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Email this citationCIAO DATE: 7/99
An Uncertain Furture for Central European Defence Industries
January 1999
Executive Summary
Strategic and global economic pressures have sparked a profound restructuring of defence industries both in the United States and Western Europe. Reduced markets, technological development, and economic globalisation are also having a profound effect on defence industries in Central and Eastern Europe, but these industries face a daunting set of challenges. The burdensome legacy of command controlled economies has compelled these countries to manage simultaneously liberalisation, market, plant, labour and managerial restructuring, technological modernisation, and a profound military-strategic reorientation laden with equipment and industrial ramifications. This is unfolding in the context of general economic austerity, military downsizing, ever more intense competition in global defence markets and a burgeoning international financial crisis. The defence sector once constituted the back bone of the region’s command economies and was a key employer. In the new strategic and economic context, however, its role has necessarily diminished. Resolving this particular transition problem has proven particularly difficult.
Central and Eastern European governments have come to appreciate the need to preserve a core defence industrial capability and their growing ties with NATO hold out the potential for developing new markets. This has inspired regional leaders and industrialists to develop new strategies. One of these has been bankruptcy — i.e. allowing firms with no prospect of success simply to fail in order to free up scarce capital that might be used by firms with a greater potential to survive. A profound shake out of the industry has consequently occurred throughout Central and Eastern Europe, but many surviving firms are still operating on shaky ground and are still subsidised. Because these firms often possess capacities that exceed domestic demand, managers must develop export markets to make manufacturing runs profitable. This is easier said than done in today’s highly competitive and often protection bound defence markets. Many of the region’s integrated systems are not particularly competitive in Western markets, although improvements have been made. Bringing in Western know-how and capital is seen as a key to addressing this problem and Western defence firms have indeed begun to invest in the region. They are drawn both by the valuable knowledge base and the prospect of gaining access to local markets overseen by states which to varying degrees are committed to force modernisation. But real budgetary constraints, exacerbated by the global financial crisis, suggest that defence outlays will not increase to the degree that was once optimistically suggested. Additionally, Western firms are often reluctant to buy into state-owned firms. Thus privatisation of the defence sector poses another set of daunting challenges.
Western European politicians cannot ignore this set of problems even though their own defence industries are facing trying circumstances. National and European leaders must work to ensure that the Central and Eastern European firms are included in the consolidation process, particularly those on the verge of acceeding to NATO and the EU. Central and Eastern European leaders must accept that their defence industries will have to be further reconfigured if they are to survive and this means managing further job cuts. At the same time, this process should not exclude the US. Doing so might further undermine the sometimes rocky transatlantic defence industrial relationship and US capital can bring both political and economic benefits to the region. Both North American and European governments should also convey to Central and East European governments that budgetary health is a vital element of national security, and in the absence of immediate threat, they should not engage in rearmament projects that exceed their means. Along these lines trans-national projects to revamp old equipment could prove particularly helpful. Finally, Western aid programmes to assist regions struck by defence industrial consolidation could yield important economic and political benefits.
I. Introduction
To say that the institutional framework for European and transatlantic security is in flux is to understate dramatically the extraordinary changes that are now underway. NATO will accept three new Central European members at its Washington summit this spring — a historic meeting that will also unveil a new strategic concept likely to be premised, in part, on mobility and force projection capability rather than static defence against massive conventional attack. The European Union is working on the even more complicated task of accession negotiations with six countries, while simultaneously revamping its own institutions. At Saint Malo this December, the French and British governments agreed to seek ways to endow the European Union with a direct role in making and carrying out security and defence policy — an initiative which could dramatically strengthen the second pillar of the Union and, for the first time, turn the old notion of a European pillar within the Alliance into a reality.
The creation of a European pillar will demand sustained engagement of European leaders on many fronts. One of the most important of these as well as one of the least appreciated will be defence industrial consolidation. Europe requires a more integrated defence industrial sector to enhance its security identity and to co-operate as well as compete with powerful American defence industries. Without it, the Union is unlikely to develop fully its own political potential as a cohesive foreign policy actor.
Formidable practical, political and cultural barriers still need to be overcome. For example, Article 223 of the Treaty of Rome explicitly excludes this sector from Commission oversight, an exemption reflecting the view that defence industrial policy represents a legitimate and necessary prerogative of sovereign states. Despite this restriction, however, market imperatives generated by shrinking Western defence markets and the competitive threat posed by larger American defence industries ensure that consolidation in Europe is now slowly getting underway. Europe’s defence industry leaders generally recognise that there is no alternative to the creation of bigger firms exploiting economies of scale, new manufacturing techniques, innovative inventory management systems, trans-national procurement and evolving synergies with commercial markets. Thus the market itself, not politicians, is driving change in this sector. If anything, political engagement has typically tended to slow down this process, as was made evident in French hesitancy regarding Anglo-German endeavours to create a large private European aerospace conglomerate.
