EUROPEAN DEFENCE EQUIPMENT MARKET

1
EUROPEAN DEFENCE EQUIPMENT MARKET

• Keith Hartley
• Centre for Defence Economics
• University of York

Seminar on European Defence Procurement,
Bucharest, 13-14 November 2007
2
OVERVIEW

• Background
• Defence Economics Problem
• Inefficiency in EU Defence Markets
• Improving Efficiency
• EU Scenarios
• Case study of Typhoon
• Offsets
• UK DIS

3
BACKGROUND

• OCCAR FGItUKSpBelg armaments agency for
  European collaborative projects
• Industrial Restructuring EADS Thales
  AgustaWestland MBDA
• Collaborative Projects Typhoon A400M Meteor
  missile JSF/F-35
• EDA (2004) EDEM EDTIB Offsets (?)

4
POLICY ISSUES

• EU as inefficient defence market both Armed
  Forces and Equipment Markets
• Economic Principles for Improving Efficiency
• Role for EDA beyond a voluntary code
• USA-Europe Arms Trade both protected markets US
  DoD awarded 78 billion of defence contracts to
  US suppliers and 1.9 Bn to foreign suppliers
  (2005)

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DEFENCE ECONOMICS PROBLEM

• Constant/falling national defence budgets (real
  terms)
• Rising INPUT costs
• -Equipment 10 pa in real terms
  smaller numbers
• - Military personnel costs of AVF
• RESULT
• Difficult Defence Choices Cannot be Avoided

6
Defence Economics Problem New Dimensions

• End of Cold War has made no difference-
• unit cost escalation has continued
• Example 1. UK cannot afford successor to Typhoon
• Example 2. By time UAVs are as capable as manned
  aircraft, they will be equally as expensive
  hence just as unaffordable

7
DEFENCE ECONOMICS PROBLEM

• Solutions
• Equal Misery gradual reduction in force
  effectiveness
• Major Defence Review
• Increased efficiency
• EU Defence Policy

8
INEFFICIENCY OF EXISTING EU DEFENCE MARKETS

• EU defence markets INEFFICIENT in providing
• Armed Forces
• Defence Equipment
• Criteria US model
• Compared with USA EU lacks
• Single EU Army, Navy, Air Force
• Large Single EU market for defence
  equipment

9
INEFFICIENT DEFENCE MARKETS

• Duplication of costly RD programmes
• Small-scale production for small national markets
• Protectionism
• Cost-based non-competitive contracts
• Domestic monopolies some state-owned

10
An Efficient EU Defence Industrial Policy

• APPLY ECONOMIC PRINCIPLES
• Rising equipment costs independence and
  duplication of RD are costly
• Gains from Free Trade based on comparative
  advantage
• Gains from scale and learning economies
• Gains from competition

11
RULES FOR AN EFFICIENT EU DEFENCE INDUSTRIAL
POLICY

• Gains from Trade 10-25 savings
• Gains from scale and learning 15 - 25

12
Single EU Market Scenarios

• Scenarios Annual cost savings
• EU Only Open to RoW
• Competitive Market 9
  11
• Single EU Proc Agency 15 17
• Twin Track 11
  14

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COSTS OF SINGLE MARKET

• Change is not costless
• Winners and losers
• Losers will oppose change
• Lobby for fair/managed competition
• Juste Retour
• Protection
• Fear cartels/collusive tendering
• RESULT Inefficient EDTIB ?

14
Collaboration as EU Defence Industrial Policy
TYPHOON

• Economic Benefits
• Jobs 100,000
• Technology/spin-offs carbon fibre technology
  civil aircraft/engines cars/F-1 supply chains
• Exports Saudi Arabia (72) Austria (15)

15
CRITIQUE

• Opportunity cost question alternative use value
  of resources?
• Spin-offs market value?
• Are Markets Failing?

16
OTHER POLICY ISSUES

• EDA study of OFFSETS what do we know/do not know
  and need to know for sensible policy formulation?
• EU and UK Defence Industrial Strategy EU moving
  to open markets (?) whilst UK DIS
  guaranteed/protected markets

17
EDA and OFFSETS

• EDA View
• OFS are INEFFICIENT
• OFS illegal under Article 296 (at least for
  civil OFS)
• EDA AIM
• Harmonise and eventually remove OFS

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OFFSETS (Contd)

• PROBLEMS
• OFS why do nations favour OFS benefits?
• OFS are Market Distorting BUT
• They reflect major distortions caused by
  Article 296 and Buy US Act and
• Govts are major market distortions

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OFS Next Steps?

• Collect a decent data base on OFS in EU
• Harmonisation of OFS requirements (eg at max of
  100)?

20
UK DIS and EU

• Possible conflicts between DIS and
• EDEM with focus on open markets
• EDTIB with an EU view of the DIB, including an
  appropriate regional balance.

21
FUTURE DEFENCE FIRM ?

• Future defence firm will be different
• - Todays defence firms differ from those of
  1950 and 1900
• - In 1900, Boeing did not exist

22
Future Defence Firm

• Future global defence firms
• - international supplier network
• - suppliers larger groups undertaking RD
  for primes
• - Electronics firms as primes
• - Primes as systems integrators and not
  metal bashers

23
CONCLUSION

• EU defence policy is topical and dominated by
  politics But economists can make sensible
  contributions to the policy debate
• Existing EU defence markets are highly
  inefficient
• Efficiency improvements mean benefits to Armed
  Forces and taxpayers but costs for EUs
  inefficient defence industries