The Bush Administration has threatened to veto any bill that contains such provisions because they would limit the administration's flexibility in applying acquisition laws and could also prompt retaliation against U.S. defense firms. Moreover, the provision that the Department of Defense must buy American-made products simply cannot be implemented. Some of the products that the Department of Defense must buy--such as electronic flat-panel displays and certain kinds of computer chips--are no longer made in the United States or are only made in limited quantities.

Another problem is posed by the subsidies that firms like EADS receive from European governments. Since the passage of the House authorization act, the United States has filed a WTO case against Airbus--which is 75 percent owned by EADS--over the subsidies it receives. It is highly unlikely that the U.S government will award a multi-million dollar contract to a company against which it is taking legal action.

EADS's future cooperation with Russia could also prove problematic. During a visit to Moscow in October, EADS management reportedly discussed involving Russia in several large commercial aviation projects. Such cooperation underscores EADS determination to expand its global market presence. However, given growing U.S. concerns about Putin's policies, the cooperation could raise eyebrows in Congress and complicate EADS's effort to penetrate the U.S. market.

LOOKING TO the future, two sets of factors--one economic and the other political--are likely to drive the development of the European defense industry. First, economic factors could influence the financial performance of defense companies, the resources available for procurement (including R & D and S & T efforts), unit costs and export sales. In addition, while high economic growth rates will not necessarily translate into higher defense budgets, low or negative growth would shrink the resources available for defense. This could lead to lower defense budgets and increase the incentives for consolidation and collaboration.

The growth of protectionism in Europe could also undermine the consolidation of the European defense industry. French Prime Minister Dominique de Villepin recently spoke of the need for "economic patriotism" to protect certain French industries. While the idea of economic patriotism is aimed largely at a domestic audience, French defense executives worry that a growth of protectionism could cause other countries to shun French companies. The effort by Thales, a French firm, to acquire German naval-electronics firm Atlas Elektronik, for instance, has been hurt by such fears.

The second is the political evolution of the European Security and Defense Policy (ESDP). The development of ESDP will have an important impact on the structure of the European defense industry. Increased progress in building ESDP and a stronger European Union may increasingly shift these from national to regional considerations. In addition, governments and defense ministries generally procure weapons, platforms and systems for use during future military operations. Future joint action should increase industry consolidation and collaboration in order to increase interoperability and standardization. Low levels of interoperability and standardization can severely impede the ability of militaries to fight effectively by complicating command, control, communications, computers, intelligence, surveillance and reconnaissance capabilities (C4ISR).

ESDP has strong public support in Europe and is likely to continue to be an important element of EU foreign policy. However, U.S. fears about the development of the EU as a counterweight seem unwarranted. First, France does not have the political weight to drive the EU integration process. This is even more true since the recent enlargement of the EU in May 2004, which has significantly weakened France's influence within the EU. Second, the majority of the members of the EU, especially the new members from central and eastern Europe, want a strong tie to NATO and the United States, as do other Atlanticist members such as Britain, Italy, Netherlands, Portugal and Denmark. Finally, it has become increasingly clear that a strong ESDP cannot be built without the support and participation of Great Britain--a fact even France has come to realize. Britain's involvement in ESDP serves as an important counterweight to France and ensures that ESDP will not be driven in an anti-NATO or anti-U.S. direction.

An additional political factor will be the development of the European Defense Agency. In 2004 the European Council established the European Defense Agency (EDA) to improve European military capabilities, consolidate defense research and technology, and promote armaments cooperation. With a 2005 budget of more than $23 million and a staff of approximately eighty people, it is small and has few resources and little decision-making authority. Currently, it is leading or managing several initiatives, including development of unmanned aerial vehicles (UAVs) and intelligence, surveillance, targeting and reconnaissance systems (ISTAR); the enhancement of command, control and communication capabilities; and the production and development of commercial and military off-the-shelf equipment.