While similar market pressures exist in Central Europe, the restructuring challenge is considerably more acute. To exclude these industries entirely from the western European consolidation process will make the already difficult task of turning around this crisis-ridden sector virtually impossible.
The historical context
Defence sectors throughout the Central European region have staggered from one shock to another over the last ten years. The collapse of the Warsaw Pact thoroughly disrupted the strategic foundation of existing market structures and precipitated a dramatic reduction in sales. COMECON’s elaborate and inefficient trans-national supply system lay in tatters, while subsidised raw material and energy inputs evaporated. Moreover, newly democratic states slashed national procurement budgets while external sales to regions like the Middle East were plunging. American defence manufactures, meanwhile, emerged from the Gulf War in a very powerful position to dominate global defence markets both because that war had put American technological supremacy on display and because US firms were increasingly able to translate America’s new-found strategic primacy into equipment sales. Central Europe’s defence manufacturers were left holding large inventories of military equipment, spare parts and unpaid bills. 1
The initial response from economists studying Central and Eastern Europe suggested that defence conversion — the process of transforming defence-industrial complexes into viable commercial producers — represented the optimal means of revamping a large and inefficient industrial base that reflected the militarist and non-market orientation of the old regimes. 2 The subsequent conversion efforts in the early 1990s were, however, often hamstrung by limited resources, falling demand in civilian markets, overly interventionist states, and the failure to respond to market signals. 3 Moreover, the idea that these countries needed to do away with their defence industrial base quickly lost currency. While some degree of defence conversion remains an option for Poland, the Czech Republic, and Hungary (and even Romania and Slovakia), their leaders are now more focused on how best to integrate national defence industries into greater European, transatlantic and global markets while ensuring that national procurement needs can be met at reasonable cost. Insofar as these industries also develop dual-use products, they will be positioned to exploit expanding commercial markets as well.
New organisational and technical requirements
Ten years ago Central European defence firms had no customer service or marketing experience; pricing techniques were virtually non-existent and thus production methods and the use of labour were highly inefficient. These firms are now compelled to pursue marketing and cost-reduction strategies, to exploit comparative advantages, and to learn when to abandon unprofitable production lines. They must also identify and exploit potential synergies between military and civilian products, particularly in optics, electronics and specialised materials. This requires that defence firms tie into broader networks of investment, production and trade. National authorities and local manufacturers must be willing to import hardware and components that would be inefficient to produce domestically while export markets are needed to reduce unit costs through larger scale production.
The governments of Poland, the Czech Republic and Hungary certainly recognise that national defence industries need to cultivate export markets and find opportunities to engage in joint production ventures. The challenge throughout the region, however, has been to open firms to greater foreign competition and to accept the consequences when these firms are not up to the challenge.
Central Europe’s defence-industrial system will also be charged with meeting fundamental national security needs by producing equipment that permits national militaries to work seamlessly with their new allies. One quick means to gain access to this technology is by forging alliances with Western firms. Such alliances are more easily consummated when local firms are privately owned, yet there are still considerable political costs to privatisation in this sensitive industry.
