Combine to survive: The European defence sector on the threshold

As the events of the last month make alarmingly clear, Europeans are now operating in more hostile and unpredictable geopolitical environment. The question of how they now defend themselves is more pressing than ever. Some aspects of this challenge can only be resolved over the long term. Enhancing the competitiveness and productivity of the European defence industry is one such aspect.

Traditional policy tools are inadequate to the task. Regulation and harmonisation are not enough. Nor is it a matter of simply increasing spending or income transfers. In short, government needs to look beyond government to achieve its goals—and find new ways to understand and boost the private sector.

The solution is to bring about transformations within defence companies. As the Letta and Draghi reports forcefully argue, European companies must enhance their competitiveness, scale and technological knowhow and capacity  in order to compete with Chinese and American companies. But—and especially in the defence realm—they can only do so if they can have certainty about governments’ intentions and thus feel confident about the levels of market risk they face.

Rising to the current challenge therefore requires a full strategic transformation of public policies to create a new relationship between governments and private firms. This renewed relationship should be about governments understanding better what companies need and how they function internally.

In the way their sector operates, defence companies know their products have their market guaranteed. There is a clear demand, and buyers can impose clear technological orientations. Defence projects respond to specific programmes and concrete demands. In terms of the present challenge, the advantage is that this market has clear purchasers, mostly governments, which can guarantee demand for a long time, reducing market risk and uncertainty.

However, until now governments have given too little direction, or invested enough in innovation and technological progress. In the United States, companies’ scale has helped create significant markets, like the space sector, made up of companies able to jump from the public to the private sphere. They were able to do this thanks to the availability of technology, human capital, a solid public-private institutional framework of knowledge and the strength of US capital markets.

Simply put, there are things that Europeans do not know how to make, making them dependent on the US

In contrast, in Europe huge sectoral gaps have long gone unaddressed. Europeans are behind in industrial capacity and technological development. Simply put, there are things that they do not know how to make, making them dependent on the US for equipment like drones or the ability to launch satellites in large numbers.

The implementation of the EU’s flagship NextGenerationEU fund has shown that the availability of funds is insufficient for private companies to undertake the large investments required to develop advanced technological innovations, bring about profound transformations in production processes or carry out pure research in experimental or “deep” science. Europe will be immeasurably strengthened if investments take place in these areas. But they are currently not happening. Funds have been available through NextGenerationEU and other channels, but companies have not used them as quickly as expected. This is for a variety of reasons, including uncertainty among companies about the profitability of what they produce. A clear market risk has too often prevailed.

Europeans therefore need to expand the EU budget (in the multiannual financial framework) and replace NextGenerationEU with a new fund for defence and create another for growth and competitiveness. European defence and technology companies should work together, merge and launch common programmes in a coordinated way. European Commission president Ursula von der Leyen’s announcement of an €800bn defence fund was welcome but details remain scarce. The apparent new mood regarding debt in the putative German government coalition is good news too in this respect.

The EU should coordinate these efforts through the European Commission’s defence department but also be open to working with countries like Britain, Canada and South Korea. The transformation of defence companies is possible—if European governments, working with EU institutions, make the right choices about the right investments in the sector.

Juan Moscoso del Prado is a senior fellow at EsadeGeo (Esade)