Global Trends In Defence Economics 2013 – 2014

From: The Military Balance IISS

Global economic growth slowed from 5.1% in 2010 to 3.8% in 2011 and an estimated 3.3% in 2012, as advanced economies continued to struggle with high levels of sovereign, bank and household indebtedness. Heightened financial contagion emanating from the eurozone – the 17 countries using the euro as a common currency – adversely affected European growth, while the unwinding of various domestic stimulus packages enacted in Asia in the aftermath of the 2008 financial crisis served to limit the extent to which Asia was able to drive global demand. High oil prices, an anaemic US economic recovery, and the lagged effects of incremental monetary tightening instituted across Asia and Latin America throughout 2011 acted as further constraints to 2012 activity.


Global Spending Changes 2011 – 2012

Despite the global downshift, emerging economies in Asia, the Middle East and Latin America are projected to maintain steady rates of growth, while advanced economies continue to address the weakness of their public finances. According to the International Monetary Fund’s April 2012 World Economic Outlook,

Gross debt-to-GDP ratios will rise further in many advanced economies, with a particularly steep increase in the G7 economies, to about 130% by 2017. Without more action than currently planned, debt ratios are expected to reach 256% in Japan, 124% in Italy, close to 113% in the US and 91% in the euro area over the forecast horizon. … In a striking contrast, many emerging and developing economies will see a decline in debt-to-GDP ratios, with the overall ratio for the group dropping to below 30% by 2017.

Defence Spending 2011–12

Reflecting these macroeconomic trends, global defence spending fell in real terms for a second year running in 2012. After a 1.5% real reduction in 2011, real defence spending declined by a further 2.05% in 2012 (constant 2010 prices and exchange rates).

Despite the overall reduction, defence spending trends varied considerably across regions. Real defence spending rose in Asia by 2.44% in 2011, before accelerating to 4.94% in 2012. In a similar vein, real defence spending in Russia and Eurasia grew by 3.11% in 2011, before rising by 13.28% in 2012. In Latin America, after a 0.71% real reduction in 2011 regional spending (caused in part by higher-thanexpected rates of inflation), real defence spending grew in 2012 by 4.0%. Similarly, after high oil prices in 2011 contributed to greater-than-anticipated inflation in the Middle East and North Africa, real defence spending is estimated to have fallen by 3.06% in 2011, before rising by an estimated 4.57% in 2012.



NATO vs ASIA Military Spending

Meanwhile, defence austerity in Europe saw real defence spending in Europe decline in both 2011 and 2012, falling by 2.52% in 2011 and by a further 1.63% in 2012. In North America, real military spending declined by 2.6% in 2011, and a further 7.5% in 2012. Sub-Saharan Africa saw a 0.3% real decline in 2011 spending (2012 trend unavailable at time of publication due to incomplete data availability), and continued to account for just 1% of global defence spending. (Note: real figures used here are measured at constant 2010 prices and exchange rates, see Figure 1 for further details.) See also ‘Comparative Defence Statistics’, pp. 41–2.

Asian and European Spending Converges

These general macroeconomic and defence-spending trends illustrate a broader shift in the underlying balance of global defence spending. This is highlighted by the convergence between Asian and NATO European defence-spending levels since the onset of the financial crash of 2008. As shown in Figure 2, between 2005 and 2007 (i.e. prior to the 2008 financial crisis), nominal defence spending in Asia (excluding Australia and New Zealand) rose from around US$148.1 billion to US$178.4bn, an average annual rate of increase of 9.8%. Nominal defence spending in NATO Europe rose at a broadly similar rate over the same period – from US$252.7bn in 2005 to US$298.5bn in 2007, an average annual rate of increase of 8.8%.