Obstacles to restructuring
- Political difficulties with privatisation
Liberalising defence-industrial policy in transition economies can also increase economic insecurity and unemployment and impede technological development. This renders such policy formulation particularly challenging because building a more efficient sector may appear to run against other goals, at least over the short-term. Given the strategic value of the defence sector, its close identity with national sovereignty, and politicians’ natural inclination not to associate themselves with policies that might result in short-term lay-offs, government foot-dragging on privatisation has been manifest — a hesitancy that has contributed to the general climate of uncertainty. - Dissipation of financial resources for the most competitive firms
For similar political reasons Central European governments are often unwilling to preside over the failure of large defence firms. Thus debt write-offs, guaranteed bank credits, tax exemptions and state-assisted efforts to find new external markets have helped keep many firms alive, some of them only just. 4 These policies, however, deaden the process of ‘creative destruction’ which is necessary to optimise credit allocation. Charged with keeping afloat too many defence firms, governments have over-stretched their resources, and the ensuing capital deficiencies have made it difficult to galvanise firms into genuinely competitive positions. Despite government subsidies and other non-market supports extended to many defence companies, it has proved impossible to stem the tide of bankruptcies that have swept through the sector. - Absence of a civilian high-technology sector
Transition states also lack a broad base of high technology civilian firms that in the West are increasingly playing a role in militarily valuable technology development. - Absence of transparent procurement procedures
Procurement procedures in communist command systems were fundamentally different from those in democratic systems. Moving toward a model which places a premium on open bidding, competition, transparency and meeting the needs of the customer has not been easy, and the lack of clear procedures in some counties of Central and Eastern Europe has sparked allegations of corruption, favouritism and waste. 5
The impact of NATO Enlargement
A modernising impetus
From the perspective of defence industrialists in Central Europe, NATO enlargement presents both challenges and opportunities. These industries now face even greater pressure to increase their competitiveness and technological level to meet NATO standards, and to compete against and co-operate with Western firms. NATO enlargement will indirectly help open new markets to the region’s firms while potentially making it easier to attract foreign investment and participate in project teaming. Indeed, this process is already well underway. Moreover, acceding governments have promised to boost defence spending to ensure that their military systems and structures are interoperable with those of NATO. Only in this way will governments credibly be able to assert that they are sufficiently well-equipped to contribute to collective security in NATO. They do seem committed to this on paper, and the Czechs for example, recently shielded the defence ministry from a round of budget cuts being carried out to stabilise the embattled Krona. This commitment is obviously welcomed by local defence producers.
Budgetary limitations: the case of fighter aircraft procurement
It is not clear that such commitments can be sustained particularly if the global economic crisis deepens. Already governments have stretched out promises to purchase new fighter aircraft. In the summer of 1998, Hungary’s Prime Minister Viktor Orban announced that the state could not afford to underwrite the purchase of new fighter aircraft for at least the next four years. 6 By 1999 Poland’s fleet of fighter aircraft are slated for retirement or modernisation, and the replacement costs could run between $7 and 10 billion (up to 2.5 billion Euro) over the next 10-12 years. Defence Minister, Stanislaw Dobrzanski has postponed a previously announced fighter purchase because of budgetary problems. The Czechs too are likely to put off the immediate purchase of fighters. Thus budgetary pressures could well overcome commitments to NATO with consequences for local defence manufacturers who have already had to manage fundamental changes in their core markets.
The Western scramble for new markets
The fighter purchase issue distils several of the key questions about the future of the region’s defence industry. At one level, it highlights the emergence of Central and Eastern Europe as a new and potentially growing market for Western manufactured military equipment at a time when Western defence markets are shrinking. Some Western firms have been very bullish about a market they felt could eventually be worth up to $15 billion. 7 But the global financial crisis and competing demands on limited capital in Central and Eastern Europe suggest that this figure is very optimistic. Western defence firms now recognise that they need to lower their expectations and position themselves for the long-term. Nevertheless their governments are supporting their sales efforts. The US Government’s Defence Export Loan Guarantee Program, for example, guarantees payments of private sector loans to eligible governments buying US-manufactured defence equipment. 8 Funding for the US Foreign Military Financing Program (FMF) to help Central and Eastern European governments purchase military equipment has been increased in recent years. European authorities are also supporting the sales efforts of their national companies, which invariably include all manner of off-set arrangements and other enticements.
Obviously Central European officials see potential benefits in this West-West competition. Peter Necas, of the Czech Parliament’s Committee for Defence and Security has suggested that regional governments are likely to make even more pressing demands on those firms seeking to sell in their markets and that offsets and technology transfers to Czech civilian and defence industries “will become one of the basic criteria in the acquisition procedure.” 9
This type of support has, at times, led to acrimonious battles within the Alliance itself and even inspired some critics to see NATO enlargement as an exercise in gaining market share for business strapped Western firms. For example, there has been strong domestic and international criticism of a deal in which the US firm Bell Helicopter would acquire the Romanian loss-making state firm IAR, upgrade its capital equipment and then use it to manufacture attack helicopters for the Romanian army. The Romanian promise to purchase 96 of these helicopters for $1.5 billion was seen as far exceeding Romania’s means, leading the finance minister to threaten resignation if the deal were not re-negotiated. According to economists from the IMF and World Bank, with Romania’s economy in a tailspin and with the state facing an external financing gap equivalent to roughly 7% of GDP, the costs of embarking on such an expensive military shopping trip would probably outweigh the political and technological benefits of Bell’s investment. 10 Western governments thus have a special responsibility to communicate to cash-strapped NATO aspirants that pursuing such expensive projects offers no panacea for the economy, and spending beyond the nation’s means is unlikely ultimately to bolster national security in the broadest definition of the term.
