In Whose Interests? Regulating Europe’s Defence Industry and the Politics of Exemptions

CSDS POLICY BRIEF • 3/2024

By Daniel Fiott

19.2.2024

Key issues

• The European Union (EU) needs to ramp-up its defence-industrial production and it is looking to do this with a new financial tool termed the European Defence Investment Programme (EDIP).
• The introduction of the EDIP will raise questions about the European Commission’s commitment to market liberalisation in the defence sector.
• Joint EU defence procurement will require an evolution of existing EU defence-industrial legislation, but it will also make it harder to define “essential security interests” in the EU.

Introduction

Europe is trying to speed up time on its defence-industrial efforts. Russia’s war on Ukraine has exposed the limits of Europe’s defence manufacturing capacities, but it has also thrust defence-industrial policy centre-stage in wider EU thinking about how to support Ukraine and strengthen European defence. As 2024 will be a year of political transition in both the United States (US) and Europe, the European Commission will seek to send the right signals to defence planners, industry and the public. The overall message, as underlined by European Commission President Ursula von der Leyen at the Munich Security Conference: we have to spend more, spend better, spend European and learn from what is happening in Ukraine. Beyond the sentiment, the chief aim of the European Commission is to provide as much sustainability and predictability for the European defence industry. Here, both the EU and NATO recognise that one of the core ways to defend against the Russian threat is to revamp Europe’s defence-industrial manufacturing capacities.

On this basis, in early 2024, the European Commission will produce two policy initiatives that are designed to stimulate the European Defence Technological and Industrial Base (EDTIB). The first initiative is the first-ever “European Defence Industrial Strategy”, which, it is hoped, will clarify how the EU will support the EDTIB and provide industry with a certain amount of clarity about expected future demand. The second initiative is the long-awaited European Defence Investment Programme (EDIP), which, it is hoped, will be a relatively large-scale fund (up to €100 billion for 7 years, if political pronouncements are to be believed) to support the development of joint military capability projects among EU member states.

Both the European Defence Industrial Strategy and the EDIP come at a time of political campaigning in Europe, where the major political parties and their supporters in the EU institutions are vying for seats in the European Parliament. Thus, in the short-term these initiatives will inevitably become part of political campaigns across the EU, with the risk that certain policy proposals become amplified during the campaign but do not materialise as the new EU legislature and new European Commission take office. In this sense, it is vital that the contents and approach taken in the EU’s recent defence-industrial initiatives meet the very real challenges facing Europe and its defence, including the ongoing war in Ukraine and shifts in the nature of the transatlantic alliance. In particular, US presidential candidate Donald Trump’srecent campaign comments about not protecting European NATO allies that do not spend 2% of GDP on defence have added a renewed sense of urgency.

The prospect of Europeans being left alone to their own defence may have the effect the clearing minds, even if today political sloganeering still prevails over concrete action. What does appear to be a clear trend, however, is that the EU will increasingly play an important role in defence-industrial policy. While some may scorn the idea of having an European Defence Commissioner after the European elections, the idea for the post is only symptomatic of the growing importance of EU defence-industrial initiatives. Indeed, any future scenario where the US (abruptly or not) seeks to decouple from NATO will presume much closer cooperation between the Union and NATO – perhaps in new and surprising ways.

In this CSDS Policy Brief, I look at some of the consequences of the EU’s renewed role in defence-industrial policy. In particular, I argue that the Commission’s recent insistence on industrial policy, financial incentives and joint procurement is, in many instances, at odds from their earlier foray into defence-industrial policy, which was marked by a combination of market liberalisation and EU-level regulation. In this Policy Brief, I therefore analyse how any future EDIP is likely to sit alongside existing legislation such as the 2009 EU Directive on Defence Procurement (Directive 2009/81/EC) and Article 346 of the Treaty on the Functioning of the European Union (TFEU). As this Directive was introduced to dissuade EU member states from invoking Article 346, which permits member states to derogate from EU law whenever there is a question of their “essential interests of their security”, they make ideal cases from which to understand how the EU’s approach to the EDTIB is evolving. In doing so, I seek to highlight some of the potential paradoxes that may emerge between existing EU legislation and the Commission’s plan to finance joint EU defence procurement.

The Paradox of EU Defence Legislation

EU institutions such as the European Commission have long occupied a policy role (albeit an indirect one) in the European defence industrial sector, but a more substantial presence only emerged in the mid-to-late 2000s as the Commission expressly developed legislation to shape the European defence market. Indeed, in 2009 the Commission released a so-called “defence package” made up of two pieces of legislation for: 1) defence transfers (2009/43/EC); and 2) defence procurement (2009/81/EC). In essence, these two EU Directives have as their overriding aim the internal liberalisation of the European defence market based on broader (and widely accepted) Single Market principles. These principles include non-discrimination on the basis of nationality for the procurement of defence equipment and the streamlining of customs procedures to facilitate the transfer of defence equipment across borders in the Union. Yet, even if these pieces of legislation were largely seen as a process of market liberalisation, they also raised questions about whoindeed was responsible for regulating the defence market in Europe. This question remains a major issue in the EU today.

