WSI

In an effort to get more and better weapons out of the limited defense budgets in Europe the EU is moving to create an integrated defence equipment market. The idea is to liberate competition for defence orders across borders, thus challenging the national monopolies and bringing down the price of military hardware. If successful the EU plans would also give new momentum to the stop-and-go process of consolidation in European defence industry.

Background

Weapons are a good unlike any other and thus may never be traded freely. They often contain classified technology and the need for maximum security of supply also limits the choice of contractors. In placing orders for military equipment EU member states’ governments historically sought to favour the countries’ own industrial base, on the grounds that in the time of conflict they can only rely on own industry to supply the necessary hardware and software.

For all these reasons weapons and related technology have been exempt from EU’s internal market rules that allow civilian goods to move freely across national borders. Article 296 of the Treaty on the European Union permits member states to bar foreign suppliers from bidding on orders of military technology. The exception, however, is increasingly viewed as a tool for abuse. A May 2005 report by the EU Institute for Security Studies found that a number of states evoke Article 296 to protect non-competitive firms rather than to serve strategic interests. The conclusion is shared by the European Commission, which wrote in its 2004 Green Paper on Defence Procurement that “some Member States believe they can apply the [Article 296] derogation automatically.”

Article 296 also fell out of favour because a decade of low budgets in Europe is forcing governments to look for creative ways to cut costs. Even defence ministries, traditionally the champions of domestic defence industrial interests, are rethinking their approach. As things stand, much of the €160 billion spent annually on defence in member states of the European Union is wasted on bureaucracy and protective measures. Competition is viewed as one way to generate more bang for the defence ministries’ Euros. Not only does competitive bidding as such bring down the price, liberalization could allow Europe’s more successful companies to sell to multiple users, thus generating economies of scale. These translate to further savings when they are passed on by defence contractors to end users: European militaries. This is a key priority given that most member states are falling behind both EU and NATO modernization goals, and – with few exceptions such as France and the United Kingdom – European defence budgets are low and stagnant.

European Initiatives

In July 2004 the Council of the European Union created the European Defence Agency (EDA) with the express mandate to optimize and harmonize the way the member states spend their military budgets. As one of its top priorities the EDA set about liberalizing the market for weapons and related equipment. On Nov. 21, 2005 it released a Code of Conduct on arms procurement aimed at spurring cross-border competition for defence orders. The Code is non-binding but if it proves popular, it would end the current procurement system that protects national defence champions at the expense of foreign – often cheaper – suppliers.

The Code of Conduct creates a virtual marketplace in military technology that allows suppliers from across the EU to bid on tenders in any participating country. The system is designed to be universal and transparent; participating governments agree to publicize most orders over €1 million along with clear selection criteria and timetables. The Code does not change or abolish Article 296 but it calls on member states to provide detailed explanation each time the exception is invoked. In a nod to the sensitive nature of the defence equipment market, the Code does not apply to biological, chemical and nuclear technology or to procurement in times of national crises.

The Code of Conduct is just one of several steps aimed at liberalizing the European defence equipment market. The European Commission has chosen a different but compatible approach at liberalization. In its 2004 Green Paper and a subsequent December 2005 Communication the Commission opted for an Interpretative Ruling, which would limit the scale of Article 296. Such ruling would in theory cut down on cases when governments evoke Article 296 as a purely protective measure rather than on security grounds. In addition to the Interpretative Ruling, the European Commission may also pass a binding Directive on defence procurement, which would establish specific EU-wide rules of competition in the field of defence. The Commission is to study the likely impact of such Directive in 2006 and is expected to make a decision the same year.

In its efforts, the Commission is being pressured by the European Parliament, which approved a resolution on Nov. 17, 2005 that calls on the Commission to act to create an open market in defence goods. The European Parliament also broadly endorses the Council’s approach. The resolution calls the fragmented nature of the armaments market in Europe “one of the causes of weakness of Europe’s military capabilities,” and urges the Commission to introduce mandatory measures injecting more competition and transparency. The Parliament’s resolution has no legal power over the work of the Commission or the EDA but its findings are often influential in shaping the institutions’ work.

Key Issues in European Debate

Defence Industry: National or European?
While the military marketplace remains stubbornly divided along national lines the defence industry itself is increasingly European. A 2000 merger of France’s Aerospatiale Matra, Spain’s Construcciones Aeronáuticas, and Germany’s DaimlerChrysler Aerospace produced the European Aerospace Defence Company (EADS), now the second largest defence contractor in the world. In 2002, Aérospatiale-Matra Missiles (of EADS), Alenia Marconi Systems' missile divisions (an Italian-British group) and Matra BAe Dynamics (a French-British-German consortium) combined to create a European missile company, MBDA.

