement on the role and scope of institutions in integration, a constructive environment (owed largely to US security guarantees and fiscal support) allowed for a lasting peace and functional institutions to emerge. The debate between minimalism versus maximalism translated into proponents of intergovernmental models versus supranational bodies. This debate goes on even today, especially as the EU attempts to manage itself through a real challenge for the first time where the economic benefits are difficult to see amidst the current economic crisis.

Aside from the challenges of integration from nationalist tendencies and questions of sovereignty, the EU delivers massive benefits in the form of a common market with minimal barriers to trade among its members. The common currency is the obvious example of reducing trade costs whereby the drag of currency exchange is evaporated. Among members there are also customs agreements that essentially liberate any trade barriers within the EU and coordinate external economic policies resulting in a uniform arrangement. The EU tries to keep competition fair among its members and maximize industry potential by exploiting the benefits of comparative advantage and economies of scale. It also attempts to address the advantages of state aid among members. Article 87(1) of the European Community Treaty prohibits state aid in the form of subsidies, provided it affects trade between member states.² This distinction is important as will be pointed out in the pursuant discussion on World Trade Organization (WTO) cases involving US and European aerospace firms.

In sum, the EU facilitates European firm competitiveness by keeping trade barriers low and allowing for firms to maximize their productivity through specialization and market access through free trade areas. The implications are profound across a variety of industries. Surprisingly (or perhaps unsurprisingly, depending on one’s perspective), these advantages are translated even to the aerospace and defense industries. The ability of EU member states to generate war-fighting equipment is becoming increasingly interdependent.

The EDA

A regional cooperation of states, such as the members of the EU, will tend to view threats to their individual (and collective) national security differently. They will thus arm and equip themselves according to those different, sometimes divergent, assumptions. In theory, this doesn’t necessarily have to result in completely uncoordinated defense acquisitions. After all, maritime or land powers might simply adjust volumes and concentrations of the major categories of defense equipment. But in practice, European militaries developed a hodgepodge of equipment that is sometimes able to be integrated among (some) members and sometimes is only workable in an autonomous environment. Indeed, under Article 296 of the European Community Treaty, member states are permitted to make the bulk of their defense purchases on a national basis. With the view that European military forces must promote interoperability through tactics, techniques, and procedures, so must their equipment procurement be coordinated. In 2004, the Council of Ministers established the EDA to coordinate defense capabilities. In doing so, it implemented strategies to promote research, development, and armaments cooperation, and strengthen the European Defense Technological and Industrial Base (EDTIB).³

The strategy to strengthen the EDTIB is grounded upon three underlying principles. The “three C’s,” serving as a guide in EDTIB enhancement, are capability driven, competence and globally competitive. The EDA endeavors to ensure Europe is equipped and capable to deal with security threats of the future by clarifying priorities with regard to military and industrial capabilities, consolidating demand, increasing investments, considering security of supply and increasing competition and cooperation within the industry.⁴ The EDA initiated efforts to improve Europe’s industrial capabilities in the aerospace sector with the Future Air Systems Project. Among other things, the main contribution of the EDA in this project is to examine the supply chain and to promote engagement with EU bureaucracies.

The idea of a coordinated strategy in European defense and procurement planning is not generally regarded in a positive way. This may be a reflection of an antipathy for real coordination among members’ national priorities. The EDA recognizes the apparent challenges of managing twenty-seven different views and has set its own top capabilities priorities appropriately. They include counter-IED, medical support, ISR (Intelligence, Surveillance and Reconnaissance), helicopters, cyber-defense, multinational logistics support, CSDP (Common Security and Defense Policy) information exchange, strategic and tactical airlift and finally fuel and energy.⁵ These priorities reflect a shift from territorial defense to a force projection capability. It happens that while conventional territorial defense warfare is more simplified for the warfighter, the limited intervention mindset involving projection of small forces is less industry intensive (think less tanks and more agile light units). This prioritization allows the European defense firms to focus on a more narrow market.