However, after the 2008 financial crisis, a marked convergence began between Asian and NATO European spending levels. Nominal NATO European defence spending fell from a peak of US$305.6bn in 2008 to a post-crisis low of US$262.7bn in 2012, declining by an average of 3.6% per annum in each of the four years since the crisis. By contrast, nominal Asian defence spending post-2008 has continued to rise at just under pre-crisis rates, with spending increasing from US$207.4bn in 2008 to US$287.4bn in 2012, equivalent to an average annual growth rate of 8.6%. In the process, nominal Asian spending overtook that of NATO Europe, with the former rising from US$268.8bn in 2011 to US$287.4bn in 2012, while the latter fell from US$290.0bn in 2011 to US$262.7bn in 2012.

Indeed, the increase in Asian spending has been so rapid, and the defence austerity pursued by European states so severe, that in 2012 nominal Asian spending (US$287.4bn) exceeded total official defence spending not just in NATO Europe, but across all of Europe, including spending by non-NATO European states. These convergence trends would be more pronounced if military pensions (a more significant proportion of defence spending in many European states than in Asian countries) were excluded from European totals.

Of course, the above trends refer to nominal spending levels at current prices and exchange rates, and therefore do not account for either exchange-rate fluctuations or variations in inflation rates between Asia and Europe. Additionally, defence spending per capita in European states remains significantly higher than in Asian states. Nonetheless, these nominal trends are indicative of the underlying shift in the distribution of real global defence spending.

Nominal NATO European defence spending now hovers at around 2006 levels (with spending in both 2006 and 2012 amounting to around $262.7bn), although the real decline in spending is substantially more than this nominal level would suggest, as the price inflation that has occurred since 2006 means that a similar amount of spending in 2012 purchases less than it did in 2006. In real terms, 2012 NATO European defence-spending levels are around 11% lower than in 2006 (at constant 2010 exchange rates and prices).

Global Supply

Governments and defence industries in advanced economies have adopted three main approaches to mitigate the contraction in Western defence markets described above. Firstly, there have been tentative moves towards consolidating defence industries and increasing collaboration between defence firms, in order to improve market access, realise economies of scale, and pool fixed costs such as R&D expenses. A second trend has been towards removing impediments to defence trade, particularly barriers to market entry, and relaxing export regulations. Thirdly, defence firms have sought to diversify their activities across a wider range of countries and sectors, in order to reduce their reliance on particular markets.

Defence – Industrial Consolidation and Collaboration

Attempts at industrial consolidation have been strongest in Europe, which saw several proposals for consolidation during 2011 and 2012. As part of the November 2010 Anglo-French defence cooperation agreement, BAE Systems entered into collaboration with France’s Dassault Aviation to study the viability of jointly developing unmanned aerial systems (UAS). In June 2012, France and Germany signed a letter of intent to explore potential cooperation in acquiring and developing a range of weapons platforms, including air- and missile-defence systems, UAS and space systems. Then, in September 2012, Paris and Berlin announced that they would work to establish a common operational requirement for a Medium Altitude, Long Endurance (MALE) UAV, with a view to developing an interim solution to their capability gaps in this area. Also, in September 2012,

it was announced that BAE Systems and pan-European defence conglomerate EADS were engaged in merger negotiations (see p. 37). Earlier, in January 2012, German firms Cassidian (the defence arm of EADS) and Rheinmetall said they would merge their tactical and MALE UAS activities to enable access to a greater resource pool for R&D. In the land-systems arena, in October 2012, Renault Trucks Defense (RTD) announced its acquisition of France’s specialist armoured-vehicle manufacturer Panhard General Defense.

Russia has also sought to expand the scope of its collaborative defence-industrial activities. Following a bilateral accord with France in January 2011 to supply Mistral-class amphibious assault vessels (with Russia’s United Shipbuilding Corporation assisting DCNS with construction), Rosoboronexport approached EADS in 2012, as well as Spain’s Indra Sistemas and Navantia, to explore opportunities forestablishing defence-industrial relations. In July 2012, Rosoboronexport reached agreement with Navantia to explore means of integrating Russian weapons systems with Navantia’s patrol boats for export markets – a collaboration that could generate greater market access for both companies to countries that had previously purchased equipment from the other. Earlier, in November 2011, Rosoboronexport signed an MoU with Indra Sistemas over technological cooperation; in December 2011, it said it was seeking further collaborative partnerships with countries in Asia, such as Brunei, Cambodia and the Philippines.

