SINCE THE end of the Cold War, Europe's defense industry has undergone important changes. There has been a marked consolidation of the defense industry and a visible increase in intra-European collaboration. In 1993 only two European defense firms--British Aerospace (BAE) and Thompson SA--were among the top-ten defense firms in the world. Today, four European firms--BAE Systems, EADS, Thales and Finmeccanica--are among the top ten. This consolidation has largely been driven by a desire to compete with U.S. defense firms on the global arms market, since, with the partial exception of UK defense companies, European firms have had difficulty penetrating the U.S. defense market.

These developments have received relatively little attention outside the boardrooms of a few U.S. defense firms. However, they raise important issues for U.S. policy, notably whether these changes will enhance transatlantic defense cooperation or hinder it.

Several factors have been responsible for the consolidation of the European defense industry since the end of the Cold War. Economic factors--the decrease in European defense budgets after the collapse of the Soviet Union, the scale of national procurement, and the rising cost of the development and production of weapons and defense equipment--clearly played a role in promoting the consolidation. But they do not give the whole story. A more important factor was the consolidation of the U.S. defense market, which created several giant defense firms led by Lockheed Martin and Boeing that threatened to dominate the global arms market. This created a notable incentive for European defense firms to compete. The decline in the U.S. defense budget in the 1990s in the aftermath of the Cold War led U.S. government leaders to push for consolidation in the U.S. defense industry. For example, Lockheed acquired the Fort Worth division of General Dynamics in 1993 and then merged with the missile manufacturer Martin Marietta in 1995 to form Lockheed Martin.

The rise of large, competitive and technologically advanced U.S. defense firms provided a major impetus for European defense firms to consolidate. As Thomas Enders, then-CEO of defense and security systems at EADS and now CEO of EADS, noted: "In view of the mega-mergers in the U.S., it was clear to European industry leaders that national consolidation and joint ventures were inadequate counters to the competitive challenge being posed by U.S. industry."

Equally important in driving the rise in intra-European consolidation and the creation of several major prime firms was a political desire for Europe--especially the EU--to play a larger and more autonomous global role. The desire among European states to build an autonomous military capability created an important incentive for consolidation. The close relationship between European states and the expectation of future cooperation meant that intra-European consolidation would preserve European security of supply, sustain a strong European defense industrial base, and maintain European technological capabilities. Indeed, major consolidation outside Europe would have decreased security of supply and would have compromised the viability of the European defense industrial base.

Two examples illustrate the rationale for consolidation. First, the establishment of EADS created a transnational European defense giant with two major benefits: the ability to compete with U.S. firms such as Boeing and Lockheed Martin; and the ability to produce a variety of advanced armaments, such as the Eurofighter combat aircraft, the Eurocopter, the A400M transport aircraft and precision-guided missiles, all of which would improve Europe's ability to act autonomously. Following the December 1997 declaration by European leaders regarding the need for regional consolidation, government and industry negotiations were initiated to create a European defense company. While British Aerospace declined to join the German aerospace company Dasa, secret negotiations in 1999 between the shareholders of Daimler Chrysler, the Spanish state holding company SEPI, the LagardÂre Group, and the German, Spanish and French governments eventually led to the creation of EADS. French Defense Minister Alain Richard and Economy Minister Laurent Fabius jointly noted that the establishment of EADS "goes in line with the European policy promoting an autonomous defense industry that is globally competitive."

Second, the creation of MBDA in the late 1990s was a significant step toward consolidating European missile production under one roof and challenging U.S. missile producer Raytheon. Following negotiations between executives from British, Italian and French missile companies and their respective governments, MBDA was established in 1999, producing guided weapons for land-based, naval and airborne requirements such as the Meteor and ASRAAM air-to-air missiles and the Exocet anti-ship missile.

