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Europe 1992: road block or two-way street?

Europe 1992: Road Block or Two-Way Street?

The 12-nation European Economic Community (EEC) has been evolving since the end of World War II. The latest step in that evolution is the enactment of what is termed the Single European Act. This process began in June 1985, with a White Paper entitled "Completing the Internal Market." The act represents a commitment to complete that internal market; it expresses the Community's "firm political will" to make the necessary decisions by December 31, 1992 -- in particular the approximately 300 directives set out in the White Paper.

The White Paper's directives cover everything from products, services and finance to labor, legal and regulatory procedures. In other words, Western Europe is changing. Ideological divisions are diminishing and borders are beginning to blur. This fusion, commonly called EC'92, is forcing the business community in the US and the rest of the world to take notice and adjust.

IMPACT ON THE GLOBAL DEFENSE MARKET

The European defense industry is not subject to the jurisdiction of the EC Commission, since Article 223 of the 1957 Treaty of Rome leaves the exclusive responsibilities for security with each of the national governments. While this exclusion has been slightly modified by the Single European Act, firms producing only defense and security equipment (many of which are state owned) will not be directly affected by EC'92. However, those companies that produce dual-use equipment (i.e., the same equipment for both commercial and military use) will be subject to the EC'92 consequences, including the development of common or mutually recognized standards.

Thus the post-1992 European environment will affect the defense products industry to varying degrees. Most likely, EC'92 will reduce the West European market for sales of US defense goods.

In the past, most of the global market for military weaponry has been served by the US, the Soviets and the Europeans. If the Soviets actually draw in their claws, the global arms market cannot help but shrink. Additionally, the recent move by the Soviets at the Paris Air Show to market their arms to other than their proxy nations could shrink the market share for US and European defense industries.

The business community worldwide is trying to determine how the coming of EC'92 will affect it. Some see it as the coming of "Fortress Europe," so their goal is to get in before the walls go up. The need to worry about being excluded from the EEC is clear when you consider that, if unified, it would become the largest market in the world. It will have 325 million consumers and account for 38% of the world's commerce.

But the concern which I believe is foremost in the minds of US defense contractors is that the two-way street between the US and Europe is narrowing in terms of our sales to Europe and widening the other way. In the past the ratio of US defense sales to Europe compared to European defense sales to the US has been as large as seven to one. Right now it is close to two to one. The Europeans would like the ratio to be closer to unity, with the trend in their favor. We're no longer in the catbird seat.

I have seen a great deal of advocacy for new programs from the services, DARPA and NASA, even in light of our declining defense budget. I see that as doing "business as usual," and perhaps some readers are comfortable with that. I also have heard optimistic and enthusiastic descriptions of the benefits of international cooperation and teaming. All this alleged good news can be accepted without much evaluation -- but only at our peril. The upcoming decade is going to be damned tough for the US defense industry, especially the small and medium size companies -- if they survive. In this environment, five-year plans are too short-sighted, as is striving to maximize just the next quarter's profits. Both our high-technology leadership and our industrial base are in jeopardy.

EUROPEAN ACTION

The Europeans are acting on tough issues while we in the US are studying them. The European defense industries are moving to improve the ratio of their R&D to production expenditures to better compete in their own market and in the rest of the world. They are also in the throes of coordinating their research to eliminate duplication.

To this end the Europeans have formed the Independent European Program Group (IEPG) to coordinate European defense procurement practices. They have recently announced the establishment of a cooperative research program called EUCLID (European Cooperation for Long-term Initiative for Defense). Its aim is to retain and foster European high-tech industries and promote intra-European cooperation. US and Canadian defense companies, by definition, are excluded.

In the case of military research, each government directly funds military projects carried out by its own national industries. This is done under a master plan coordinated under the auspices of the 13-nation IEPG. Mr. George Younger, the British defense minister who chairs the IEPG defense ministers group, has openly stated that the IEPG has "agreed to the continuing need to avoid protectionism in our pursuit of an open defense market, and to assure our friends in the US that we have no intention of becoming a protectionist market." How much encouragement should be drawn from these words I will leave to the reader.

Although the push is for an economic rationalization of fragmented European production capabilities, that policy runs contrary to the desire of some countries to maintain a complete capability in military products. Arguments to bring those countries who have less developed defense industries into the fold are that a competent defense industry could do much to enhance that nation's economic stability. While the argument has validity, its application to these countries is nonsense. There is a great deal of overcapacity in the aerospace and defense field worldwide right now. The only sane argument would be that they keep at least core defense industries in every country healthy. Holding out the carrot of economic stability is demagoguery.

Regarding technology transfer between European nations, they, like us, will be unwilling to transfer technology without adequate assurances that the receiving nation will protect it. On top of that, the developing country will want its fair return on its investment. This could take the form of a prescribed ratio of production contracts placed with a nation to its percentage of contribution to the research. The IEPG sees the likely demise of European industry if European governments continue to buy from the US to get lowest prices. So even if the US does become the prime contractor for a European piece of equipment, rules will be in place to ensure that European companies do an appropriate portion of the work.

