EMCC European Monitoring Centre on Change

Defence - challenges for the future

This third and final article in the Sector Futures series on the European defence industry sector looks at the major policy issues and challenges facing the sector. It tries to tease out some of the main factors likely to shape the industry, looking at challenges in the area of strategy and security, governance, and technology and industrial restructuring. As the article suggests some possible futures, it is more speculative than the preceding two articles.

Major policy issues and challenges

The end of the Cold War brought the defence sector into a world of uncertainty, a world where there is no longer a powerful and well-defined enemy, but a world that is, nevertheless, a dangerous place. Since the early years of the 1990s, the global military economy has been transformed by trends in military expenditure and technology that have reinforced US dominance. Unlike most other countries, the US is forecast to increase its military spending rapidly. The fixed costs of research and development (R&D) for major systems continue to grow, both for platforms and for the infrastructure (such as satellites, strategic air assets) and information systems needed to support network-centred warfare. Developments in the defence industry sector include the increasing internationalisation of production, growing importance of information technology (IT) companies and the privatisation of services that were once provided by the military.

In Europe, the defence industry is an important user of skilled labour and resources and has faced a period of change and uncertainty since the end of the Cold War. It is also an industry where national governments have had considerable control. The recent EU Code of Conduct for defence procurement is intended to bring more openness to the market and the European Defence Agency (EDA) is meant to strengthen cohesion.

The changes in demand and the nature of production, and the dominance of the US, are all factors likely to shape the sector’s future.

Policy issue 1: Strategy and security

Time profile

The changes in the nature of security threats and in the roles of the defence forces have immediate short-term and medium-term effects. Four effects stand out in the short term:

  1. The US and Europe (in the form of the North Atlantic Treaty Organisation, NATO) are unlikely to face an enemy that is as well armed, they will thus have to deal with asymmetric conflict.
  2. The lack of a clearly identifiable enemy, the nature of the war on terror and national security concerns are changing the nature of demand for defence resources; they are also making communications and surveillance technologies more central to defence activities.
  3. The armed forces are being called upon to assume more peacekeeping responsibilities around the world. This role necessitates changes in training and composition of the forces, as well as in the equipment required.
  4. These changes in the role and nature of the armed forces are happening at the same time as the existing structures of NATO and the EU feel the pressures of enlargement.

Over the medium to long term, there are two broad areas where the range of possibilities makes it difficult to forecast what will happen:

  1. The extent and nature of links between the EU and the US will need to be determined. One current example in this area concerns the presence of European defence companies in the US market. European companies are increasingly buying US companies in order to gain a presence in the US market, and so far the US is satisfied with this.
  2. It is likely that the US will continue to take a capability approach to defence production and be willing to use foreign suppliers in order to gain access to their technology; but this policy could change.

As for strategy and security issues, while it is highly unlikely that a confrontation of the nature of the Cold War will exist again, many factors will shape the future geopolitical and security environment, including:

  • the future role and nature of China and its relationship with the West;
  • competition from emerging markets;
  • the future of the war on terror and the relations of the West with the Muslim world;
  • the success or failure of the peace process in Palestine;
  • US foreign policy in the Middle East and oil;
  • the success and role of the United Nations (UN) in future security structures.

The range and interrelationships of such issues make the future a very uncertain one. They also make it extremely difficult to predict the ways that these issues will affect the defence industry, whether by geographical location within Europe, or in relation to other industries, or even in relation to the gender distribution of those who work in the industry.

It is clear, however, that these geopolitical and strategic factors - in conjunction with the other trends in technology and governance that relate more immediately to defence activities - will make the environment in which the defence industry functions one of continual change.

Geographical and sectoral

The effects of changes in strategy and security are likely to be felt in defence industries across the EU, but change will obviously be felt most in the major arms producing countries. Two different kinds of change are possible and neither excludes the other:

  • a widening of the range of industries whose products and services are sought by defence organisations;
  • consolidation of the sector.