Analysis of institutional Effects on Performance

The EU seems to increase productivity by allowing its members to specialize in those areas where they enjoy a comparative advantage, and the EDA seems to allow its members to specialize within the global aerospace and defense market according to its strategy. The consequences of exploiting such advantages are extremely beneficial to the European aerospace and defense industry. This study analyzed export data from UN Comtrade of thirty-nine European countries from 1996 to 2010. The EU and EDA status is depicted in figure 1. It accounted for changes in membership status during the expansion years of 2004 and 2007. This analysis is limited to commodities related to aerospace and defense, in addition to components. These included ammunition, missiles, armored vehicles, warships and aircraft (civilian and military). Figure 2 is a graphical representation of total exports and depicts a steadily increasing trend. Other reports confirm this trend. The EU Observer cited SIPRI data indicating EU arms trade growth despite the economic crisis that embroils the rest of European industry.⁶
    

What could cause such an increase? The Center for Strategic and International Studies (CSIS) published a study indicating that while European defense spending cumulatively fell over the period covered here, expenditures on equipment remained constant (see figure 3). The increase is clearly not the result of domestic consumption. One might expect that integration would encourage specialization and dispersion of factor production; thereby supply chain effects might explain the increase in exports. This appears to be part of the story, but not all of it. Figure 4 shows the total exports separated by trading partners outside the EU and intra-EU trade. The intra-EU trade rises steadily as expected but exports to the rest of the world increase even more rapidly. These results indicate that European aerospace and defense firms are increasing their competitiveness abroad.

  

What is most interesting is that a regression analysis of exports on institutional membership makes a compelling case for the EU and EDA. This study included multivariate regressions where the independent variables included institutional membership status as well as a qualified and quantified variables depicting conflicts. These conflict variables normalized for an increase or decrease in global conflict that might have spurious effects on aerospace and defense export volume. These variables were generated from the Uppsala Conflict Data Program from the International Peace Research Institute in Oslo. The analysis further considered fixed effects of trading partners of the exporting countries. Furthermore, the logs of the export volume served as the dependent variable so that data from low volume exporters could be compared to that of high volume exporters. The results showed that both EU and EDA membership serve as reliable predictors of export growth.

At the Firm Level

Using data from Defense News Top 100 firm rankings reported each year from 2000 to 2010, this study is able to depict individual firm trends during a similar period. Figure 5 displays defense revenue of every European defense firm that made the Defense News list from 2000 to 2010. Table 1 lists the top European defense firms for 2010. It is apparent that most firms enjoy the same trend of increasing revenue as was observed on European aerospace and defense exports. All this during an increasingly sparse domestic market for these defense-related products. This trend is confirmed by the EU Observer’s report on SIPRI’s 2010 analysis noting that most of the large firms saw measured growth while a few smaller firms witnessed contraction in revenue.⁷

The results and trends demonstrated in figure 5 beg more in depth investigation of some of the notable cases. The top performing firms vary in state involvement, product specialty and location, though all reside in the larger economic powers of the core of Europe. This study will examine BAE Systems, EADS, Finmeccanica and Thales.

BAE Systems is a London-based defense firm that currently ranks second only to Lockheed Martin (US) in defense revenue. It is a multinational company with strong markets in the EU, US, Saudi Arabia, Australia, and India. Its products range from cutting-edge aerospace technology to conventional armored vehicle production. It is closely tied to US defense firms and has an integral part in the production of the multinational joint strike fighter, the F-35 Lightning. The firm plays an important role in the UK’s nuclear technology as well as high-end shipbuilding. BAE also develops cyber defense and information technology systems. Though primarily a UK based firm, it is also invested in several European aerospace and defense firms.