Another concern in Europe is that there has been a spectacular lack of success in achieving common operational requirements -- not unlike the lack of success we have had in trying to get joint-service programs for major weapon systems like the F-111 and now congressionally directed Navy use of the Air Force ATF. Suffice it to say that if there are no common requirements, there can be no common programs.

The same is true for the lack of common European specifications for components and subsystems used in military equipment. When you currently buy a bolt in Europe, you have to know the standards of the country of origin to know how tightly you can torque it.

Additionally, the IEPG has evaluated US industry in terms of relative competence in defense development and production. Here are the areas where either "no US threat is perceived" or "the US threat is minimal": military vehicles, armored vehicles, engineering equipment, conventional weapons, powders, explosives, warheads, ships, submarines, protection equipment and military aircraft except for large transports.

The "high threat" areas are advanced sensors and computing technologies for guided weapons (smart and brilliant) and torpedoes, large transport aircraft and helicopters.

The two areas of greatest concern are the development of dual-use technologies in electronics (where the US is perceived as the highest threat and Japan a lesser threat) and materials. European questions of whether to start their own programs, buy US technology, manufacture under license or buy US products remain unanswered.

WHO CONTROLS THE FUTURE?

Now that the picture of IEPG perceptions has become focused, we enter the world of international mergers, takeovers and joint ventures. To address the question of "Who controls the future of defense R&D?" permit me to couple R&D with technology in general and our defense industrial base. The Defense Science Board and the Defense Manufacturing Board are looking into these long-range, interactive issues. As of now, there are few if any government policies that treat these three areas as a unified issue. Hopefully, some recommendations or guidelines will emerge from these boards.

Fundamental research conducted in academia and other unclassified arenas is usually not regarded as defense related until it is recognized as being a potential solution to a military problem. Even then, the independent research and development (IR&D) that defense companies undertake to pursue the expansion of such technology is usually unclassified, although held to be company proprietary.

Another cold reality is that 60% of our science and engineering doctorates are being won by students not native to the US. That's the bad news. The good news is that half of that 60% choose to remain in the US to pursue their careers. Why? Because the US is still the world leader in science and technology (otherwise, the foreign students would not be here in the first place). Note that during the past 10 years, US citizens have won 34 Nobel Prizes for scientific endeavors while Japan has won but two.

A final set of data is that of foreign takeovers of US firms. In 1986, 1987 and 1988 there were 264, 220 and 307 foreign takeovers respectively. In 1989, there were 154 takeovers in the first six months. The percentage of these takeovers to total US takeovers grew during those years from 8 to 14%. This year it's expected to be 16 to 17%.

Congress responded to this trend by enacting the Exon-Florio amendment to the Defense Production Act in August 1988. It calls for a review of these foreign takeovers for potential impact on our national security. Of the approximately 90 takeovers reviewed to date, none have been denied. One was withdrawn, a couple modified, but none denied.

However, it is extremely difficult to clearly demonstrate that there is or can be an impact on national security when the only definition of national security that the Defense Department ascribes to is that in JCS Pub-1. To get the gist of the problem, here is that definition:

National security: (DOD) A

collective term encompassing

both national defense and

foreign relations of the United

States. Specifically the

condition provided by: (a) a military

or defense advantage over

any foreign nation or group of

nations, or (b) a favorable

foreign relations position or (c) a

defense posture capable of

successfully resisting hostile

or destructive action from

within or without, overt or

covert.

Let me add that all classified programs in these (soon to be) US subsidiaries of foreign corporations are more than adequately safeguarded by DOD regulations on Foreign Ownership, Control and Influence (FOCI). These have been in place and operating for nearly 30 years.

So we face: (1) evolving, as yet unclassified technology; (2) a brain drain; and (3) foreign takeovers. Based on the details of the foreign takeover and other issues (such as the potentially very different profitability standards of the foreign owner and its US subsidiary), if the foreign corporation terminates and transfers the US subsidiary's research to the foreign home country, the development site of that emerging technology would shift as well. That being the case, the technologists will gravitate to where the action is, which will be outside the US.

So I put it to you -- Who controls the future of defense R&D?

I do not believe that we have as firm a grasp on that future as we should, but we could. And we can get it without resorting to overt protectionism. I don't have all the answers, but two simple entries into foreign corporate takeover agreements could make life easier: (1) a minimum proportion of the US subsidiary's gross government sales, consistent with the US subsidiary's prior record in R&D investments, must be invested in R&D in the US and (2) any plans to close a US subsidiary engaged in defense-related work must be made known to the government six months in advance.

Of course, one could find flaws in even these two demands, but even the free trader cannot easily object to maintaining a defense R&D base proportional to the defense dollars poured into the US subsidiary. Simple guidelines of this type can do more to prevent the erosion of defense-related R&D than can heavy-handed, unaffordable measures currently being espoused by some members of Congress.

PROTECTIONISM VERSUS FREE TRADE

There must be a middle ground between "protectionism" and "free trade" for defense R&D. The US has to find it by using the best heads it can find and not rely solely on the "old boy network" -- an idea that seems to be currently in vogue.

