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Wednesday, January 26, 2011

European Mandate: Cut Spending, But Carefully

Defense budgets will decrease in 2011 in many European countries with few exceptions: Poland is increasing its budget, while Italy, France and Turkey are keeping spending essentially stable. Countries facing the most pressure to reduce national deficits—the U.K., Spain, Greece and Portugal—are being forced to take exceptional measures, but this is not going to have a great effect on capital investments such as the force modernization or R&D. Where cuts are necessary they are being applied gradually and are often not as dramatic as feared. For example, in the U.K. last summer, a 20% budget cut was envisioned, but the actual figure is 8%.
Almost everywhere attempts will be made to spend efficiently and reduce overhead and support costs. For many nations this means reducing the size and personnel of the armed forces. Most have moved away from “mixed” militaries made up of professionals and conscripts. Abolishing conscription has reduced overall numbers and led to leaner, better qualified and more motivated forces. Even Germany, which among the major players is the only one still using a mixed force, has decided to eliminate conscripts. Turkey, reluctant to shift toward an all-volunteer force, is creating more professional units that are performing better against PKK (Kurdistan Workers’ Party) guerrillas and suffering fewer casualties.
Overall, end strength will continue to decline: European militaries had 3.5 million personnel in 2001 and 2.3 million in 2009, with further cuts looming.
The reduction in numbers does not diminish combat capabilities. On the contrary, it generally leads to an increased “capitalization ratio,” i.e., more money spent per soldier. This trend is not new but is accelerated by operational requirements—money to improve protection of soldiers in Afghanistan or those deployed in other operations is set to increase.
There is also a qualitative change on how money is going to be spent, with a shift toward land warfare and areas such as intelligence and counter-IED (improvised explosive device) systems. The Brussels-based Aerospace and Defense Industries Association of Europe reported recently that revenues derived from sales of land and naval defense systems in 2009 were, at €45.5 billion ($60.5 billion), higher than those from military aeronautics, at €41 billion. It adds that “the emergence of new priorities—such as maritime surveillance, border-control missions, situational awareness, as well as [urgent operational requirements], through-life operational support, and integrated logistics and training—have led companies to adapt and transform their traditional structure.”
To compensate for budget cuts, some defense ministries, notably in France and Italy, are counting on selling redundant real estate and other military assets such as radio frequencies, or the lease and sale of satellite services to raise revenue. However, in France, where expected income from these sales has been included in the budget for the past two years, sales have either not materialized (radio frequencies and satellites) or failed to bring in as much as hoped. Complicated accounting mechanisms have to be brought into play to ensure this does not weigh too heavily on the 2011 budget.
Those countries with big defense industries—U.K., France, Spain, Italy, Germany and Sweden—have resisted pressure from NATO and the European Union, and sometimes their own governments, to rationalize and specialize to avoid technology duplication. NATO, in particular, while insisting that defense budgets need to be spared deep cuts, points out that only four countries meet the alliance minimum for defense spending of 2% of GDP. NATO proposes that each country provide one or more key capabilities in the name of efficiency, but nations have rejected this for years, trying instead to build a little of everything in order to be able to mount independent military operations.
Nevertheless, the economic crunch has accelerated a rapprochement between two nations, the U.K. and France, which together account for 50% of Europe’s defense budget. In November they signed two wide-ranging defense and security treaties to maintain critical capabilities in an era of budget shortfalls, says Etienne de Durand, of France’s Institute of International Relations. The U.K. made the overture, but for both countries the choice was “entente or oblivion,” he adds.
“The U.K. wants to be global, and cannot afford to be. Perhaps Britain and France can back each other up a bit as the two principal countries that can be taken seriously [in Europe],” notes Robin Niblett, director of the London-based think tank Chatham House.
Robert Walter, president of the European Security and Defense Assembly, welcomes the agreement as “a major bilateral contribution to European security, covering the whole range of security and defense aspects including deterrence.” But he warns that even if the accord provides further impetus to European cooperation, it would first have to prove its relevance through results.
There are 17 points of agreement in the treaties, which include aircraft carriers. The U.K. will install a catapult in its future aircraft carrier, enabling France’s Rafale aircraft to use it. The aim is for at least one of the French or British carriers to be available at all times. No mention was made in the treaties about a joint carrier, an idea that was shelved in June 2008, although work on it was far advanced (DTI January/February/2007, p. 17). But Laurent Collet-Billon, head of France’s DGA procurement agency, told parliamentarians in October that “we are actively working with our British counterparts on the project of a second aircraft carrier.”
The other points of agreement include setting up a Combined Joint Expeditionary Force, which will be available “at notice for bilateral, NATO, European Union, United Nations or other” operations; shared maintenance of Airbus Military A400M aircraft; joint development of a medium-altitude long-endurance combat unmanned aerial vehicle (UAV) that enters service in 2015-20 and longer-term research into the next generation of such vehicles; joint procurement of missiles; and an agreement that each country spend at least €50 million a year on research and technology in 10 priority areas ranging from satellite communications, UAVs, naval systems and missiles, to simulation and electronic warfare. The aim is to reduce the cost of complex weapons by 30%.
Other initiatives include a cybersecurity framework, development of a joint approach to mine detection and countermeasures and the possibility of France using “spare capacity” in the U.K.’s future air-to-air refueling fleet “provided it is financially acceptable to both nations.”
A separate treaty on nuclear weapons was also signed, calling for a joint facility to be built at the Valduc research center in Burgundy, France, to “model performance of nuclear warheads and materials” for “long-term viability, security and safety.”
In the face of closer cooperation between its main clients, European industry is keen to respond. In the past integration has tended to be industry-driven: EADS, for example, is the result of merging companies from Germany, Spain and France. But governments are pushing and industries are resisting, even if in many areas there are overcapacity and too many players. Naval shipbuilding is one such segment, defense electronics another. Attempts by France to rationalize redundancies in optronics, among other areas, between Thales and Safran fell on deaf ears until most of the companies’ contracts with the government were frozen—which had the desired effect and got them talking again.
European aerospace did well in 2009, with revenues of €155 billion, sustaining 696,000 jobs and maintaining high R&D investment. Airbus Military had a bumpy ride in 2010 when it appeared at times that the biggest joint European defense project, the A400M transport, might sink. Airbus is now in better shape following a revised delivery agreement between the seven customer nations finalized in November (see p. 68).
U.S. companies will expand in Europe, while investors in the Middle East and elsewhere take stakes of technology-rich European companies in financial straits. Others will modify business models and core businesses, entering markets such as cybersecurity, intelligence, homeland security, and support.
The near-term scenario for the European defense industry is Darwinian: Companies that adapt to changing markets and exploit opportunities will survive and profit. Those that do not will be acquired, or decline.

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