Capitalist crisis and European defence industry

Wendela de Vries

Of the global top 20 arms producers, 4 European companies are ranked in 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 Defence News, using another ranking system, is listing BAE Systems third after the American companies Boeing and Lockheed Martin. Besides 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-owned and EADS is partly French state and a Spanish state holding company-owned. 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 of high-level corruption.

This state involvement marks the fact that the defence 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 defence 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 defencce industry. In Europe, the United Kingdom and France together account for about 40% of the European defence spending and 50% of the equipment budget. British defence 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. This has lead to the 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, but BAE Systems recently announces axing up to 1,350 jobs across the UK, resulting from the government’s decision to scrap the Nimrod and Harrier jets.

In France, the growth in the defence budget is merely slowed down. So far the defence industry is hardly affected, most saving comes from lay-off of personnel. Programs like a midlife update for the Mirage are delayed rather than suspended. On the other hand the French industry worries about losing 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. This is another advantage – for industry – that of being a protected national security interest. When the debt problem persists, analysts expect more defence cuts though, notably after the 2012 elections.

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

In Germany it is yet unclear how the announced defence cuts will be paid for. It is not likely that the abolition of the draft alone will cover the cuts. Cuts on orders are also under consideration, possibly affecting EADS profits. On the other hand, Germany has risen to the third position of global arms exporters applying practically no export restrictions. Italy, contrary to former warnings for defence 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 wishful 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 defence 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 defence budget by 7.1 percent as compared to 2010, much of which is spent on armament modernisation.

It is not always possible to delay or cancel procurements. What will become, for example, of the 4 FREMM frigates cancelled by the Italian navy? Either they are not built at all – with employment consequences for Italian yards – or they are built and resold immediately. The problem is however: who wants to buy them?Emerging? 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 may not be the slightly cheaper second hand frigate but instead the frigate which comes with employment and technology transfer.

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 passing on the consequences of the crisis over to the subcontractor. It also means coping with different customers’ wishes. For years, customers preferred tailor-made products and fast production. Especially for weapons for direct use in the battle front, 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. Most probably the crisis will also end the irresponsible habit of ordering a weapon system before it is fully developed, as is done with the Joint Strike Fighter. To say to industry: “we will buy you product anyway” has resulted in overrunning of costs being permitted.

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. Industry also hopes that spending cuts in manpower might increase demand for more automation and robotics to do ‘dirty, dull and dangerous tasks’ and that the new market for ‘homeland security’ will continue to grow. 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 are exports 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 as affected by the economic crisis this trend will continue. Other countries, such as India, try to arm up to live up to their their new status as an up and coming power. The worried neighbours of these countries react by also buying more arms. Thus, 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 of arms exports.

EU arms export facilitation

In 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 on 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 Defence Agency (EDA) to develop European defence capabilities which managed to minimise the role of the EU security exception (article 296 of the EU Treaty). However, 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 national security under an EU budget line/limit?. In this way it is possible to support defence industry research programs with EU money while evading political sensitivities, simply by calling defence production security production. Progress on European defence cooperation is only made when just a few countries are involved. One such example is 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 2nd 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.” This is important because the biggest threat to Europe’s defense industry is not the economic crisis. It is the American and maybe in due time the Chinese defence industries. And of course a lasting peace.

Published in FriedensForum November 2010