The challenge of regional defence procurement co-operation
The fighter purchase problem also raises questions about defence industrial and procurement co-operation within Central and Eastern Europe itself. At a time when Western Europe appears to be on the verge of consolidating its defence industries and co-ordinating overall defence policy, possibly even through the European Union, Central and Eastern Europe must both anticipate these changes and prepare for their profound impact on the market. While Central and Eastern European states are still outsiders, they can still adopt a proactive approach. This would involve greater co-operation amongst themselves in dealing with Western firms and in procuring new systems. Procurement collaboration, like defence market consolidation, can yield real cost savings and deepen trust among participating states. But it does require those states to yield some degree of control over their national defence sectors (a hard-won prerogative which they only acquired after the collapse of COMECON).
Along these lines, some defence industrialists in Central Europe have promoted the idea of a trilateral fighter purchase. This would undoubtedly generate greater cost, maintenance, logistics and spare parts savings and result in a more rational division of labour. However, there has been little initial enthusiasm from the region’s governments. 11 There have also been discussions on how to jointly modify Warsaw Pact equipment so that it meets NATO standards. This represents a cheaper alternative to purchasing new equipment or pursuing strictly national modification programmes. The Czechs, for example, need to modernise their fleet of 353 Soviet designed T-72 main battle tanks. A team of British, American, Israeli and Czech defence firms have developed a prototype, and a procurement contract for the upgrade will be signed this year. It would make sense, however, for the Czechs to engage the Polish and Hungarian militaries in this project, and even others not invited to join NATO but working closely with it through the Partnership for Peace (PfP) programme. So far, the level of co-operation in T-72 tank development has been minimal despite the fact that military establishments throughout Eastern and Central Europe face similar upgrade challenges. 12 NATO’s PfP programme could also help forge more cost-saving development and procurement collaboration among Partners and between Partners and full NATO members.
II. National Experiences
Hungary
Hungary’s leaders perhaps more so than in other CEE countries, have employed a particularly draconian model of industrial restructuring and privatisation, and the defence sector has not been exempt from sudden exposure to the rigors of the market-place. This was partly possible because Hungary did not have a large defence sector to begin with, and in those areas where it displayed a potential comparative advantage, in electronics, radar, telecommunications equipment and software, for example, civilian sales potentially could compensate for the sudden reduction of production subsidies and the collapse of demand from Eastern European and Soviet defence establishments. Bankruptcy has been characteristic of the Hungarian transition model as a whole, and although the process has been particularly painful, it has also created new opportunities to generate economic prosperity.
In the years immediately preceding the fall of the Berlin Wall, Hungarian defence firms were producing 20 billion Forints (over 80 million Euro) of equipment annually while employing 20 thousand workers. Roughly one fifth of production was targeted for the domestic market, and the remainder was exported mostly to Warsaw Pact members and the developing world. 13 Although those export markets subsequently collapsed, the Hungarians nevertheless were familiar with the modalities of competing for foreign market share — something that their relatively open model of socialism encouraged. Today, Hungarian military industries sell only about 15% of their products domestically; the remainder is exported. 14 Communication and radar equipment are now top procurement priorities for the region’s military establishments, and several Hungarian firms specialising in military communications systems have been selling successfully on the international market. This represents a potentially lucrative business as new NATO members must upgrade command, control and communications equipment as well as air defence systems and avionics.
The Hungarian transition model has relied heavily on privatisation and direct foreign investment, and so far has proved remarkably successful in revamping Hungarian industry and finance. This has involved painful restructuring, numerous bankruptcies and lay-offs, but recently also impressive job creation. Although the Defence Ministry still owns outright some repair companies and the Privatisation and Property Management Corporation, (APV Rt.) holds ownership rights at several munitions firms, these are more the exception than the rule and are unlikely to last.
Poland
In contrast to Hungary, Poland’s defence industry is large, benefits from a bigger domestic market and historically has been somewhat less dependent on exports. Poland’s large defence firms employed thousands of workers. Soon after the collapse of the old order, Polish authorities adopted a shock therapy strategy of macro-economic stabilisation but moved slowly to privatise large industry. Big defence plants were re-organised into four holdings, structured along production lines of weaponry, aircraft, military electronics and armoured vehicles. Defence firms remain in the state’s hands and like other state-owned commercial assets, they have not ranked among the high performers in Poland’s otherwise remarkable economic story.
