Capitalist crisis and European defense industry

Friedensforum, November 2010 by Wendela de Vries — The global top 20 of arms producers ranks 4 European companies on high positions. Leading is British BAE Systems (former British Aerospace).

The Swedish peace research institute SIPRI even ranked BAE Systems as the biggest global arms producer in 2008, but US weekly Defense News, using another ranking system, is listing BAE Systems third after the American companies Boeing and Lockheed Martin. Beside BAe the three other European giants are Italy’s Finmeccanica and formally Dutch-based EADS, both  mainly aeronautical companies, and French electronics company Thales. The output of these giants is bigger than the output of many a developing nation. They arose from the mid-1990’s in a process of mergers and acquisitions, when international (notably American) competition forced European defence companies to overcome national limits in order to survive. At that time a lot of state-owned defence companies were privatised, facilitating the accumulation process. Still national governments often kept a say in their defence industries: Finmeccanica is 30% state-owned, Thales is 27% French state and EADS is partly French state and a Spanish state holding company. Note that in contrast BAE Systems is private, although the company can count on strong government support, including export promotion, sales financing and even covering up high-level corruption.

This state involvement marks the fact that the defense industry is not a normal sector of the capitalist economy. Arms production is a case of national interest more than just an economic activity. By a national security exception arms trade is excluded from the 1947 GATT agreement and from every trade accord since, including the WTO and EU treaties. This gives governments the possibility to subsidize research and production and to promote sales. National arms industries are pampered.

Spending cuts

Since the economic crisis however, even in the United States defense budgets are no longer sacred. The fact alone that the US Senate trimmed the budget at all –with just a little more than 1% off the $678 billion that Obama requested – is worrying the defense industry. In Europe, the United Kingdom and France together account for about 40% of the European defense spending and 50% of the equipment budget. British defense now faces severe cuts of 8% over 4 years. Including the decommissioning of Harrier aircrafts for aircraft carriers, and the cancelling of the vertical landing – aircraft carrier version – Joint Strike Fighter. Which leads to military sneering that the UK will be the only country with an aircraft carrier without aircrafts to carry. Even the replacement of four nuclear submarines will be delayed. Other orders, like for Chinook helicopters, have been reduced in numbers. Both the White House and the UK defense industry have expressed their worries. It is yet to be seen if all announced spending cuts will indeed materialise.

In France, the grow in the defense budget is merely slowed down. So far the defense industry is hardly affected, most saving comes from personnel lay-off. Programs like a midlife update for the Mirage are delayed rather than suspended. On the other hand the French industry worries about loosing its position in the arms export market. No Rafael fighter jet deals have been signed last year and the French government has to jump in to keep up production levels. Another advantage – for industry – of being a protected national security interest. When the debt problem persists, analysts expect more defense cuts though, notably after 2012 elections.

Other European countries show a mixed picture. Spainis cutting its 2011 defense budget by 3,5% in real terms as compared to 2010, mainly reducing personnel spending. In Sweden it is yet unclear if and how the new centre right government will cut in defense. The new Dutch government cuts defense spending with € 600 mlj. but saves the air force pet plan to buy Joint Strike Fighters, favouring defense industry which profits from participation and offsets.

In Germany it is yet unclear how the announced defense cuts will be paid for. It is not likely that the abolition of the draft alone will cover the cuts. Order cuts are also under consideration,possibly affecting EADS profits. On the other hand, Germany has risen to the third position of global arms exporter applying practically no export restrictions. Italy, contrary to former warnings for defense cuts as deep as 10%, keeps the budget for 2011 stable. According to a Finmeccanica CEO procurement spending will even rise in 2011. That might be wishfull thinking though: Italy recently reduced its order of Eurofighter jets by 25 planes and will buy 6 FREMM frigates instead of 10.

On the other hand, Norway increases its defense spending by 3,5% based on its rising oil revenues. There is also still growth in eastern Europe, notably in Poland which is raising its defense budget with 7.1 percent as compared to 2010, much of which is spend on armament modernisation.

