The European Defence Industry Programme: Revolution or Repetition?

In March, the European Commission proposed its Defence Industrial Strategy and accompanying Regulation aimed at achieving “structural defence readiness.” Although promoted as a paradigm shift, the proposed Regulation contains little innovation compared to earlier initiatives and is unlikely to fix the industry’s problems, argues Isaak de Kroon.

In March, the EU announced its first ever European Defence Industrial Strategy, stressing the need to invest more, better and together in the European defence industry to integrate this fragmented sector. The Strategy, accompanied by the proposal for a European Defence Industry Programme (hereafter: the Programme), aims to shift the EU’s strategy from “emergency responses to structural EU defence readiness.” The Programme allocates 1.5 billion euros in subsidies for the EU and Ukrainian defence sector under the current Multiannual Financial Framework, and is meant to be extended under future ones. The overall message the Commission tries to convey seems to be a shift to a structural, long-term approach after the initial ad-hoc measures adopted earlier.

Since the Russian invasion in 2022, Western supplies of military equipment and ammunition have been a top priority for Kyiv. Two years later, Ukraine has exceeded expectations, but now faces acute shortages and a renewed Russian offensive. Meanwhile, European stockpiles are drying up and production capacities are still not on the level needed. These shortages are nothing new, mid-2023 the EU adopted the Act in Support of Ammunition Production (ASAP). This 500-million-euro fund was the EU’s initial response to the artillery ammunition shortages by investing in European production capacities. Although the official evaluation is not due until June of this year, the subsidies in the Programme are based on the same logic as the ASAP. In addition to production capabilities, the Programme subsidises common procurement; joint purchasing of equipment by at least 3 Member States, with the option for EEA members to join in. Collective purchasing is a voluntary way of standardising European weapons systems, and the Commission again seems to be doubling down on tried methods; similar subsidies were made available in fall 2023 under the European Defence Industry Reinforcement through Common Procurement Act (EDIRPA). Lastly, Chapter IV on Security of Supply bears stunning resemblance to ASAPs initial proposal. Although marketed as a paradigm shift, the similarities with the instruments of last year raise the question – what has actually changed since these initial measures?

Subsidies: ASAP & EDIRPA and FAST

The proposed 1.5-billion-euro subsidy fund targets three areas: production capacities, common procurement and private financing. The first two areas extend the ASAP and EDIRPA logic for two more years and broaden the former’s scope from solely ammunition to include a wide range of defence products. Although the proposal does combine the different subsidy measures in one comprehensive program, the subsidy logic is nothing new and faces a number of problems.

Production capacities

The goal of the subsidies for production capacities is clear; to incentivise investments in upgrading existing production facilities and building new ones. Investments in production lines are costly, so suppliers usually need reassurance that they will get the orders to get a return on those investments. Although increased national defence budgets have given some certainty, Member States spend their budgets on too many different weapons systems and too many different suppliers. This leads to fragmentation, which is considered to prevent economies of scale, reducing the profitability of large investments. Subsidies on their own do little to fix this underlying problem. The funds are available for all manufacturers of ‘relevant defence products’ and the award criteria in Article 16 of the Programme are of little standardising effect. Because standardisation leads to fewer different weapon systems, coupling subsidies to standardisation requirements risks excluding certain industries from the scheme in favour of others. The political momentum needed for these reforms therefore seems to be missing. Furthermore, national spending dwarfs the funds the Commission has made available, and thus remain the main determining factor for investments in production capacities. In comparison, the EU subsidies seem like a mere drop in the bucket. Worse yet, the subsidy package is financed by money drawn from the European Defence Fund. The Commission thus repurposes money already meant for the defence industry rather than providing actual additional funding.

Common procurement

Standardisation efforts currently happen on a voluntary basis, primarily through NATO and the European Defence Agency (EDA). Because the Commission cannot dictate to Member States which weapons to buy, it tries to standardise weapons systems by incentivising common procurement, first through EDIRPA and now the Programme. The new subsidies also cover costs throughout the lifecycle as opposed to mere initial purchasing costs. Other than that, little has changed compared to EDIRPA. Common procurement has long been on the Commission’s radar. Member States already agreed on a 35% target under the EDA framework in 2007. Even though this already proved too ambitious, with joint procurement accounting for only 18% in 2021, the Strategy increases the target to 40% by 2030.

As Meershoek argues, military procurement is not primarily driven by economic considerations like cost-efficiency, but rather by “sovereignty and interdependence.” In short, when actually procuring military equipment, the calculations states make are based on a wide range of factors other than costs; first and foremost, national security implications, but also supporting domestic industry and relationships with other nations. The amounts of money involved in these tenders are enormous and the procedures are lengthy, complicated, and politicised (look for example at the political upheaval in the Netherlands and Australia over submarine procurement). Whether a subsidy scheme this small, will change that calculation is doubtful.

If the Commission truly wants to change procurement, a better place to start would be a review of the procurement rules, embedded within the Defence Procurement Directive (2009/81/EC). This Directive does actually contain provisions that impose binding obligations on Member States. Unfortunately, even this does not work. As Meershoek points out in various contributions, procurement liberalisation is heavily constrained by the national security exemption clause of Article 346 TFEU.