Part of the problem has been the resistance of Poland’s Ministry of Defence which, for national security reasons, advocated a go-slow approach to privatisation, and supported special tax exemptions, subsidies and relatively more protectionist commercial strategies for this sector. This has not been a formula for economic success and failed to stem a huge shake out in a sector in which the work force fell by 80% between 1989 and 1994. 15 The share of defence expenditure in overall national production has fallen significantly over the last decade, 16 a trend reflecting the exuberant growth of start-up companies in Poland and their vital contribution to national growth.
The new Polish government has shown a greater willingness to advance a more liberal management model and is looking at several schemes for privatising defence firms. It also appears to be more open to the idea of luring foreign investment in order to lower costs and raise technical capability and quality, improve Poland’s capacity to sell equipment in external markets and forge partnerships with established firms in Europe and North America. 17 Polish authorities have outlined a 16-year plan to modernise national military and defence industrial systems. The programme is ambitious, and among other things calls for rapid privatisation and increased foreign investment, adoption and development of more sophisticated technology and higher exports. 18
At the end of 1997 the government estimated that Poland would spend roughly 70 billion Zloty (over 17 billion Euro) on defence between 1998 and 2002, 30% of which was for equipment. Ten to fifteen billion Zloty (2.5-3.5 billion Euro) was to be set aside for the purchase of 100 multi-purpose training and combat aircraft, but as discussed above, this purchase has been postponed. 19 The delay may grant the Poles, like the Hungarians, time to adjust to a rapidly changing defence industrial structure in Western Europe and open up new opportunities for a joint purchase.
The Czech Republic
Within the Warsaw Pact, the old Czechoslovakia was the largest arms manufacturer in Central and Eastern Europe and also enjoyed a prominent position as an international arms exporter. Arms sales comprised 10% of total exports. 20 The Czech and Moravian regions specialised in light weaponry, aviation, and electronics while Slovakian defence industries concentrated on heavy weapons — industries which now face intense competition for shrinking market share. 21 Indeed, collapsing markets for goods manufactured at large Slovak defence industries precipitated by defence cuts and the Warsaw Pact’s demise, and debates about how to resolve the ensuing industrial crisis proved a source of friction between Slovak and Czech leaders — one of many disputes which were ultimately resolved by the creation of two separate states.
73% of Czech defence production is in the aeronautics sector while electronics constitute another 11.5%. 22 The Czech strategy for coping with the collapse of traditional defence markets has involved widespread privatisation. By 1994 most defence enterprises were operating as shareholder companies with state ministries, the National Property Fund or state-owned banks retaining majority share-holdings. 23 While the reigning ideology was liberal, state resources continued to support the sector, in part by writing off large losses. Since 1994, defence production has risen. The prospect of NATO accession has inspired authorities to promise to boost defence spending by 0.1% of GDP per year; so that by the year 2000, it should reach 2.5% of GDP. But the sector still finds itself in a very precarious position. 24 Capital shortages constitute another serious challenge to the industry. An insufficiently transparent regulatory framework, particularly of the financial sector, has complicated this problem. Economic growth is now hovering around zero, and international investors recently displayed some misgivings about investing in Czech markets despite recent improvements in the state’s regulatory apparatus.
The government has identified 59 projects which should help make national forces inter-operable with those of NATO, and it has set aside $274 million to underwrite the effort. There are 80 firms operating in the defence sector, and the Czechs have achieved relatively high standards in developing training systems for military pilots, radio systems, and small weaponry. 25 International partnerships are vital to sustaining these businesses. The most important deal so far is the Boeing-CSA purchase of a 34% stake in Aero Vodochody, the state-owned military aircraft maker. This was a strategic move on Boeing’s part to gain an inside track on regional fighter sales. The government has agreed to extend to Aero Vodochody state-backed loan guarantees worth $1.1 billion to complement Boeing’s large investment. 26 Czech industrialists have also struck several international deals to support the tank and anti-aircraft sectors. A shake out of Czech defence industries seems inevitable. The electronics sector may emerge largely intact from this process as it has been fairly well restructured. The future of heavy armament producers is more uncertain.
III. NATO and the EU
NATO offers technical advice
While these three Central European countries are set to join NATO they are still in the midst of difficult accession talks with the EU. The institutional framework for defence integration remains relatively undeveloped for the countries of Western Europe, and, not surprisingly, it is virtually non-existent in Central and Eastern Europe. NATO, for example, is a purely inter-governmental body, and has no mandate to integrate defence markets. It can, however, assist in identifying military requirements and facilitating dialogue through the Conference of National Armaments Directors (CNAD) and various NATO Committees working in armaments related fields.