It is not always possible to delay or cancel procurements. What has to become for example of the 4 FREMM frigates cancelled by the Italian navy? Either they are not build at all – with employment consequences for Italian yards – or they are build and resold immediately. The problem is however: who wants to buy them? Upcoming countries like Brazil might have the cash but are well-aware of their strong position in this buyers paradise with only a limited group of possible clients. They go for the best bargain, which might be not the slightly cheaper second hand frigate but the frigate which comes with employment and technology transfer – which means buying new build – .

Reacting to budget cuts

The arms industry is preparing for leaner years by cutting internal costs, reorganising and restructuring. For the big prime contractors this means cutting in bureaucracy, increasing production efficiency and turning the consequences of the crisis to subcontractor. It also means coping with different customers wishes. For years customers preferred tailor-made products and fast production. Especially for weapons for direct battle front use, like the bunker buster bombs, developed in record time when the US wanted to attack underground Iraqi command centres. The wars in Afghanistan and Iraq have shortened the time between design and production and increased direct military involvement in design, but at a financial cost. Post-crisis costumers are becoming more cost conscious again.

The arms industry is not depending on new procurement alone. Maintenance and upgrading, of existing systems can be nearly as profitable and demand will rise as older material will be used longer to fill gaps arising from procurement delay. Neither is the European industry depending on European spending alone. Notably the Big Four – BAE, Thales, EADS and Finmeccanica – are global players with production facilities all over the world. The merger process of the last decade not only expanded production capacity but also bought access into new markets, often through partnerships with local industry which later changed into full ownership. Notably Thales and BAE have strongholds in the US market which might make up for European order losses, especially when the US continues its wars, which unfortunately it is likely to do.

And of course, there is export to developing countries. Due to high raw material prices (notably oil), countries like Brazil, Venezuela and Algeria could spend a lot on arms. As raw material prices are not that much affected by the economic crisis this trend will continue. Other countries, such as India, try to arm up to their new status as upcoming power. The worried neighbours of these countries react by also buying more arms. Resulting in regional arms races in the south and profits in the west.

Shortage of financing might cause problems for big arms deals. International trade in general is hit hard by the economic crisis as banks are more reluctant to finance big and risky projects. For this reason some governments have extended their export credit budgets. European export credits pay for approximately one-third for arms exports.

EU arms export facilitation

On the international arms market Europe encounters strong US competition, not only outside Europe but also inside the European market. With their extensive home market US companies have a cost-cutting scale advantage over Europeans. Common production programs such as the NH90 helicopter have been developed to counter this. Most of these programs however are inefficient and extremely overrunning time and budget, because work is divided on political rather than on economic grounds. The name NH90 illustrates this, it was named so because it was supposed to be the helicopter of the 1990s, but deliveries began in 2006.

A more standardised European procurement in the context of the Common Foreign and Security Policy CFSP is also struggling with too many national interests to reckon with. The EU founded a European Defense Agency (EDA) to develop European defence capabilities which managed to minimised the role of the EU security exception in arms procurement (article 296 of the EU Treaty) but the EDA instrument to create a public tendering system for military production – an electronic bulletin board – has been not very successful so far.

Probably the most successful EU measure to support the arms industry has been to bring homeland security under a EU budget line. In this way it is possible to support defense industry research programs with EU money while evading political sensitivities, simply by calling defense production security production. Progress on European defense cooperation is only made when just a few countries are involved. Such as the French-UK initiative launched in 2006 in St.Malo, when a high-level working group was created comprising the two deputy defence ministers and two top industry executives. On November 2 this year the two countries met again at Portsmouth. Cameron and Sarkozy signed a defence treaty for more cooperation. Amongst others, the treaty will help solve the British aircraft carrier problem. The treaty stands firm, it cannot be reversed by successor politicians and will be ratified by the French National Assembly and possibly by British MPs.

According to a government official “this firm underpinning is important, especially if you want to give confidence to the countries’ defence industries to work together more closely.“. Which is important because the biggest treat to Europe’s defense industry is not the economic crisis. It is the American and maybe in due time the Chinese defense industry. And of course a lasting peace.

Wendela de Vries