Defence Trade Facilitation

States have also been trying to reduce barriers to trade in defence markets. For example, with the volume of US Department of Defense domestic contracts set to decline relative to the past decade, and as defence firms based in the United States seek to expand their global footprint, the US administration has sought to reform US arms-export-control regulations and procedures, particularly those applying to close allies. Priorities have been the transfer of thousands of restricted items on the State Department’s US Munitions List (USML, where all items on the list are subject to the same restrictions) to the Department of Commerce’s more flexible Commerce Control List (CCL, where export-licence restrictions are calibrated according to the nature of the item). The idea is to create a Single Control List consisting of only the most sensitive defence technologies. The administration also began streamlining the procedures by which the Department of State notifies Congress of proposed transfers from the USML to the CCL and of proposed Foreign Military Sales (FMS). Unbounded informal consultation periods built into the current FMS procedure allow a single lawmaker to delay the entire process, with the result that notifications to Congress are often withheld to prevent the stalling of other legislative items. This causes lengthy delays that diminish the United States’ reputation as a reliable arms supplier. According to the State Department, it takes 90–95 days on average to obtain approval for a major arms sale, and an average of 215 days to move an item from the USML to the CCL.

Specific bilateral arrangements between the US and its close allies to expedite export approval and reduce delivery times for defence items also came into effect in 2012. The Defence Trade Cooperation Treaty with the United Kingdom (first signed in 2007 and ratified by the US Senate in 2010) to reduce export-licence and ITAR (International Traffic in Arms Regulations) approval requirements came into effect in April 2012. A similar defence trade cooperation treaty signed with Australia (in 2007, ratified in 2010) was implemented in November 2012 with the passage of the Defence Trade Controls Bill in Canberra.

In late 2011, Japan also eased its long-standing defence-export regulations and restrictions on the participation of its domestic defence industry in collaborative international defence-industrial programmes. In June 2012, Japan signed an MoU with the United Kingdom that included an undertaking to cooperate on joint R&D and defenceequipment production. Later, in September 2012, Japan announced a similar bilateral agreement with Australia, which aimed to expand defence research ties and exchange information on areas of defence technology of common interest.

Elsewhere, European Union Directive 2009/81/EC on Defence and Security Procurement came into force in August 2011, attempting to unify Europe’s fragmented defence markets, thereby encouraging greater defence trade across the region.

Geographic and Sectoral Diversification

Economic turbulence in developed markets has made it more important for defence firms in advanced economies to have a strong portfolio of foreign orders. These companies have correspondingly put increasing emphasis on emerging markets, particularly in Asia, the Middle East and Latin America. In Asia, maritime territorial disputes have seen an expansion in the market for intelligence, surveillance and reconnaissance (ISR) systems, while procurement budgets in Indonesia, the Philippines, Bangladesh and India have also increased. India remains one of the largest defence markets for foreign suppliers, importing some 70% of its equipment requirements. The Middle East continues to spend record amounts on defence, as countries upgrade their combat-aircraft fleets, radar and missile-defence systems. Meanwhile, Latin American states have increased spending on border-defence systems, training aircraft, light helicopters, naval patrol vessels and UAS.

Foreign defence companies seeking to penetrateregional markets have increased their engagementwith domestic defence industries and research institutionsto better meet offset requirements and securecontracts. In other cases, foreign firms have enteredinto partnership agreements with, or taken direct stakes in, local defence firms, in order to take advantage of lower manufacturing costs, improve market access and their regional presence. Many emerging market governments have themselves placed considerable emphasis on the establishment of industrial partnerships with advanced suppliers in order to accelerate their own defence-industrial transformationand to raise their defence production capacity. These trends are explored in depth in the Latin American and the Caribbean chapter

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