Integration processes in the defense industry complex.

The development of the defense industry complex (DIC) at the beginning of the 21st century and therefore its ability to implement the government armaments program will be contingent on the ongoing integration processes. These processes have to a very large degree evolved as a reaction to the spontaneous conversion, de-monopolization, and privatization of the defense industry in the 1990s. The DIC's deplorable condition at the time compelled the state to look for new ways of revitalizing the defense industry, mainly by reforming it through the creation of integrated structures. There were two opposing trends underlying the integration processes: On the one hand, the state's aspiration to formalize them by using administrative resources and on the other, the effects of the economic laws of corporate merging and acquisition, characteristic of free market relations.

The formation of integration structures in the defense industry complex as a general rule follows one of the two scenarios. In the event of integration "from above," the enterprises have government contracts and state control but rather small chances for rapid "prosperity." If integration structures are created on the "bottom" level--i.e., on the initiative of DIC enterprises themselves--they get direct access to the market which, however, involves a considerable risk of ending up without any contracts at all.

The first trend is represented by the federal program Reformation and Development of the Defense Industry Complex in 2002-2006 whereby the creation of integration structures is seen as the basis for restructuring the defense industry (the ultimate aim being the creation of system forming, diversified interbranch scientific production corporations of a new type, manufacturing both military and civilian products and able to compete on the world market). The general assumption is that integration of defense industry enterprises is objectively the only viable option for carrying through deep (cardinal) structural changes and creating a new-look DIC, capable of competing with multinational corporations operating on international markets. This is why the creation of integrated structures in the defense industry complex is today thoroughly supported by the state and geared to meet the following requirements:

-- a project's importance for ensuring state interests;

-- the conformity of an integrated structure project to the principal directions of the DIC reform program;

-- participation in the fulfillment of state defense production orders and federal target-specific programs;

-- preservation of production, scientific-technical, and cadre capabilities, the integrity of technological cycles and cooperation links in the development, production, maintenance, and testing of military equipment;

-- preservation of mobilization capacities in accordance with mobilization targets;

-- development and production of civilian products;

-- cutting production costs;

-- effective use of state property in the course of a project's implementation; and

-- an ability to attract extra budgetary resources to finance a project.

Market based integration processes in the DIC were to a very large degree expedited by military-technical cooperation which, amid the limited availability of government defense contracts, enables integrated structures to control substantial financial flows. For example, export turned out to be the only survival chance for many enterprises in the aviation industry. Oftentimes entry into a foreign market became a strong incentive for restoring cooperation or establishing new contacts.

Integrated structures within the DIC are being established both on the federal (inter-regional) level* and on the regional level (regional integration processes are exemplified by the Rostov Oblast authorities' plan to create a holding of defense industry enterprises that will amalgamate into a single structure the AO Taganrogskiy aviatsionnyy nauchno tekhnicheskiy kompleks im. Berieva joint stock company and the AO Taganrogskaya aviatsiya joint stock company, as well as the integration of several munitions producing factories in Samara Oblast into a holding called Samarskaya elektromekhanicheskaya korporatsiya).

Furthermore, there is deepening international integration with the participation of domestic defense industry enterprises. Thus, a protocol of cooperation was signed between Navair Inc., a company providing logistical and technical support for U.S. sea aviation, and the Saratov aircraft factory (the sides intend to cooperate on a project to create a new-generation amphibious aerial vehicle called Ekip that has no counterpart in the world); the Samara based Aviakor aircraft making plant and the Kharkov based aircraft production association (Ukraine) registered in Russia a joint venture called International Aviation Project 140 to promote An-140 aircraft on the market; the Russian-Belarussian Inter-Governmental Commission on Military-Technical Cooperation decided to create joint ventures in the modernization and sales of arms and military equipment.

Integration processes, however, are compounded by a number of problems. First of all, this is the financial status of defense industry enterprises involved in integration processes: In 2003 alone, 32 such enterprises were put into receivership, which is the last stage of bankruptcy, when their assets begin to be sold off. Integration in the defense industry complex is also aggravated by such a problem as the withdrawal of private investors from the defense industry (for example, the Sibur oil and gas chemical holding decided to sell off the OAO Kurgansky mashinostroitelnyy zavod joint stock company while the Interros company continues to shed its DIC assets). These problems to a very large extent cause constant changes in the plans of creating integrated structures. Thus, whereas under the aforementioned federal program Reformation and Development of the Defense Industrial Complex in the 2002-2006 Period, 70 integrated structures were to be created within the period of three years, now it is planned to create only 42 holdings (in 2004, five holdings were formed).