If the European Commission and EDA succeed in shaking up the procurement system, they will inevitable trigger more consolidation in defence industry. Limits on the government’s use of Article 296 exception could mean that some companies that sell exclusively to their national defence ministry will find themselves squeezed out of their only market by foreign competitors. In contrast, suppliers who are better adapted to working across national borders may find their business opportunities dramatically expanded. As a consequence, some of the less competitive companies are likely be acquired or go out of business altogether.

How Much Consolidation Is Too Much?
In pursuing further consolidation, the European Commission and the EDA will be careful to avoid the United States’ painful experience. From 1993 to 1998 the US Department of Defense encouraged and oversaw a wave of mergers that dramatically reduced the number of suppliers while spawning global military giants such as Lockheed Martin. However, in a number of key technological areas competition essentially disappeared, producing upward pressure on prices. The cost of virtually every important weapons program of the past decade has spiralled beyond the original estimate. By 1998 the Pentagon has reversed its previous policy and put a halt to further mergers. More recently, in an acknowledgement that industrial consolidation has gone too far, the U.S. Department of Defense began encouraging European companies such as EADS to compete in the United States so as to introduce more choice to the U.S. defence equipment market.

Liberalization: Within or Without Europe?
While member states agreed to liberalize procurement within Europe, differences persist on whether European markets should be opened to non-European industries. The debate focuses primarily on the United States, the home to mammoth defence contractors such as Raytheon, Lockheed Martin and Boeing. Broadly speaking, the viewpoints in Europe can be divided into two categories: some member states adamantly oppose opening the markets to U.S. companies on the grounds that U.S. Department of Defense discriminates against non-U.S. suppliers. (So-called ‘Buy American’ provisions have a strong support in U.S. Congress but a number of European companies manage to do considerable business in the United States nevertheless; UK-based BAE Systems is the fourth largest supplier to the Pentagon.) The European Parliament’s Nov. 17, 2005 resolution specifically linked opening of the European markets to U.S. companies to reciprocal changes in U.S. procurement rules.

Another school of thought among European governments holds that if the ultimate goal of liberalization of defence markets is to bring down the costs it must be open to the most competitive – even non-European – bidders. (Most European governments already buy considerable amounts of U.S. weaponry.) Not surprisingly, governments whose companies have a strong foothold in the U.S. market – such as Great Britain through its BAE Systems – tend also to favour keeping European orders open to U.S. bids.

Timeline

2006 – European Commission is to issue an Interpretative Communication on the application of Article 296 of the Treaty in the field of defence procurement
Dec. 6, 2005 – European Commission releases “Communication from the Commission to the Council and the European Parliament on the results of the consultation launched by the Green Paper on Defence Procurement and on the future Commission initiatives”
Nov. 21, 2005 – Council of the European Union releases Code of Conduct on Arms Procurement
Nov. 17, 2005 – European Parliament approves resolution on defence procurement
June 23, 2005 – European Parliament holds public hearing on defence procurement in the Internal Market
Sept. 23, 2004 – European Commission releases Green Paper on Defence Procurement
July 12, 2004 – European Defence Agency (EDA) created
March 11, 2003 – European Commission releases communication “Towards a European Union defence equipment policy”
Nov. 8, 2000 - European Commission's Conference "European Defence Procurement in the 21st Century"

Sources for further reading

Communication from the Commission to the Council and the European Parliament on the results of the consultation launched by the Green Paper on Defence Procurement and on the future Commission initiatives, Dec. 6, 2005

The Code of Conduct on Defence Procurement of the EU Member States Participating in the European Defence Agency, Nov. 21, 2005

European Commission’s Green Paper on Defence Procurement, Sept. 23, 2004

European Defence Agency’s web site

Burkard Schmitt (rapporteur), “Defence Procurement in the European Union. The Current Debate,” EU Institute for Security Studies, May 2005.

Toward an EU Defence Equipment Policy, web site of the European Commission’s Directorate General for Enterprise

“Intra-Community Transfers of Defence Products,” report prepared by Unysis for the European Commission, February 2005

Commission Communication to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on Implementing European Union Strategy on Defence-Related Industries, Nov. 12, 1997