At the time of the adoption of the two Directives, EU member states were keen to retain their regulatory power of the defence sector by insisting on their long-standing derogation from the EU Treaties for matters where essential security interests were deemed at stake. Based on Article 346 TFEU, the derogation effectively means that member states are not obliged to apply EU rules on defence procurement, should they deem it a risk for their national security. In practical terms, no one really disputes the continued necessity of Article 346 in certain cases. For example, imagine France opting for a public tender for the acquisition of nuclear submarines. To do so, it would have to be extraordinarily specific in the tender documents about its technological needs and priorities – its nuclear weapons programme would effectively be publicly exposed, and buying nuclear submarines from non-French suppliers could end France’s long-standing national security policy of strategic autonomy. Yet, this logic of “national security” – as the European Court of Justice (ECJ) has made clear in several rulings – has limits. For example, militaries seeking to procure civilian clothing such a t-shirts from exclusive national suppliers rather than through open tenders is prohibited.

The continued application of Article 346 for the most sensitive military systems and technologies, while understandable, poses a dilemma for the European Commission as it pushes towards the notion of joint EU defence procurement under the EDIP. Indeed, for those capabilities that do not raise substantial national security interests, it should be possible for the EDIP and the Defence Procurement Directive to work in unison. That is, the principle of non-discrimination for defence procurement should help stimulate cross-border collaboration, as is also the idea behind the European Defence Fund (EDF). Yet, the relationship between the EDIP and the Defence Procurement Directive will be strained when (and if) it concerns more sensitive military technologies. This puts the Commission in a particular bind: if EU legislation is insisted upon to avoid discrimination in procurement, this may serve as a disincentive for EU member states to jointly launch defence procurement for the most sensitive and relevant military systems and equipment. In essence, it may be necessary to forego EU legislation for the benefit of joint defence procurement.

This paradox may, however, not seem as dramatic as first presented. In fact, the Directive on Defence Procurement is already riddled with legal exceptions, including the fact that a derogation from the Directive under Article 346 may be sought where projects are of a technologically sensitive nature and/or form part of government-to-government cooperation (e.g. between a European state and the United States). However, the act of not applying the Directive in case of joint, EU-funded, projects should not be overlooked. Already, smaller and medium-sized (SMEs) member states are concerned that they will be asked to financially contribute to an EDIP that will exclusively be used to finance large-scale defence projects which the largest firms (in the large member states). Indeed, imagine a situation whereby the EU finances a multi-million Euro project under the EDIP, but the major partners invoke Article 346 to ensure that they, first, do not have to be transparent about the project, and second, that they will not opt for public tenders, which would effectively exclude a multitude of SMEs across the Union and give power to the larger firms to hand-pick their own supply chains and partners.

“Judgement Day” for Europe’s Defence Industry?

The European Commission is not in an easy position here. One option is to write into the forthcoming EDIP Regulation a clause stipulating that no member state can invoke Article 346 for EDIP projects. As has already been stated, however, this is a very risky proposal as larger member states may simply decide not to launch EDIP projects, but rather do so outside of the EDIP funding framework while nevertheless invoking Article 346 (thereby diminishing the power of EU legislation anyway). If the Commission wants to use EDIP to finance the most relevant joint military capabilities in the EU, then it must accept that the military technologies being handled will be of a nature that bears the “essential security interests” label. In this sense, there is a need to balance the management of future EDIP defence procurement as some degree of non-transparency for sensitive and large-scale defence projects will be required to protect sensitive data, techniques and processes. How the Commission can ensure the full involvement of SMEs in this type of balanced procurement process under the EDIP remains to be seen.

Information handling will become an increasingly important element of EU-funded defence procurement under any future EDIP. In fact, a major part of the decision of member states to invoke Article 346 in the first place – apart from the obvious industrial interests – is to protect the sensitive data, processes and knowledge associated with the development and procurement of defence technologies and equipment. There are legitimate concerns here. Accordingly, the EU’s Defence Procurement Directive already allows for the need to share classified information on defence projects. This is an interesting aspect of the existing legal order, as the Defence Procurement Directive stipulates that a minimum amount of classified information-sharing should occur between partners but not any further. When the EDF was established after 2016, this emphasis on sharing classified information between EU-funded project partners became the norm. There was an initial fear that the Commission would apply it long-standing approach in civilian research – namely, to ensure research results are shared across the Union – in defence. That was never realistic in the defence sector. However, the bigger issue facing the Commission under the future EDIP is how to effectively ensure that member states can share technology between partners for defence projects that go beyond the initial stages of R&D and R&T – and where the technological stakes can be much higher for defence industries.