The EDA, together with the European Commission, is scheduled to begin conducting a detailed inventory of EU defense industrial capabilities this year. The inventory is designed to map the entirety of Europe's defense technological and industrial base, from testing and evaluation facilities to industrial capacities. This will give the EDA's steering board an overview of the gaps in the defense sector regarding the fulfillment of the headline capabilities goals for the EU's 60,000-soldier rapid-reaction force, agreed upon at the EU summit in Helsinki in December 1999. When completed, the map will provide the basis for a coordinated cross-border defense industrial policy. However, gathering the information for the map may prove difficult. There are still some barriers to information-sharing among European defense ministries. Thus the EDA will have to overcome the reluctance of both European governments and industries to share information if it is going to produce a useful map.

The EDA has agreed on a new code of conduct aimed at creating a single EU defense market by opening competition for defense contracts worth more than $1.2 million. The code is designed to constrain the use of Article 296 of the Treaties Establishing the European Communities (2002), which allows EU governments to invoke national security considerations to shield national defense industries from foreign competition.¹ However, the code has been criticized by European defense executives because it is voluntary and non-binding. Many European defense firms feel that only a binding agreement can prevent countries from evading open competition by declaring certain programs "politically sensitive."

U.S. FOREIGN policy decisions, especially regulatory obstacles to transatlantic cooperation, will also have an important impact on the European defense industry. The persistence of obstacles like the Buy American Act over the next decade would encourage greater collaboration among European defense firms. In addition, if the Europeans were to develop the EU as a counterweight to the United States and NATO--as some French officials advocate--the United States might be even less inclined to open its market to European firms. A serious weakening of NATO might cause the U.S. government to conclude that there were few benefits to transatlantic collaboration.

However, there are several steps that the United States and Europe could take to alleviate--though probably not eliminate--future sources of potential discord. One is to improve transatlantic interoperability in such areas as C4ISR, which will be critical for future coalition operations. In Afghanistan, for example, the United States and Europe have been deeply involved in combat and reconstruction operations, though there continue to be interoperability challenges. This was particularly evident at the level of special forces. Highly specialized communications and other equipment were frequently incompatible, and there were significant challenges in passing classified information between U.S. and European forces. Royal Air Force tanker aircraft flown by British aircrews in Afghanistan were compatible with U.S. Navy carrier-based fighters conducting air strikes, but U.S. Air Force tankers were not. There is some prospect for improved cooperation based on lessons from Afghanistan, but the gap is still large. It is also important for U.S. policymakers to recognize that European defense policy is increasingly being shaped within the parameters of the European Union, not NATO. This means that the U.S. military may increasingly have to engage European countries through the EU, not NATO.

Finally, the United States needs to streamline and revise its export licensing regime. The current regime is too restrictive in preventing foreign companies--including those from allied countries--from cooperating with U.S. companies. All military technology exports or overseas transfers require a license from the Office of Defense Trade Controls in the State Department, following interagency coordination. The slowness and complexity of the process, and the large number of items on the Munitions List, make transatlantic collaboration difficult. U.S. firms that wish to collaborate with European firms encounter delays in this process. The British government has been deeply frustrated about export-control hurdles for the Joint Strike Fighter. European firms seeking to acquire U.S. components find the system unpredictable. In addition, European defense firms are often excluded from the U.S. market through political obstacles. The restrictive U.S. licensing regime and the exclusion of European firms from the U.S. market may leave European firms with little choice but to sell to third countries such as China.

ONE OF the major policy issues in the future between the United States and its European allies is likely to be the growing interest of third countries in acquiring European military and dual-use capabilities through licit or illicit means. This has already begun to happen. Of particular concern are European technology transfers to U.S. adversaries, especially China. The United States has expressed concern that the EU may lift its arms embargo of China, which was implemented in 1989 following the Chinese government's crackdown in Tiananmen Square. A decision to lift the arms embargo, coupled with a closer European-Chinese economic and political partnership, would likely lead to military and dual-use technology transfers to China. This development could increase China's military capabilities by accelerating important components of military modernization and could ultimately impede America's ability to sustain deterrence in Asia.

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