Private financing

In addition to continuing the ASAP and EDIRPA logic, the Programme introduces a third, new, subsidy track focussed on incentivising private financing. The Fund to Accelerate Supply-chains Transformation (FAST) aims to make debt and equity financing better available for SMEs and small mid-cap companies, by de-risking private investments. As noted in the Strategy, the defence industry struggles with access to private finance through loans or equity sales. This notably prevented the implementation of the ASAP Ramp-up Fund, FAST’s predecessor.

The same logic hindering investments in production capacities hold up for private financing. Banks and investors want a reasonable risk-return rate on their investments and loans, which is still mostly dependent on national defence spending. In addition, large institutional investors have avoided the arms industry out of fear for public backlash. On a more positive note, the Strategy takes a broader approach to tackle financing difficulties. It calls on the European Investment Bank and its national counterparts to review and modify their lending policies under the banner of mainstreaming a defence readiness culture. Mobilising the vast sum of cash stowed away at Europe’s financial institutions, such as banks and pension funds, will certainly be of great benefit to the sector.

Security of Supply: Priority Rated Orders

Perhaps the most controversial provisions in the Programme are those found in the section on Security of Supply. These equip the Commission and Council with a potentially far-reaching toolkit.

Following a proposal by the Commission, a qualified majority in the Council can adopt an implementing act declaring a ‘supply crisis’ or ‘security-related supply crisis’ state. According to Article 44(1) of the Programme, supply crises arise when shortages of non-defence products cause problems in supply, repair and maintenance of actual defence products with “serious detrimental effect” on defence supply chains, “impacting the society, economy and security of the Union.”

When a security crisis (Article 1 (8) of the Programme) in the EU or “its neighbourhood” causes shortages or trade disturbances in the supply chain of actual defence products, both up and downstream, the Council can declare a security-related supply crisis state under article 48 of the Programme. Because a security crisis can arise in both associated and non-associated third countries, the current conflict in Ukraine and the creaking defence supply chains would arguably warrant immediately declaring a security-related supply crisis.

The main consequence of declaring one of the crisis states is that it enables the Commission to place so-called Priority Rated Orders (PROs) and Priority Rated Request (PRRs), which take legal priority over other contractual obligations. These are coupled to the two crisis states. PRRs solely include defence products, which are excluded from PROs. Both are placed at the request of a Member State which is unable to place, or execute, orders of defence products because of the crises. After approval by the undertaking’s Member State of establishment, the Commission can place a prioritised order. Because the Commission can force the undertaking to accept this order and impose fines, PROs could significantly decrease production times. However, both types of orders have critical weaknesses; when it comes to PRR’s, undertakings are free to decline and both orders are subordinate to equivalent national measures.

In the United States, the President has similar powers under the Defence Industrial Acts and PROs are seen as one of the Commander in Chief’s most important tools to mobilise the American economy for military purposes. A European approach to PROs makes sense. However, unlike in the US, the European defence industry is spread out across many different national jurisdictions. National PROs stop at the border, supply chains and production lines do not. EU-issued PROs could thus, potentially, be a more effective tool to tackle cross-border supply-chain issues.

Unfortunately, EU prioritised orders face a number of challenges when put into practice. First, they completely rely on the willingness of the Member State of establishment, and in the case of PRRs even on the manufacturers themselves. In times of (security) supply crises it is unlikely that Member States will be willing to prioritise orders placed by the Commission over their own. Furthermore, prioritising orders from one Member State over those of others will surely cause outrage. Orders and Requests placed by the Commission are thus only likely to decrease delivery times when they are prioritised over non-Member States. Because these tools depend on Member State sign-off, they are more comparable to a combination of national PROs, which would in theory already be possible through intergovernmental cooperation.

Thus far, Member States have been unwilling to bestow the Commission with such a far-reaching tool. Furthermore, it is questionable whether it falls within the scope of the internal market lawmaking competence of Article 114 TFEU. The Commission included a similar provision in the ASAP’s proposal, which was killed by the Council during negotiations. Despite the Commission including additional control mechanisms for the Council, it is implausible that the section will survive the negotiations unscathed, if it survives at all.

The challenges of EU military industrial policy

The PRO problem is illustrative of the conundrum facing EU-defence policy. Under Article 4(2) TEU, national security remains the prerogative of Member States and Article 346 TFEU allows for derogation from EU obligations in case of justified national security concerns. Furthermore, any EU military decision is taken by the Council within the realms of the Common Security and Defence Policy. EU defence policy is consequently heavily constrained by national interests, which prevail in unanimity-based decision-making procedures. Because of these constraints, the Commission has few tools to impose binding obligations and can only focus on certain industrial aspects of military security. As illustrated by the ineffectiveness of the DPD, the Commissions efforts to integrate the industry by regulating the demand side of the market have largely failed. PROs and PRRs have similar flaws due to the decision-making procedures and their subordinance to conflicting national orders. The Commission’s approach now consists of subsidising investment and facilitating intergovernmental cooperation. As I have argued in this contribution, whether this strategy alone will bring about the demand-side cooperation and economies of scale that the Commission aims to achieve is doubtful.

Isaak de Kroon

Isaak is completing the final year of his law degree at Utrecht Law College. This blogpost sprouted from his bachelor thesis on the legality of the ASAPs legal bases, which was written under supervision of mr. dr. Nathan Meershoek.