TCS Daily

A European Defense Market?

By Marcus Stober - November 3, 2005 12:00 AM

European defense markets are fragmented into 25 different entities in which few common rules are applied and national interest prevails over economic rationales. This ends up costing consumers. Just how much European taxpayers are overcharged due to a lack of competition in the EU's €32 billion procurement market is open to discussion but a study by the authors Keith Hartley and Andrew Cox from back in 1992, suggested there was a 10 to 17 percent deficiency in procurement management. In other words, European taxpayers could have up to 17 percent more defense equipment or - depending on how one looks at it -- reduce their procurement budgets by the same percentage.

The explanation for this is of course history and the very nature of defense materials. As in the U.S. defense markets are protected because of their sensitive nature and importance to national security. The EU treaties exclude "military goods" from the previsions of the internal market, casting doubt on procurement procedures and leaving politicians to overrule economic rationales.

In an atmosphere of declining defense budgets, technological development and political integration, Europe is set to address this problem. In a first step the European Commission has come out with a so-called Green Paper opening up the discussion on how to apply market logic to EU defense procurement.

To be fair, European defense markets have changed since Cox and Hartley presented their findings. The European defense industry has been consolidating itself and we have seen the creation of a pan-European defense company, EADS. Compared to ten years ago European industry is more integrated and we have seen internationalization of large defense projects. EU governments are today more eager to work together on large military projects. This cooperation is done both at a bilateral level within the EU and sometimes together with American firms. Most notably the A-400 transport aircraft, the European satellite navigation project Galileo (although not conceived to serve the military market -- it has potential military applications), the Joint Strike Fighter Project and the Euro fighter aircraft, are examples of increased pooling of common resources.

At a political level the Common Foreign and Security Policy has developed with the Security Strategy and we have seen the creation of the European Defense Agency, which is a modest but important step in centralization of EU defense resources. The rationale for these developments is simple.

Technology has become too expensive to develop on a purely national basis and the customer base too small to sustain at commercial ground. Falling European defense budgets and increasingly expensive technological projects push for a change towards a more integrated approach. Europe can simply not afford not to cooperate at the defense industry level. But Europe has still a long way to go before it can talk about a common market in defense. In reality, collaboration happens mainly at prime-contractor level. This means that it is only the larger contractor who is exposed to some competition; at lower end of the value chain little competition occurs. Still, the bulk of business is done without invoking a greater European dimension. Non-market practices such as work-sharing (juste retour) and compensation agreements (offset) are still common features and often exceed the underlying purchasing value.

This unsatisfactory situation has prompted the Commission to move on the issue. It is considering ways to achieve greater harmonization and level the playing field for the defense industrial market. First, it is outlining the legal uncertainties and pushing for increased transparency. A second approach would be a legal inventory at Community level in the form of a "list" of products that are of "military nature" and therefore not subject to common procurement rules. The idea is not to override member states' competencies but to complement and increase transparency in a world of murky rules and regulations.

These are all steps in the right direction but they are limited in scope and in what they can achieve. European defense markets will unfortunately be left in the shady corners of treaty exemptions -- even after the latest EU initiatives. Overcoming this fragmentation and introducing real competition among industry players will require a more aggressive application of common procurement rules. This would provide real value for money for European taxpayers. It will require not only political courage but, even more important, plain old trust among allies.

The author is director of policy at the European Enterprise Institute. He writes here in personal capacity.


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