The three candidate countries dispatch observers to CNAD meetings and NATO organised consultations with defence manufacturers in the NATO Industrial Advisory Group (NIAG). NIAG-sponsored dialogue between NATO and Partner manufacturers began in 1995. Some pre-feasibility studies for co-operative projects have been launched, and CNAD has shared most of its standards and technical information with partner states. Czech efforts to catalogue Western standards and regulations are underway and firms are obtaining accreditation for managing quality in accordance with NATO standards. Data transfer systems designed to help manufacturers enter into co-operative international projects are also needed in the region if co-operation is to deepen.
NATO’s PfP has also set out to promote greater inter-operability between NATO and Partner military forces. NATO committees on armaments and technical standards have accordingly worked on harmonising standards on quality assessments, materiel codification, and contracting methods, 27 all of which are pre-conditions for a more integrated transatlantic defence market engaging Central and Eastern Europe. NATO’s Committee for European Airspace Co-ordination (CEAC) is furnishing partners with advice and technical assistance related to airspace management.
These initiatives all involve the technical elements of creating more integrated transatlantic and pan-European markets, but the real problems are both budgetary and political. Years of efforts to promote tighter defence integration between Europe and North America have given way to a lack of consensus on what form future co-operation should take and to strident competition for diminishing markets. Within NATO there is far less optimism regarding future co-operative arms projects and the hope now is that the more minimal goal of achieving inter-operability will not be sacrificed. 28 This does not bode well for Central Europe.
The EU assists industrial consolidation
At the same time, movement among European defence firms to create a more unified and consolidated defence industrial base as a competitive response to US defence firm consolidation is actually outpacing the politicians. European defence industrialists understand the competitive challenge posed by the creation of mega corporations like Boeing-McDonnell Douglas and the great strides U.S firms have made in enhancing productivity, technological innovation and in slashing costs. They have little choice but to begin a merger process in response even thought they began this process without the unanimous endorsement of European governments. Indeed, French authorities initially appeared very reluctant to give way to international market forces beyond their control. This reluctance assumed two forms: resistance to privatisation and resistance to a market-driven merger process in which politicians take a back seat. But the pressures for change have been relentless, and French authorities appear to be backing away from their insistence that the state continue to exercise significant ownership. Europe is moving to create an aerospace and defence company through the merger of British Aerospace and Daimler-Chrysler Aerospace. 29 The French would hope to include in this merger process its soon to be formed national champion born out of the merger of Aerospatiale, Matra Hautes Technologies, and Dassault Aviation. In all, six European states have approved the goals of creating a genuinely European aerospace firm and promoting more cross-border mergers. But the terms on which such a firm would be constructed could still prove the subject of intense disagreement.
Europe’s politicians have begun to recognise the inevitability of a de facto single market in the defence sector and EU regulations are increasingly being used to assist the consolidation process although they were not initially designed to do so. For example, Article 223 of the Treaty of Rome which exempts the defence industry from EU regulations has increasingly been invoked to shield potential mergers from EU competition and monopoly regulations. In addition, the Union has begun to assume some competency in related areas. The European Parliament, for example, played an important role in defining a code of conduct for arms exports. This was signed by 15 EU member states in June 1998 and in August the Associated Countries of Central and Eastern Europe declared that they shared the Code’s objectives and accordingly aligned themselves with its criteria and principles. The Code includes a notification and consultation mechanism which marks a new stage in the EU’s development of an arms export policy. It seeks as a principal goal to ensure that weapons exports from signatory countries will respect arms embargoes, not contribute to a degradation in human rights in the importing country nor contribute to regional instability. Exporting states must also assess the potential for re-export or diversion. The Associates, however, are not part of the institutional information sharing and transparency mechanisms. Nevertheless, because these countries are aspiring EU members, the agreement possesses a certain informal power. This is a welcome development. It not only strengthens Europe’s collective security identity, but will ensure that short-term economic criteria alone are not guiding European arms export policy. That 13 non-EU countries have signed the Code of Conduct intimates that the Union’s influence in security matters has begun to produce positive results. The lure of Europe is outweighing the temptation to prop up suffering industries through lax export policies.
For its part, the Commission has sought to define market parameters related to dual-use technologies. Given the growing importance of information technology in weapons systems, this is not inconsequential. It also produced a White Paper on the European Defence Industry in 1995 in which it explicitly supported further international industrial consolidation, and is currently formulating a White Paper on arms export regulations. In September 1998, France, the UK Italy and Germany signed an agreement which endowed the Joint European Armaments Organisation (commonly referred to by its French acronym — OCCAR) with a legal identity. Yet OCCAR has struck no relationship with Central or Eastern European states and its own mandate is restricted. 30 Indeed, even the smaller members of the WEU have feared that their interests would be sacrificed in this body — something that points to the difficulties of ever achieving a genuine European defence identity. While the three new NATO members will become Associate members of the WEU and new EU members could have observer status within the WEU, this is a far cry from genuine integration. Moreover, the EU’s pre-accession talks with six countries do not mention defence industries and so defence industrial consolidation is unfolding without Central and Eastern European involvement.