The European Aeronautic Defense and Space (EADS) Company is a conglomerate of several consolidated defense firms in Europe. Headquartered in the Netherlands, its main subsidiaries are in France, Germany and Spain. These include Airbus and Eurocopter. It mainly produces aircraft and electronic systems and its primary markets are in the UK, North America, the Middle East, Russia, India, China, Brazil and Australia.

Finmeccanica is one of Italy’s largest industrial groups and is partially nationalized (30 percent). It also mainly produces aerospace technologies and develops components of Europe wide defense products like the Eurofighter (joint venture between BAE and EADS). 

The Thales Group is a French defense firm specializing in communication technology. It is also a somewhat nationalized firm, with state ownership at about 27 percent and is closely associated with Dassault Aviation.

The contrast and confluence of these competing firms is remarkable. BAE and EADS are publicly traded while Finmeccanica and Thales rely heavily on state support and investment. Finmeccanica, BAE and EADS work closely on the Eurofighter project among others.

EU and state programs give these firms even greater advantage, sometimes in a controversial manner. Airbus, the European civilian passenger aircraft manufacturer, and Boeing, the US aerospace firm, are engaged in a tit for tat legal battle citing improper subsidies on both sides. The US filed suit to the WTO that Airbus received an unfair advantage in government loans and launch aid. The EU countered with accusations of illegal tax breaks for production facilities in certain US cities. After nearly seven years of legal arguments, the WTO ruled in separate findings that both parties had cause to their accusations, though not as severe as initially brought forth. The competition and complaints are likely to continue for years to come. This case demonstrates two key advantages of the EU institutions. First, the very launch aid that the WTO declared illegal provided the necessary capital to get the industry up to a profitable level in Europe. Second, the EU was organized and large enough to bring great weight to the WTO in advocating the European industry’s case.

What About Externally Generated Competition?

This study has shown the advantages the European aerospace and defense industry enjoys due to its integrating and coordinating policies. The EU maintains regulations that protect firms from adverse effects of competition within the confines of its members, but firms also compete with each other in the external market. For instance, the top firms attribute their most important markets to the US, the Middle East, Australia, and India. Regulations on the conduct of member states in serving as an advocate for domestic industries do not appear to exist.

Competition for lucrative fighter aircraft contracts is generally fierce. In 2011, after years of deliberation, Switzerland announced that it would award Saab (Sweden) with the contract to furnish its military’s new aircraft. Saab had been in competition with Dassault Aviation (France) and Eurofighter (BAE/EADS/Finmeccanica). The evaluation was highly politicized, and leaked documents exacerbated speculation of unfair political pressure. Fast-forward a few months to January 2012 and the competition is eerily familiar, this time in India. The Indian military announced it would award its aircraft procurement contract to Dassault Aviation. This follows intense lobbying by the French government to woo buyers for its fighter. A foreign market is essential for France in particular because of the high priority it places on its strategic independence. Without a foreign buyer, its production lines would have to cease since it cannot afford to perpetuate production given its own budgetary constraints. Having been the lowest bidder in the Indian competition, it is entirely likely that the French government subsidized some of the costs in the agreement, thus undermining its competitors at Saab and Eurofighter. This kind of undercutting could also have taken place in bidding in the UAE and Brazil.

What are the Implications for the Future?
    
The characteristics of the EU institutions and proclivity to export could be defining a new type of military industrial complex. This European military industrial complex is one that enjoys the benefits of government advocacy but does not influence state fiscal policy. Instead, the European aerospace and defense industry maximizes profit and productivity by selling its war fighting equipment abroad. The trend of diminishing defense spending coupled with increased defense revenue points to the likelihood of such a scenario. The EU and EDA are likely to act as complementary institutions to facilitate and coordinate specialization in a way few countries will be willing to do. These firms will have all the aforementioned advantages but will not be constrained to a domestic market that will demand exclusivity. Instead, they will be allowed—and even encouraged—to pursue profit maximization while various member states exert political influence to secure contracts. The pursuit will not be uniform, as exemplified by nationalized firms in France and Italy. That said, European firms would most likely become even more integrated to reap economic benefits. The European aerospace and defense industry market penetration is also interesting to consider. These firms produce products that are not necessarily the most advanced (the US firms still clearly hold the advantage), but are very competitive in a cost to capability perspective. They court areas where there is a demand for their products at their price. Considering that these areas are places like the Middle East, India, Brazil, and the Pacific, these firms are likely to continue to do well. These areas are not only emerging markets with enormous potential, but also they are highly prone to armed conflict. With the influence the European aerospace and defense industry may exert upon the EU, it is not inconceivable that EU foreign policy (however uncoordinated) might seek to stabilize its market by accepting conflict abroad.    

