1. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU EUROPEAN DEFENCE EQUIPMENT MARKET Keith Hartley Centre for Defence Economics University of York Seminar on European Defence Procurement, Bucharest, 13-14 November 2007

2. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU OVERVIEW l Background l Defence Economics Problem l Inefficiency in EU Defence Markets l Improving Efficiency l EU Scenarios l Case study of Typhoon l Offsets l UK DIS

3. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU BACKGROUND l OCCAR: F;G;It;UK;Sp;Belg: armaments agency for European collaborative projects l Industrial Restructuring: EADS; Thales; AgustaWestland; MBDA l Collaborative Projects: Typhoon; A400M; Meteor missile; JSF/F-35 l EDA (2004): EDEM; EDTIB; Offsets (?)

4. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU POLICY ISSUES l EU as inefficient defence market: both Armed Forces and Equipment Markets l Economic Principles for Improving Efficiency l Role for EDA: beyond a voluntary code l 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. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU DEFENCE ECONOMICS PROBLEM l Constant/falling national defence budgets (real terms) l Rising INPUT costs: -Equipment: 10% pa in real terms = smaller numbers - Military personnel: costs of AVF RESULT: Difficult Defence Choices Cannot be Avoided

6. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU Defence Economics Problem: New Dimensions l 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. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU DEFENCE ECONOMICS PROBLEM Solutions 1. Equal Misery: gradual reduction in force effectiveness 2. Major Defence Review 3. Increased efficiency 4. EU Defence Policy

8. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU INEFFICIENCY OF EXISTING EU DEFENCE MARKETS l EU defence markets INEFFICIENT in providing: Armed Forces Defence Equipment l Criteria: US model l Compared with USA = EU lacks: Single EU Army, Navy, Air Force Large Single EU market for defence equipment

9. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU INEFFICIENT DEFENCE MARKETS l Duplication of costly R&D programmes l Small-scale production for small national markets l Protectionism l Cost-based non-competitive contracts l Domestic monopolies – some state-owned

10. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU An Efficient EU Defence Industrial Policy APPLY ECONOMIC PRINCIPLES: 1. Rising equipment costs = independence and duplication of R&D are costly 2. Gains from Free Trade – based on comparative advantage 3. Gains from scale and learning economies 4. Gains from competition

11. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU RULES FOR AN EFFICIENT EU DEFENCE INDUSTRIAL POLICY l Gains from Trade = 10-25% savings l Gains from scale and learning = 15% - 25%

12. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU Single EU Market Scenarios Scenarios Annual cost savings EU Only Open to RoW 1. Competitive Market 9% 11% 2. Single EU Proc Agency 15% 17% 3. Twin Track 11% 14%

13. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU COSTS OF SINGLE MARKET l Change is not costless Winners and losers l Losers will oppose change Lobby for fair/managed competition Juste Retour Protection l Fear = cartels/collusive tendering RESULT: Inefficient EDTIB ?

14. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU Collaboration as EU Defence Industrial Policy: TYPHOON l Economic Benefits l Jobs = 100,000 l Technology/spin-offs = carbon fibre technology; civil aircraft/engines; cars/F-1; supply chains l Exports: Saudi Arabia (72); Austria (15)

15. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU CRITIQUE l Opportunity cost question= alternative use value of resources? l Spin-offs = market value? l Are Markets Failing?

16. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU OTHER POLICY ISSUES l EDA study of OFFSETS: what do we know/do not know and need to know for sensible policy formulation? l EU and UK Defence Industrial Strategy = EU moving to open markets (?) whilst UK DIS = guaranteed/protected markets

17. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU EDA and OFFSETS l EDA View OFS are INEFFICIENT OFS illegal under Article 296 (at least for civil OFS) l EDA AIM: Harmonise and eventually remove OFS

18. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU OFFSETS (Contd) l PROBLEMS l OFS – why do nations favour OFS – benefits? l OFS are Market Distorting BUT: They reflect major distortions caused by Article 296 and Buy US Act and Govts are major market distortions

19. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU OFS: Next Steps? l Collect a decent data base on OFS in EU l Harmonisation of OFS requirements (eg at max of 100%)?

20. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU UK DIS and EU Possible conflicts between DIS and: l EDEM with focus on open markets l EDTIB with an EU view of the DIB, including an appropriate regional balance.

21. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU FUTURE DEFENCE FIRM ? l Future defence firm will be different - Todays defence firms differ from those of 1950 and 1900 - In 1900, Boeing did not exist

22. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU Future Defence Firm l Future = global defence firms - international supplier network - suppliers= larger groups undertaking R&D for primes - Electronics firms as primes - Primes as systems integrators and not metal bashers

23. © OECD A joint initiative of the OECD and the European Union, principally financed by the EU CONCLUSION l EU defence policy is topical and dominated by politics – But economists can make sensible contributions to the policy debate l Existing EU defence markets are highly inefficient l Efficiency improvements mean benefits to Armed Forces and taxpayers but costs for EU’s inefficient defence industries