Alongside the merger process, there has also been an increase in intra-European defense projects. During most of the Cold War, European states tended to collaborate with American defense firms rather than with other European firms; now European defense firms are almost twice as likely to pursue coproduction and codevelopment projects with each other than with U.S. firms. As with consolidation, this trend is driven by the desire to both compete with U.S. firms and address gaps in current European capabilities. A recent report, Towards an EU Defence Equipment Policy (2003), concluded that "there is a danger that European industry could be reduced to the status of sub-supplier to prime U.S. contractors, while the key know-how is reserved for U.S. firms." This concern was reinforced in a joint statement issued on June 24, 2004, by the CEOs of Europe's three largest defense firms--BAE Systems, EADS and Thales: "Industry in Europe is under enormous competitive pressure from the United States. With U.S. defense research-and-technology investment running at around eight times that of Europe's fragmented total, and with substantial growth in the Pentagon's vast procurement budget in a heavily protected national market, American industries are reaching new heights." They stressed that intra-European defense consolidation is critical because European governments and industry do not "wish to see indigenous defense technology overtaken or dependence on foreign technologies become a necessity."

Take the development of the Galileo global navigation satellite system. European governments could have continued relying on the U.S. global positioning system (GPS) for navigation, but they became increasingly concerned about the security of supply. As a European Commission document noted: "If the EU finds it necessary to undertake a security mission that the U.S. does not consider to be in its interest, [the EU] will be impotent unless it has the satellite navigation technology that is now indispensable. Although designed for civilian applications, Galileo will also give the EU a military capability." The evidence strongly suggests that European states have established the Galileo program to decrease reliance on others (especially the United States) for global navigation satellite capabilities and to support the European desire to develop an autonomous capability. Galileo is a joint initiative of the European Commission and the European Space Agency, and includes the participation of such firms as EADS Astrium, Alenia Spazio, Alcatel Space and Thales. It also involves the participation of several non-European countries--such as China, Ukraine and India--who are interested in Galileo's space-based navigation technology.

WITH THE partial exception of BAE Systems, most European defense firms have had difficulty penetrating the U.S. market. This is largely a function of political factors in the United States. The United States has historically been autarkic in the defense industry. There has been deep reluctance to cooperate with foreign governments and defense firms for much of American history, going as far back as Alexander Hamilton's Report on the Subject of Manufactures. Political obstacles to transatlantic cooperation have included extensive export and technology-transfer controls and restrictive regulatory processes regarding foreign investment in U.S. firms.

Consequently, most European defense firms have been unable to make significant inroads into the U.S. defense market. For example, Thales's sales to North America in 2004 were 9 percent of overall sales--the same as in 1999, despite massive efforts by Thales executives. Finmeccanica's sales to North America also remained constant between 1999 and 2004 at 8 percent of total sales. (The major exception was BAE Systems, which nearly doubled the percentage of exports to North America from 17 percent of overall sales in 1999 to 31 percent in 2004, aided in part by the UK's close strategic relationship with the United States.)

Some European defense firms have begun to break into the U.S. market lately by teaming up with U.S. firms. AugustaWest, which is owned by the Italian firm Finmeccanica, recently won a contract to produce the U.S. presidential helicopter by joining forces with Lockheed Martin, which served as prime contractor on the bid. Finmeccanica has also teamed up with Lockheed Martin, L-3 Communications and Rolls-Royce to bid on producing the U.S. Army's future cargo aircraft. EADS and Northrup Grumman have agreed to cooperate in a bid to replace the U.S. Air Force's aging fleet of aerial refueling tankers. Northrup will act as the prime contractor, while EADS would be the principal subcontractor.

However, European firms face a number of obstacles. One is congressional support for the Buy America Act. In May the House of Representatives attached three Buy America provisions to the House version of the 2006 Defense Authorization Act. One of the provisions prohibits the Pentagon from buying from any foreign company that receives subsidies from a government in the World Trade Organization. The legislation is partly aimed at barring EADS from getting a tanker contract with the Air Force. Another provision would prohibit the Defense Department from doing business with foreign companies that have sold military goods to China for commercial reasons. The third provision requires that more than 50 percent of the products bought by the Department of Defense be American-made.

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