On the other hand, the US military industrial complex must take note of these trends. It is fortunate the US firms are so integrated with European firms. The US leadership of the F-35 program is an important multinational production proof of concept. The problem is that the US commands a great amount of influence due to its own consumption capacity. The estimated US share of orders accounts for half of the demand. With more and more participants reevaluating their orders, that share is likely to increase. This actually perpetuates the status quo of the US military industrial complex generating a supply and forcing domestic consumption. It also reinforces the European firms’ practice of benefiting from an export surplus. The US is likely to seek to maintain its dominance on innovation and comfortable lead in technology. It must seek to exploit comparative advantage across the aerospace and defense industry. In doing so, it might be worth increased cooperation with the EDA or even to establish somewhat of a bilateral body to maximize efficiencies in the transatlantic defense industry. Such an arrangement would have limitations, of course. The Boeing and Airbus competition is not likely to subside, but then neither is competition among EU members abroad.    

Members of the defense cooperation community should take heed of these trends and seek to support cooperation with European firms and take advantage of internal EU competition where possible. The EDA’s priorities should serve as a guide to where the EU would like to head with respect to capacity development. The US has a lead in some of these areas. It might be worth engaging the EDA to narrow its list to further maximize comparative advantage vice duplicating efforts of US firms willing and able to sell products like ISR and strategic airlift equipment. The US has a lead in these sectors. Furthermore, US security and industry would profit from factor specialization, particularly in cyber defense, fuel and energy. Efforts in defense cooperation in key emerging markets such as Brazil and India will benefit greatly from understanding developing trends in the European defense industry. If the Dassault Aviation case serves as a guide, officers should pay attention to important contract competitions—not for the winners, but for those who lost out in recent battles who must secure a contract in order to maintain production. These firms may receive benefits from the state in the form of diplomatic persuasion or subsidies (or both) in the interest of maintaining domestic industry and employment. It is more probable that the nationalized firms would profit from such action compared to the consortium or public companies. Those firms might have their own method of lobbying through private means.

Conclusions

The results of this study indicate that not only do EU institutions and policies benefit European consumption but they also enhance their export capacity abroad. This is most likely attributable to the efficiency-promoting incentives of EU policies and coordinating efforts of the EDA. In doing so, industries across European borders are able to pursue their comparative advantages and reap the benefits of specialization. These benefits do come with a trade off. In specializing, the European military industrial complex becomes dependent upon mutual cooperation and coordination. This is exactly what Jean Monet had in mind at inception of the European Coal and Steel community. As the EDA progresses and European defense products increase their global market share, the world will observe a new type of military industrial complex. This new model is one that does not influence its government to put its products to use (as in the US), but rather may encourage others to fight among themselves.

About the Author

MAJ Michael Wise, US Army, is a Foreign Area Officer (FAO) specializing in European Affairs. He holds a BS from the United States Military Academy and is pursuing an MA from the Bush School of Government and Public Service at Texas A&M University. His assignments in Europe include Germany and France.

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Notes

1  Staab, (Kindle Locations 114-116).

2  Artis and Nixson, 137.

3  European Defense Agency.

4  Ibid.

5  Ibid.

6  Nielsen.

7  Ibid.

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