The first kind of change will come about if changes in the nature of defence activities increase the use of what are at present civilian products and, thus, expand the types of goods and services procured by defence ministries. Such a development could on Europe’s industry, by increasing demand for goods in IT and communications, and security services.

The demand for a wider range of goods and services for use in defence would involve new entrants to this field, who will almost certainly be smaller than the leading defence contractors. It is also possible that the main contractors will take over such new entrants, thus bringing about further consolidation in the industry.

The benefits of such changes in the industrial base of the defence industry may not be limited to Europe. The internationalisation of supply chains allows for increased competition from emerging markets.

Gender

As arms manufacture is a male-dominated industry, any changes are likely to have greater impact on men than on women, at least within the traditional defence companies. Insofar as changes in defence activities lead to more civilian companies becoming involved, female employment would be affected. However, the women involved would continue working as before and would not necessarily enjoy the traditionally higher than average wages of long established defence workers (see previous articles). Their companies would simply be supplying a new market, which, of course, could lead to the creation of more jobs.

These remarks about the implications for gender apply to all three policy issues; and so will not be repeated under the following two policy headings.

Policy issue 2: Governance

Time profile

At present, two major initiatives are under way within the EU. They will alter the nature of the defence industry, but it is too early to tell how much of a difference they will make or when their effects will be seen. Their impact, if they are successful, is likely to be felt more in the medium and the long term.

The European Defence Agency was created to help EU Member States to develop their defence capabilities for crisis management operations under the European Security and Defence Policy. The EDA’s aim is to encourage EU governments to spend defence budgets on meeting future challenges, rather than past (Cold War) threats, and to help them identify common needs and promote cooperation.

The Code of Conduct for the defence sector should open up the EU national markets to competition from other EU countries. Where exemptions are invoked, which is the case today for more than 50% of defence equipment purchases, the EDA Code of Conduct is intended to ensure that there is transparent and fair competition. How well this will work in practice is unclear, but, given the other pressures that have been discussed, it is likely to increase competition and hence lead to a consolidation of the industry.

Apart from the effects of these two initiatives, there is also the question of corporate governance. In the US and the UK, financiers have played an increasing role in the restructuring of the defence industry, but this has not happened in mainland Europe, because of the different ownership and corporate governance structures there. In the medium term, the privatisation of arms producers and their involvement with the US market may bring about changes in the role of finance. If capital plays the role it has played in the US, this could well lead to considerable consolidation in the medium term. However, it is difficult to assess the implications of changes in governance structures, because any implications will be shaped by the other policy issues.

It is not yet clear whether the two EU initiatives will succeed in creating an EU-wide governance structure for the defence sector in the medium term. If there is the political will and if the EU governance structure can manage the formation of an EU defence force, this will have a major impact on restructuring of the industry. However, several forces complicate the development of an EU-wide governance structure:

  1. There is the role that NATO has managed to gain for itself. NATO has taken many of the roles that an EU defence force would have had, but it also maintains transatlantic ties.
  2. There is EU enlargement and its effects over the medium and long term. EU enlargement could remove potential areas of conflict and, thus, make the development of a governance structure easier; but it could also increase the threats to which the EU is exposed, making it more difficult to develop a governance structure.
  3. The way in which links between the EU and the US develop will be important, whether or not an EU defence force is created. These links are likely to determine the involvement of EU companies in the US market and of US companies in the EU. Such involvement will have an important influence on the size and composition of the industry.

Moreover, any such changes will be taking place at a time when competition from emerging markets could be making life more difficult for European producers.

Geographical and sectoral

As in the case of strategic and security issues, changes in governance will be felt mainly by the major arms producing countries. However, companies in these countries have links with the smaller producers in the second rank of EU countries so that the effects will certainly be felt across Europe. Although much of the restructuring that would result from changes in governance would affect the larger contractors, larger companies may also take over smaller companies to maintain or develop expertise. They may relocate to particular areas. Furthermore, they may make increasing use of overseas companies in their supply chains which would weaken the position of smaller companies that are dependent on larger contractors.