Integration processes are closely interconnected with the processes of privatization and corporatization of defense industry enterprises. At present, the state is invigorating its course toward privatization of the defense industrial complex without which, the RF government believes, it will not be competitive. One of the principal tasks in the foreseeable future is the creation of self-regulating organizations in Russia's DIC that would integrate branch of industry structures and perform regulatory functions. Meanwhile, the current trend toward a reduction in the state's administrative functions in the business sector requires defense industry enterprises to show a higher degree of self-organization so they are bound to be transformed into branch of industry holdings. Privatization, however, does not mean the elimination of state controls. In theory as well as in practice, the state always has ways of influencing the operation of a private company through the issue of licenses to develop and produce arms and military equipment or export licenses. The state exerts its influence also through the state certification and acceptance system and the procurement of alternative weapon systems.

In August 2003, the RF government approved the Program (Plan) for Privatization of Federal Property in 2004 and the Basic Lines of Privatization of Federal Property until 2006, whereby it is planned, before 2006, to complete the reorganization of state controlled enterprises in the defense industry as joint stock companies and the privatization of stakes in joint stock companies that fail to contribute to the performance of state functions and tasks. As a result, the state will retain in federal ownership only strategic enterprises and controlling stakes in strategic joint stock companies producing unique products (goods, services) that have a strategic importance for ensuring national security or are elements of federal infrastructure operating in a non-competitive sector of the economy (as of July 2004, the list of such enterprises included 518 federal unitary state enterprises and 540 joint stock companies). (1) The 2004 privatization program included another 117 state enterprises (107 of them subject to incorporation into integrated structures: after reorganization as joint stock companies, their stock is to be transferred to the incorporation capital of the parent companies of integrated structures) as well as stakes in 89 joint stock companies (37 of these are strategic companies whose privatization is only possible under a special edict by the president of the Russian Federation changing the list of strategic joint stock companies; their stakes are to be transferred to the incorporation capital of the parent companies of integrating structures--that is to say, these stakes will not be put up for auction).

In practice, however, these plans failed to materialize. In particular, the privatization of the greater part of organizations slated for privatization under that program was postponed until 2005, while privatization prospects for another 300 enterprises have yet to be assessed. (2)

The problem is that due to the socio-economic importance of corporatization, privatization may be at odds with regional interests. Thus, legislative assemblies in a number of regions demand that privatization of defense enterprises and scientific research centers be stopped since this poses a real threat to national defense.

Yet another important but gradually waning process is conversion of the defense industry, as a result of which many enterprises, which used to produce defense related products, moved into other spheres of activity. Conversion saw its peak in the early 1990s, which was caused by the need to adapt the DIC structure to the actual volume of state defense contracts. The state played an organizing role in conversion projects and the related restructuring of the defense industry, to which end a number of federal target-specific programs were adopted. Then the role of the state in funding conversion projects began to decline. Different methods of conversion were used in different DIC sectors and not surprisingly, its results also varied. The problem became especially acute in such a specific sector of the defense industry as the nuclear weapons complex where conversion projects began in 1989 with new scientific-production lines emerging in the sector since then, considerably diversifying its activities.

Conversion also intensified such a process as diversification of production which helps to achieve an optimal correlation between civilian and military output, thus ensuring the maximum possible profits. And although the role of diversification in the development of the military industrial complex is still rather insignificant, it is becoming increasingly consequential, expediting yet another important process--military-civilian integration.

In conclusion, it should be pointed out that the integration process in the defense industry has a complex and contradictory character and is accompanied by a number of problems, especially in the process of creating integrated structures.

NOTES:

1. V. Kramar, V. Myasnikov, "Oboronnye predpriyatiya rassortirovali na vazhnye i ostalnye," Nezavisimoye voennoye obozreniye, No. 30, 2004.

2. Vremya novostey, July 14, 2004.

Maj. Gen. V.M. BURENOK

Doctor of Technical Sciences

Col. G.V. BABKIN

Col. A.A. KOSENKO (Ret.)

Candidate of Technical Sciences

* At present, work is underway to create the Integrated Aircraft Building Corporation, a private/state partnership, which is to produce military, passenger, and transport aircraft, provide after-sales servicing and maintenance, and also conduct leasing operations. There are plans to form Vertolety Milya, a helicopter holding, that will integrate Mi helicopter developers and producers. It is also planned to create integrated structures in other sectors of the defense industry.