BUILDING THE INTERNAL EUROPEAN DEFENSE MARKET: EU

C O N F I D E N T I A L SECTION 01 OF 03 BRUSSELS 004342

SIPDIS

DEPARTMENT FOR EUR/ERA AND EUR/RPM

E.O. 12958: DECL: 12/08/2015
TAGS: MARR PREL EUN USEU BRUSSELS
SUBJECT: BUILDING THE INTERNAL EUROPEAN DEFENSE MARKET: EU
TAKES NEXT STEPS

REF: A. BRUSSELS 4203 B. BRUSSELS 4202 C. BRUSSELS
3747 D. BRUSSELS 3611

Classified By: USEU Political Military Officer Jeremy Brenner for reaso
ns 1.4 (b) and (d).


1. (U) Summary. The European Union is taking steps to
consolidate the European defense equipment market. The
European Defense Agency has established a code of conduct for
defense procurement, and the EU is developing plans to match
US levels of investment in defense research and development.
A number of decisions will be made over the next six months
concerning the standards and rules that will applied for
procurement. These decisions must be examined carefully
because there is a lack of assured transparency in the
process, and subsidies for R&D, and provisions for ad hoc
arrangements could be detrimental to US interests. This
message identifies the major initiatives now underway. They
will be examined in greater detail in subsequent cables. End
summary.

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Be Careful what you wish for...
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2. (C) The US faces a conundrum as the European Union takes
steps to consolidate its defense equipment market. On the
one hand, a number of the measures put forward by the
European Defense Agency are necessary - if not sufficient -
for the creation of a European Defense industry that can
provide the effective military capabilities we have urged for
decades. At the same time, some of these measures - if not
closely monitored - could move the European Defense market
away from a system that will be open and transparent toward a
system that could be detrimental to US industry.

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Building European Capabilities
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3. (C) In order to build, buy and employ the long-sought
capabilities to act credibly as a strategic global partner of
the United States, "Europe" must overcome many internal
challenges. The way in which theses challenges are addressed
will have significant implications for important US
interests. In the defense capabilities area, the European
Union is taking steps to harmonize European defense
industrial output while creating a European common market for
defense. One of the questions they face as they move ahead is
how to create a competitive environment in which
harmonization can take place while protecting their fledgling
initiatives from better capitalized and more experienced
(often US-owned) multinational defense firms? The answer, so
far, suggests an approach to market development that will
inject European Union capital into essential R&D activities,
and might set proprietary standards inconsistent with those
currently in use in NATO and the US. The reform effort
threatens to hinder US access to future defense contracts.
Careful monitoring of these developments will be critical to
preventing damaging conflict, but it will be difficult to get
a clear picture because of a lack of transparency.

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The European Defense Agency
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4. (U) The EDA as an institution is developing quickly.
Beginning with a staff of 25, it has reached its full
authorized staffing level of 80, though it can draw on
national experts, giving it additional resources. After its
creation in 2004, the Agency was to establish rules governing
access to information thereby ensuring the same amount of
transparency as already exists for other EU institutions. To
date, this has not occurred. Existing transparency rules
allow EU institutions to refuse access to documents that
would undermine the protection of defense and military
matters. Further, the EDA has stated that it views its role
as "the instrument to achieve mutual transparency and
accountability" for the implementation of the new defense
procurement rules. The European Commission and the European
Parliament each have a role in overseeing the development of
this process. The Agency is also required to report
regularly to the European Council. Still, the EDA is its own
watchdog for implementation of the Code of Conduct, meaning
that there is currently no guarantee of transparency with
respect to substantial EDA-driven changes within the European
defense industry.
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Code of Conduct
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5. (U) The EDA's newly-announced code of conduct is broad
and lacks specificity. It is a mutual guarantee of open
defense markets by EU Member States that choose to
participate on a reciprocal basis. There is no guarantee
that contracts issued under the Code of Conduct will be open
to American defense companies. The EDA leaves it up to each
individual Member State to decide whether to issue contracts
for defense equipment to non-EU companies. Member States
must commit to participating in the Code of Conduct by April

2006. The Code is slated to go into effect in June. Work
has already begun on the creation of an electronic bulletin
board, where all defense contracts will be posted. The rules
of access to this bulletin board will be an important
indication of the openness of the system.