Future prospects
At the extraordinary Anglo-French summit in St. Malo in December 1998, the leaders of those two countries announced an initiative to work together to galvanise Europe’s defence identity, a process which, at its conclusion, could result in the WEU being folded into the EU and the Commission acquiring real powers to forge a more unified European defence identity. 31 Insofar as this initiative spills over into the defence industrial sphere, it will undoubtedly hasten the arrival of a more unified defence market in Europe appropriate for the radically changed circumstances of European security and the resulting shake-out in the global defence market. It could also mark a critical spill-over from the creation of a single currency.
The likely role of the Central and Eastern European States will be dictated by their dual Atlantic and European ambitions. Within Europe they could potentially help remind others that US firms should not be excluded from the process. The region’s defence industries are in dire need of capital injections, and regional leaders cannot afford to discriminate against American or European firms seeking to acquire shares in local companies.
IV. Conclusion
How Central and Eastern European industries are to be integrated into dramatically changing European and transatlantic markets has yet to be determined. The degree to which Central European defence producers will be able to broaden their production runs by selling in the West is likely to be limited. Those markets remain relatively protected and are restricted by serious budgetary pressures confronting virtually all the region’s governments. Central European manufactures are thus challenged to adjust simultaneously to serious domestic macro-economic challenges, a sharply changing global market, and global corporate restructuring. These markets are also being buffeted by relentless technological advances that are narrowing the gulf between the civilian and military sectors and which are likely to dramatically alter war-fighting strategy and procurement patterns. In order to keep pace, Central and Eastern European firms at a minimum need to strike industrial partnerships with Western firms. Ultimately, however, they will have to participate in European mergers, forge new ventures with American firms or focus narrowly on speciality areas where they may possess certain skills or cost advantages.
Even though the defence sector is quite large in countries like Poland, Romania, the Czech Republic and Slovakia, national leaders must recognise that this industry holds little promise as a source of national prosperity. Accordingly, resources should not be squandered propping up businesses that have no prospects of becoming profitable. Indeed, the demand for Central and Eastern Europe’s fully integrated weapons systems is unlikely to be very high, and this suggests that further reconfiguration of the sector is in store. The problem is that regional actors are determined to defend their respective defence-industrial base in some form and are not likely to adjust easily either to a role as parts subcontractor nor as off-the-shelf purchaser of Western hardware. Given that many defence manufacturers are regionally concentrated, political pressures to keep them afloat, and thereby avoid high regional unemployment, will be all the more intense. As the EU begins to consider the kinds of assistance it extends to Central and Eastern Europe, support for regions affected by the shake out of the defence sector might prove particularly helpful.
Western firms look at Central and Eastern Europe first as a potential market, and then as a supplier of lower end technology and components. Politicians from the West, as everywhere, face perennial pressures to buy national, even when the costs of doing so constitute a sub-optimal use of already scarce public resources. This protectionist instinct must be resisted. New and aspiring members of NATO must feel that they have a role to play as Europe’s market for military equipment grows more integrated and concentrated. This region must feel confident to pursue its comparative advantages and to abandon or, at least, pare back those sectors where it cannot compete and cannot forge international partnerships. Inevitably, Central and Eastern European defence firms will see Western European and American manufactures as both competitors and potential collaborators. Western firms, in turn, perceive opportunities in Central Europe for sales, joint ventures and production deals. Their own interest in lowering production costs makes Central Europe particularly attractive as a source of components and other inputs. Indeed, the region’s highly skilled but low cost work force represents a potential comparative advantage which is already attracting foreign investment. Thus the promise of co-operation is real. The question is whether the political will is also there, and if NATO and EU enlargement will provide a sufficiently robust framework to ensure that Central Europe, in particular, but Eastern Europe, as well, are able to cope with these fundamental changes.