Perhaps one area where the Commission can push back against the larger defence-industrial players in such circumstances is on dual-use technologies. Indeed, Directive 2009/81/EC on Defence Procurement already sees the need to address so-called “mixed contracts”, whereby military platforms integrate civilian or dual-use technologies or components. In this regard, any defence procurement process that would normally invoke Article 346 to protect the sharing of defence technologies is much harder to do when defence systems integrate civilian technology. Here, the Commission and the ECJ have long considered dual-use technologies to fall under Single Market legislation rather than the specific nature of EU defence industrial regulation. Not that the idea of “mixed contracts” makes life easier for the EU institutions. In fact, the introduction of the EDIP and EU joint defence projects is likely to make the life of the ECJ much more difficult in the realm of defence industrial policy, as it eventually has to decipher how (and what) technologies are integrated into EU-financed weapons systems.

The European Court of Justice is, over time, likely to play a much more substantial role in the legal management of the EDTIB. So far, the ECJ has ruled on known cases of Article 346 and it has adjudicated in many cases that the application of the notion of “essential security interests” by member states was unjustified. In one case, a member state invoked Article 346 for textiles and argued that it was necessary on the grounds of “essential security interests” to ensure that only its national suppliers could kit-out its military with t-shirts and other non-combat clothing. As time goes by it will be increasingly difficult for the ECJ to define “essential security interests” in the context of the EDIP – presumably we are talking tanks and not t-shirts under the EDIP. Here, the Court will have to increasingly adjudicate between the “essential security interests” of member states and the general interest of the EU – as far as that can be discerned. I recognise that this statement appears rather shallow today, not least because the EDIP is not yet a reality, but the future prospect of joint defence procurement between member states raises the fact that “essential (national) security interests” will become much more complex to define, at least as far as joint procurement is concerned.

Industrial Policy for EU Defence

As we draw nearer the creation of the EDIP, the spectre of a “politics of exemptions” emerges whereby it becomes increasingly difficult to manage the different interests of large, medium and small defence players in the EDTIB. Should exemptions to existing EU legislation in the defence sector become the norm in order to access financing under the future EDIP, this will likely cause discontent and contestation among member states. This at a time when the underlying logic is to use the political unity that has a emerged during the Ukraine war to build-up European defence. At the very minimum, and as a small policy prescription, the forthcoming European Defence Industrial Strategy could give way to the publication of a further guidance note by the European Commission on how exactly Directive 2009/81/EC and Directive 2009/43/EC would feature in the context of EU-funded joint projects under the EDIP. Writing such a Guidance Note will not be an easy affair, as this Policy Brief has indicated.

What should be avoided, however, is the easy route. For example, in the EU Regulation establishing the European Defence Fund in 2021 the drafters thought it adequate to simply state that the Fund would complement the Defence Procurement Directive (see recital 4 of the Regulation). In reality, little attempt (at least publicly) has been made to assess how Directive 2009/81/EC has aided the EDF and vice-versa. True, it may still be too early as the European Defence Fund has only be in place for a few years now, but the last evaluation of the Directives by the Commission took place for the period 2011-2015 – long before the Fund was even introduced. It will not do for the EDIP Regulation to simply assume that the defence Directives will aid EU-funded joint defence procurement – it must be shown to with reliable data and a thorough assessment.

Of course, and to conclude, many of the issues I have highlighted in this Policy Brief speak to a broader challenge for the EU: namely, how to balance the impulse for a free and open internal market with the need to develop a sound industrial policy. In the defence sector, this task is made harder by the competing industrial and political interests found amongst firms and member states. As Europe prepares for more potential turbulence in transatlantic relationship, and the war in Ukraine grinds on, the EDIP clearly comes at the right time. Any financial tool that helps Europe’s defence industry meet the geopolitical realities of the day is to be welcomed. Much will depend on the financial muscle put behind the EDIP, and that should be the main focus of decisionmakers right now – getting to €100 billion over a 7-year period is a good place to start. Should this money start to flow, there will be a need to ensure that existing EU legislation can help channel these Euros in the most effective way.

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This CSDS Policy Brief was presented as a contribution to the panel “Capital – Defense Industrial Base” held on 7 February 2024. The panel was part of an international seminar organised by the United States Military Academy entitled “States, Societies, and Security in the 21^st Century”, held at West Point, New York, 7-8 February 2024.