The US has had many hightech new starts in the past 15 years. Usually, a few smart engineers with a good idea are the nucleus. Time and time again, these companies get into financial trouble for the same reasons. Either they cannot sustain rapid growth for lack of good people or they become undercapitalized for expansion. Thus, they become targets for a takeover, and when they cry that "if we are not taken over, we will go out of business," the government generally approves foreign takeovers. If the takeover target has classified contracts, special provisions are made.

The free trader's reaction to foreign takeovers is that we still have the jobs in the US and the facility can be mobilized in the event of a national emergency. I say that the jobs and the facilities are secure only for the present. Anything can happen in the future. For example, the spokesmen for the foreign corporations usually sweeten the "verbal pot" initially, with talk of infusion of money and technology transfers to expand the existing capabilities of the US subsidiary. Little evidence supports such promises to date, and none of the promises are legally binding.

International procurement of defense weapons and cost sharing of their development is another tricky issue. In most cases, the few successes have come from company-to-company alliances on a program-by-program basis, and the technologies employed were usually not at the leading edge. The Defense Science Board is purported to be making recommendations to delete technology transfer rules considered onerous by out NATO allies and to restructure third-party sales rules on weapons.

I must agree that there are times that tech transfer is handled poorly by the government, and third-party sales regulations were a major deterrent to many of our aircraft subsystems manufacturers in bidding on the European Fighter Aircraft program. But cooperative development on a multinational basis has been a disaster. While there is a paucity of data, it appears that relative to a single nation's development cost, the cost of multinational programs increase as the square root of the number of nations involved -- if they survive at all.

How about Bill Perry's "family of weapons" concept? We develop AMRAAM, you develop ASRAAM. Look at where ASRAAM is today, and AMRAAM has not lived up to its initial expectations (although it is better than the AIM-7 Sparrow). The Germans have dropped out of ASRAAM, and the costs for the Europeans to produce AMRAAM are considerable.

"Buy American" has been the byline for too long according to the Europeans. As you know, there have been few American buys of totally European systems such as Durandal, the French runway cratering weapon bought by our Air Force. However, there have been joint ventures where European-developed systems have found their way into the US inventory, such as the Harrier, Roland (which we re-engineered to death) and a few others.

ADJUSTING TO FUTURE REALITIES

In summary, I believe that the European Unification Plan will facilitate mergers and streamline companies across European borders. European industry will become more competitive with the US. While joint ventures between US and European firms might provide access to European technology, this will occur only by osmosis. Anyone who thinks that a US company will be made privy to a European partner's advanced technology by virtue of a single joint venture is deluded. Significant intra-European cooperation could actually translate into diminished transatlantic cooperation.

Perhaps mergers and alliances between US companies are an answer to the European unification. Fortress Europe is imminent in the multiple alliances of the European Economic Community and the IEPG.

All that I read and hear tells me that Europeans want a share of the US R&D defense budget (which is reportedly four times that of the EEC). Claims by members of the European defense industry that they would be a steady partner, reduce duplication of effort and bring competition to the US market are all self-serving. If enacted, introduction of the Common External Tariff to cover military imports to Europe currently exempted from import duties by the Treaty of Rome will certainly have repercussions in the broader transatlantic sense. This protectionist measure has not yet been adopted, but it has also not been dropped from consideration.

The Europeans see the single-market program and close defense cooperation in the context of the IEPG as crucial to their future well being. From a European point of view, Europe has supported nearly as many defense industries with associated R&D as they have nations. Unification and IEPG policy should benefit the European cause, except for a few nations' national pride.

In Europe, military exports remain critical to national defense industries. As the US military spending goes down, US firms increasingly will look abroad to book arms sales, thereby competing with the Europeans. Presently, US firms are precluded by the US government from freely competing in many parts of the world. Economic pressures will probably cause Congress to re-think this issue to save American jobs, if nothing else.

While it is hard for the US to understand that it is not the only rich Western power anymore, the days of US technological pre-dominance and leadership are not yet gone. But the US must address the advent of the global market in a unified way; Congress, industry, labor and academia must work hand in hand. Congress is going to have to help by providing incentives for industry's investments in R&D and productivity and erecting disincentives to short-term business strategies. Industry must become more efficient to survive competitively. Labor must be cross trained and considered an asset instead of a replaceable cog in the wheel. And finally our schools, from the lowest grades on up, are going to have to raise their standards to compete academically with the rest of the world.

Dr. Victor D. Cohen is the deputy for tactical systems in the office of the assistant secretary of the Air Force for acquisition, a position he has held since 1980. His recent efforts have entailed the determination of national security effects that might result when US companies are taken over by foreign firms. He also has studied the impact that the evolving EEC and the associated IEPG will have on the prospects for US defense research, development and production beyond 1992.
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Title Annotation:European Free Trade Agreement, 1987-1992
Author:Cohen, Victor D.
Publication:Journal of Electronic Defense
Date:Nov 1, 1989
Words:3258
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