Given the great sensitivities attached to the defence sector, sensitivities not only driven by economic issues but also by sovereignty concerns, (concerns that are particularly acute in former Warsaw Pact countries), it would be unreasonable to expect Central and Eastern European to meet national defence requirement exclusively through off-the-shelf purchases from the West. This is clearly a politically and even an economically inferior option either to genuine co-development and co-production deals with Western firms. Along these lines, Central and Eastern European governments are coming to the conclusion that major systems purchases from the West cannot be justified from a budgetary nor a strategic perspective and are now seeking ways to upgrade and modernise ageing equipment. This should involve Western firms but it also represents an area where regional governments should work together to eliminate costly redundancies.
Finally, in responding to the technological and price challenge of powerful American defence companies, Europe has begun to consolidate its defence industrial sector and may soon develop a capacity to forge common European defence policies. But it would be foolish if, in this process, current EU members neglect the fact that EU enlargement is on the horizon. Thus new institutional arrangements must be sufficiently flexible to accommodate new members, many of whom will also be NATO members. In practical terms, this will mean coming to terms not only with Central and Eastern Europe’s strategic concerns, but also its defence industrial problems.
Endnotes
Note 1: Judith Kiss, “Trapped in transition: Defence Industry Restructuring in Central Europe”, European Security, Vol. 4, No. 1 Spring 1995, pp. 56-84. Back.
Note 2: The Bonn International Center for Conversion (BICC) has done extensive work on conversion and worked closely with Central and Eastern European authorities to develop relevant strategies. Back.
Note 3: Pawel Wieczorek and Katarzynya Zukrowska, “The influence of equipment modernisation, building a national arms industry, arms export intentions and capabilities on national arms procurement policies and procedures”, draft paper. Back.
Note 5: Massimo Calabrese, “Czech Choices,” Time Magazine, June 29, 1998. Back.
Note 6: “Should we buy used Aircraft?” Budapest Magyar Nemzet, 25 August 1998. Back.
Note 7: Brooks Tigner, “Central Europeans Downplay Region’s Likely Market Potential,” Defence News, 19-25 January 1998. Back.
Note 8: Barbara Starr, “NATO enlargement to boost C4I system sales”, Jane’s Defence Contracts, July 1997. Back.
Note 9: Brooks Tigner, ibid. Back.
Note 10: Stefan Wagstyl and Virginia March, “Romania in bid to alter deal terms,” Financial Times September 2, 1998. Back.
Note 11: Brooks Tigner, “Central Europe Industry Promotes Common Fighter Acquisition”, Defence News, 1-7 December 1997. Back.
Note 12: Brooks Tigner, “Western firms navigate East bloc markets”, Defence News, 29 June-5 July 1998. Back.
Note 13: “Aspects of Defence Industry Analyzed”, Budapest Magyar Honved, 7 November 1997. Back.
Note 14: “Hungarian Military Industry Faces Recovery Prospects”, Budapest Magyar Mezet, 12 November 1997. Back.
Note 15: Brent Fischmann, “The Implications of Defence Industrial Restructuring for International Armaments Co-operation”, p. 4 (unpublished manuscript). Back.
Note 16: “Interview with Deputy Economy Minister Dariusz Klimek”, Warsaw Gazeta Wyborcza, 8 July 1998. Back.
Note 17: Pawel Wieczorek and Katarzyna Zukrowska, “Determinants of recipient dependence on a single source or pre-dominant arms suppliers”, (unpublished manuscript). Back.
Note 18: Pawel Wieczorek and Katarzyna Zukrowska, ibid. Back.
Note 19: Judith Kiss, ibid p. 73. Back.
Note 20: M. Holl, and L. Nemec, “Challenges facing the Czech defence industry”, Paper presented at the NIAG Partner meeting at NATO Headquarters, 4 November 1997. Back.
Note 21: Judith Kiss, ibid. Back.
Note 22: M. Holl, and L. Nemec, ibid Back.
Note 23: Judith Kiss, ibid. p. 64. Back.
Note 24: Judith Kiss, ibid. p. 66. Back.
Note 25: M. Holl, and L. Nemec, ibid. Back.
Note 26: Brooks Tigner, “Officials urge support for struggling defence industry”, Defence News, 20-26 April 1998. Back.
Note 27: Brent Fischmann, ibid. p. 5 (unpublished manuscript). Back.
Note 28: Brooks Tigner, “NATO Scrambles to revive Arms Co-operation”, Defence News, 12-18 January,1997. Back.
Note 29: Douglas Barrie, “Europe continues slow march to consolidate”, Defence News, December 7-13, 1998. Back.
Note 30: “Quatre pays européens créent une agence commune de l’armement”, Le Monde, 5 September 1998. Back.
Note 31: Theresa Hitchens, Christina Mackenzie, “Europe’s Big Three Drop Defence Bombshell, Defence News, December 7-13, 1998. Back.
