European Defence Industry Cooperation: The Problem with Current Incentives

The Russian invasion of Ukraine has seemingly prompted a ‘whatever it takes’ moment for European defence, with European states announcing substantial increases in their defence budgets, in some cases even surpassing the NATO benchmark of 2% of GDP. By May 2022, according to the European Commission, European countries had announced defence spending increases of around €200 billion since Russia’s full-scale invasion began. Surely, Europeans putting their money where their mouth is on matters of defence policy represents a positive development, especially in light of the lethargic approach to defence spending that has characterised the continent in the post-Cold war era. Yet, every time new money is injected into European defence, the same old questions resurface over whether it is being spent cooperatively and efficiently, generating the same old answer: it is not.

In Europe, the defence sector is politically sensitive and heavily protected. The region’s defence industrial base exhibits prime contractors functioning as high-value systems integrators situated at the top of critically important supply chains. National defence primes act as custodians of critical engineering expertise, aggregated through generations of investment into both physical and human capital. As such, the autonomy and competitiveness of national defence champions is strongly protected by the state, which typically favours domestic firms in tendering processes or, whenever cross-national industrial cooperation is necessary, engages in political manoeuvring to allocate high-value work packages to its own key industrial players. As such, the European defence industrial base continues to be a patchwork of different national markets predominantly operating in silos. Notably, in 2020, only 11% of investments were spent collaboratively – as opposed to the 35% benchmark agreed by member states under the European Defence Agency framework. This limited cooperation has, in turn, resulted in critical defence capability shortfalls, hampered interoperability among European armies and created economic losses due to unrealised economies of scale.

A market regulator by design, the EU has long tried to address this problem, shifting from an initial ‘regulatory sticks’ approach to a ‘financial carrots’ one. In addition to promising an increase in the size of the extant European Defence Fund (EDF), the Commission has recently announced a new set of financial tools. These would innovatively address the procurement of defence equipment as opposed to tackling only the research and development stages, on which previous financial measures were exclusively focused. The first tool is the European Defence Industry Reinforcement through common Procurement Act (EDIRPA), a €500 million short-term fund aimed at subsidising member states' joint procurement of defence equipment that is developed cooperatively during 2023–24. The second is the European Defence Investment Programme (EDIP), which will serve as the anchor for future joint development and procurement projects starting from 2024. Specifically, EDIP aims at encouraging member states to create European defence capability consortia by exempting those who engage in such cooperative activities from paying VAT. The financial volume of EDIP is yet to be pinned down and is a matter for future decision-making.

As recent initiatives show, the EU’s value proposition for the European defence industry has mostly been a financial one. However, financial incentives might not be enough to get European member states to cooperate on a more regular and frictionless basis, especially when they are relatively limited in nature.

Building Effective Governance and Delivery Structures

The European defence market comprises the coming together of two uncomfortable bedfellows: the continued political preference for sovereignty and national capability and the managerial need for defence businesses to cooperate on big projects to deal with the constant rise of acquisition costs. This leads, as studies show, to a Janus-faced situation whereby the European industrial field is characterised by the simultaneous presence of inter-state competition and European cooperation. National governments sometimes collaborate in joint defence industrial activities, while in other instances they prefer to maintain a strictly national defence industrial policy or to acquire weapons systems from non-European suppliers. When European countries will decide to cooperate with other partners is difficult to predict due to their having a mixture of common and conflicting interests: a mutual desire to combine their resources to increase absolute gains, yet divergent interests when deciding how to divide the joint benefits of cooperation between them. In previous collaborative defence programmes, this inherent tension between the need for both competition and cooperation translated into a high complexity of workshare arrangements between partners, leading to arbitrary decision-making, inefficient supply chain structures and a continuous need to rebalance workshares, which can elevate cost structures.