Policy issue 3: Technology and industrial restructuring

Time profile

Many of the technology issues are already apparent; but, by their nature and the nature of the defence industry, they will work themselves out over the medium to long term rather than have their effect in the short term. One major issue is the afterlife of previous Cold War weapons systems. Some of these are still in production despite the loss of their direct justification, e.g. Eurofighter/Typhoon. At the very time when these weapons systems are coming into production, different future systems are being planned, but the long lead times and the expense of the semi-redundant systems ensure that they will be around for a while yet.

Another - arguably the major - technology issue is the change that has replaced the spin-off from defence to civilian technology, with the latter now taking a leading position of influence. Contractors are increasing their use of civilian technologies in weapons systems because of their superior technological development. This is changing the nature of contractors: it has already made them systems integrators rather than producers and, in time, they may become designers, project managers and providers of R&D services.

The increasing use of commercial off-the-shelf products (COTS) has reduced barriers to entry at all but the highest level of defence contactor, while joint ventures and other forms of collaboration are undermining the comprehensive control that major contractors and subcontractors used to exercise over systems. Not least among the technological forces for change is the increasing importance of communications and control in the field of operations. Network-centred warfare is changing the nature of demand and creating the so-called Revolution in Military Affairs. Closely allied to this change is the noticeable growth in the use of unmanned vehicles (drones), which could lead to new types of systems and technologies.

All of these changes influence the nature and composition of the industry and move it further away from its Cold War form as time passes.

In the short to medium term, there is likely to be consolidation in Europe, stimulated partly by cooperation between countries and companies, and by the continued internationalisation of supply chains. There will also be an increase in the use of civilian technologies, bringing more civil firms into the industry through product sales or company takeovers. Another trend likely to remain important is the privatisation of defence services and support, as the security services industry expands as a periphery around the core arms industry. This expansion is creating a new sub-sector, important as a supplier to governments and defence ministries. Indeed, the former defence industrial base is becoming a security industrial base. This could have implications for the influence, visibility and accountability of the industry.

In summary, it is likely that there will be further important changes in the nature, structure and location of the defence industry over the longer term; however, the uncertainties of strategic and governance factors make it difficult to judge exactly what they will be. It is clear that R&D policy will need to change because the old Cold War specificity of military technology has become far less appropriate. Some technologies have only military applications, such as stealth, but the increasing dominance of civilian technologies suggests that the types of resources needed are changing.

Geographical and sectoral

Changes in technology could mean that defence production is not necessarily going to remain in the long-established locations. Systems integrators may need to be closer to clusters of high-technology civilian production than to other defence contractors. Furthermore, many weapons factories were sited in particular areas for security purposes; however, this rationale for their location has disappeared.

If there is the expected consolidation across the EU, there are likely to be important geographical changes. For example, it is likely that there will be one major area for producing warships (probably in Germany or German-dominated production in the Baltic region), and it is also possible that other major types of systems production will be sited in particular areas of Europe. On the other hand, it is also possible that the Airbus model of polycentric production will be adopted which seems rather unlikely.

The geographical changes will affect all companies. Major contractors are already changing their nature; the composition of the defence sector is also changing, as outlined in the three articles of this series. The EU will play an important role in managing the regional changes taking place as a result.

Conclusions

In an industry as complex as the defence sector, the interactions between the issues of governance, strategy, security, technology and restructuring - combined with the move away from a relatively well-defined Cold War model - make it extremely difficult to look forward with any certainty. The one sure prediction that can be made is that there will be changes, and these will have important implications across Europe. In an effort to be more concrete, this article has tried to tease out some of the main factors and suggests some possible futures. It is easier to see what is happening in the shorter term, but the uncertainties of the geopolitical strategic environment make it almost impossible to move further with any degree of certainty. What is clear is that the future holds challenges for the European governance structures to control the changing nature and location of the industry.

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