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Ad Hoc Projects
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6. (C) In addition to the Code of Conduct, the European
defense equipment market will change substantially over the
next few years by the formation of ad hoc defense projects
within the context of the EDA. The EDA envisions that some
projects will include all Member States and may be funded
based on a Gross National Income scale. The Agency also
envisions the possibility of a more selective group of ad hoc
defense projects that would only be open to certain
self-selected Member States with no requirement that other
Member States be allowed to join. Further, it is unclear
whether these "coalitions of the willing" for defense
projects will be subject to the Code of Conduct. Decisions
on the ad hoc projects may be reached on a qualified majority
basis, which will reduce the influence of many smaller,
pro-US Member States from "New Europe."

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Standards and Practices
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7. (C) The EDA will be drafting standards such as a Code of
Best Practices in the supply chain to allow for the
participation of small and medium sized businesses. The
Agency will also develop standards for the security of
information and/or security clearances. Further, the
development of larger ad hoc defense projects could have the
effect of creating a de facto EU standard for defense
equipment that may or may not be compatible with NATO and/or
the US. If the established standards are inconsistent with
NATO standards, or will adversely affect the competitiveness
of bids by US defense companies, only US political-level
intervention is likely to be effective in altering EDA's
course. Even at this early stage of development, it is
unclear if US companies will have the same degree of access
to requests for proposals/bids in the electronic marketplace
and on electronic bulletin board that the EDA is
establishing.

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Toward a "Cartel" of National Producers?
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8. (C) The EDA has stated that it does not intend to create a
European preference or exclude US companies. However, the
practical effect of the reform effort is that US defense
companies must continue to merge or form joint ventures of
convenience with European defense companies to remain
competitive in Europe. (Note: Representatives of European
industry argue to us that European companies in the US face
the same situation. End note). If the Commission ensures
that existing law is enforced, Member States will be required
to give up the notion of supporting national or European
champions as well as allowing politically-sensitive
government-supported national enterprises to fend for
themselves in the competitive marketplace. Because the
Member States will ultimately decide the outcome of the EDA's
initiatives, compromises will likely emerge between the
forward-looking ideas of EDA and the protectionist tendencies
of the Member States. Any lack of transparency of EDA
defense procurement could combine with Member State
governments' support for national suppliers to create an
environment where cartel-like activity could be attractive to
some.

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Research and Development
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9. (U) The EU has launched an effort to increase investment
in R&D across all sectors within the EU from 1.9% to 3% of
GDP by 2010. This includes a focus on developing R&D and
common programs in civilian-military applications that will
involve funding from multiples sources such as the
Commission, Member States or the EDA. The Commission has
stated that the gap in research investment between the
European Union and the United States is in excess of 120
billion Euros per year. The EU is attempting to address this
gap with the adoption of "Lisbon-type" agenda for R&D that
would include increasing the funding of programs with
civilian-military overlap. The EU believes that Commission
funding for civilian-military R&D programs, national defense
funds from the Member States, funds from the European Defense
Agency (EDA) and a proposed new European Security Research
Program of Euro 1 billion will help close the gap in security
research. The EU is currently laying the legal and budgetary
groundwork to carry out its plan. The main obstacle remains
the EU fiscal framework for 2007-2013 that has yet to be
approved by the Member States. Despite the optimistic
planning by EDA, under current political circumstances within
the EU, the budget -- when approved -- is unlikely to provide
new funding for R&D. The EU plan also depends upon greater
R&D spending by Member States and private enterprise, and
while targets have been set, implementation of the program
has not begun.

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Conclusion
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10. (C) Clearly, any moves toward "Fortress Europe" by the EU
and the EDA in the sensitive area of defense procurement
will be detrimental to US economic and political interests.
In anticipation of a negative US reaction, some in Europe are
already referring to the "Buy America Act" and restrictive US
licensing practices as justification for EDA countermeasures.
The European Commission and Parliament are already raising
issues of openness, potential business impact, and possible
effects on NATO harmonization. It is clear the political
debate in Brussels over how to build a coherent European
defense market is far from over. (see septels). Still, the
new and rapidly developing aspects of the European Union push
to establish a more coherent European defense equipment
market warrant close scrutiny, and may require political
intervention in the event that the EU chooses a path that
could damage US or NATO interests.

McKinley
.