As such, even if states concede to external incentives and decide to cooperate, international arms collaboration means that the problem is shared but not necessarily reduced: the pie may become bigger, but the problem of who gets the largest slice persists. A financial incentives-based approach should not be dismissed altogether. A parallel conversation is needed, however: one which discusses the governance structures that can best accommodate multinational endeavours in the inherently competitive European defence industrial base. This conversation should recognise that defence partnerships should be built on states’ core strengths, organised along two dimensions: industrial and technological expertise, and value for money. For instance, the greatest inefficiency associated with the Typhoon collaborative programme has arguably been the absence of a genuine division of labour between partner states. This has meant that production inputs, such as systems and subsystems, are not sourced based on industrial comparative advantage, but rather based on ensuring that the work is equitably shared among the participating states.

Therefore, effective governance structures are needed to ensure that workshare is allocated according to criteria of competitiveness and comparative advantage. Another critical structure to have in place is delivery-focused government and industry frameworks. These would empower clearly accountable bodies that have as their primary purpose the need to deliver capability quickly with minimal bureaucratic hurdles. Getting the governance and delivery structures right is key to the success of collaborative endeavours. Flagship defence industrial collaborative programmes such as the Global Combat Air programme (GCAP) between the UK, Italy and Japan have acknowledged this, and are exploring new governance structures to ensure more agility and a fairer workshare model, where a single empowered governmental body deals with a single industrial body. This is in stark contrast to the Typhoon/Eurofighter model, in which both the governmental central body (NETMA) and the industrial venture (Eurofighter GmbH) had little power and needed to pass most issues back to member governments and corporate headquarters for rubber-stamping.

The Industrial Relevance of Non-EU Allies

Another problematic aspect of the EU’s financial incentives approach is the degree to which third countries can be involved in EU defence projects. So far, European defence initiatives have been underpinned by a ‘play as you pay’ rationale. The level of integration with the EU single market is decisive for accessing EU financial incentives in this policy area. The EU emphasises that third-party cooperation is always an exception, and done for specific projects in an ad hoc manner, as the EU's interest is to draw a clear line between those inside and outside the Union. This rationale is reflected in both the PESCO and EDF regulations, as well as in the newly announced EDIRPA. Indeed, the latter envisages that funding will be designated exclusively to those projects in which components sourced from the EU’s single market make up 70% of the overall cost. This requirement makes sense vis-à-vis the objective of strengthening the EU defence industrial base. Yet, it might fall short on the other objective of delivering quickly, if non-EU companies – which may have greater technical skills and more appropriate equipment in some areas – are excluded.

Industrial rivalries inexorably permeate the European defence landscape. Precisely because some European countries cannot constructively coexist within certain joint ventures where their national defence primes would be in direct competition, industrial synergies should be pursued with extra-EU partners that have similar requirements and complementary capabilities to their European counterparts. Supranational programmes establishing financial incentives should reflect this. Strategic autonomy cannot have autarkic underpinnings in the European defence industrial context. Rather, it should be geared towards two interrelated goals: first, as an instrument to cut asymmetric dependencies with – and avoid overreliance on – one specific party (that is, the US); and second, as a means of gaining an increased capacity to act through the diversification of supplies. As such, any supranational solution to incentivise arms cooperation should be open and capable of evolving over time, as well as able to welcome and accommodate new partners with different requirements and industrial capabilities who share common objectives with the EU. Steps are being taken towards keeping EU programmes open to non-EU partners who share the Union’s values and interests. The EU and NATO have recently signed a joint declaration committing to encouraging ‘the fullest possible involvement of NATO allies that are not members of the EU and its initiatives’. Despite this statement of intent, the latest EU financial incentives do not mirror this ambition, and rules for the accession of third parties to EU collaborative defence ventures remain quite restrictive.

That European states should spend more – and spend more together – is a policy imperative, and hence recent increases in funding are hard to criticise. But the value proposition for strengthening the European defence industrial base cannot simply be making more money available both at the national and supranational level. Financial incentives are not enough to promote a more collaborative defence industrial base, characterised by a balancing act between cooperation and conflict. Appropriate governance structures to deliver collaboration as well as meaningful reflection on defence partnerships based on ‘best athlete principles’ are urgently needed to make the new pot of money deliver the goods.

This contribution first appeared in a slightly different format in the Internationale Politik periodical, in the German language.

The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.

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