EUROPEAN ARMS COOPERATION: Developing a Single Market and a European DIB

1
EUROPEAN ARMS COOPERATIONDeveloping a Single
Market and a European DIB

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

2
ECONOMIC DRIVERS

• Defence Economics Problem
• Inefficiency in EU Defence Markets
• Improving Efficiency
• Arms Cooperation EDEM Scenarios
• Challenges EDEM EDTIB
• Collaboration Case study of Typhoon
• Future Defence Firm

3
Background

• Arms Cooperation
• EDA EDEM EDTIB
• Removing market distortions
• Arms Collaboration
• Typhoon A400M Meteor missile JSF/F-35
  USA/Europe

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)

5
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
  AvoidedEconomic Drivers

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
• 2. 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
• 1. Rising equipment costs independence and
  duplication of RD are costly
• 2. 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 cost savings
• Gains from scale and learning 15 - 25 cost
  savings

12
Single EU Market Scenarios

• Scenarios Annual cost savings
• EU Only Open to RoW
• 1. Competitive
• Market 9
  11
• 2.Single EU
• Procurement Agency 15 17
• 3. 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 ?

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CHALLENGES EDEM

• Requirements for EDEM
• Open Market Free entry/Exit
• Abolish preferential purchasing Article 296
  Buy US Act
• Abolish Subsidies State-owned enterprises
  Offsets Cost plus contracts
• Problem Govt determines defence markets. As
  buyersdistort markets

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CHALLENGES EDTIB

• Features of strong EDTIB
• Private firms
• Free entry/exit
• Sufficient numbersrivalry (5 or more similar
  sized firms)
• Fixed price contracts
• Average/normal profits in long run
• Capital market pressures

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CHALLENGES EDTIB

• Features of weak EDTIB
• State-owned monopoly
• Entry/Exit barriers
• Inefficiency
• Lossessubsidiessoft budget constraints
• Cost-plus contracts
• No capital market pressures no take-overs/no
  bankruptcy

17
Collaboration as EU Defence Industrial Policy

• Case Study TYPHOON
• Economic Evaluation
• Benefits/costs
• Methodology How to assess collaborative
  projects?

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ECONOMIC EVALUATION

• Benefits The ideal case
• Cost Savings in
• RD sharing between partners
• Production Combined orders lower upc via
  economies of scale and learning
• Life-cycle costs Combined orders for spares,
  etc

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ECONOMIC EVALUATION

• BENEFITS The actuality costs
• INEFFICIENCIES from work-sharing
• RD eg duplicate flight testing
• Square root rule
• Production national final assembly some loss
  of learning economies

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ECONOMIC EVALUATION

• Other Inefficiencies
• Bureaucracy/contractors International
  organisations for government buyers and for
  suppliers create transaction costs result is
  Delays in delivery
• Average delay of almost one year

21
METHODOLOGY

• How can we assess collaborative projects?
• Problems
• Counter-factual
• No national comparators
• Choice of comparators eg For Typhoon
  Rafale Gripen US rivals?

22
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)

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Typhoon Exports

• Export orders
• Value Euros 10 Bn (minus offsets)
• Jobs 12-13000 jobs
• Import-savings Euros 33.5 Bn 54 Bn
• (higher figure if Typhoon least-cost lower
  figure based on US alternatives- F-15/F-18

24
CRITIQUE

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

25
Typhoon Other Criteria for Assessment

• Cost escalation/Delays
• Astute 47 on costs
• 41 months late
• Type 45 Destroyer 18 on costs
• 36 months late
• Nimrod MRA4 24 on costs
• 89 months late
• Typhoon 14 (but lack of current data)
• 54 months late

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Collaboration Rules and Questions

• Rules
• Aim for minimum number of partners Two.
• Others can join but not as partners
• End juste retour for individual projects and
  for range of programmes work sharing on
  political criteria is inefficient

27
Collaboration Questions

• Why so few European companies
• Instead project specific companies/consortia
  Panavia Eurofighter (loose federations)?
• But Success of Airbus
• Achieving US scales of output
• Is JSF a future model?

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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 for key UK firms

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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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OFS Next Steps?

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

31
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

32
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

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Future Defence Firm

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

34
Future EU Defence Firm 2018

• More mergers larger firms both primes and
  suppliers
• More emphasis on upgrading existing platforms
  services/military outsourcing focus on homeland
  security
• Greater use of civil technologies
• Scope for removing duplication and excess
  capacityjob losses (200,000-350,000 job losses?)

35
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

36
ECONOMIC DRIVERS

• Constant/Falling defence budgets
• Rising costs equipment/personnel
• Case for Arms Cooperation
• Cost savings from competition and scale
  economies
• Case for Arms Collaboration
• Cost savings in RD and production
• (Economies of scale/learning)

37
Major Policy Challenges for EU

• Maintaining Competition.
• Options Open EU to foreign firms
• Or regulation of private monopolies
• 2. Maintaining DIB during troughs in orders
• Problems where key capabilities are defence
  specific (eg nuclear submarines)