Ron Matthews and Aidan Turner, part of the Centre for Defence Management and Leadership at Cranfield University, outline their views on the current defence landscape and the future of UK overseas arms sales
In 2013, the government undertook to support defence exports through the Defence Growth Partnership. The intention was to make industry more competitive, via investment in skills, enhanced support for small and medium size enterprises and encouragement of inward investment. The rationale behind this government intervention was the positive link drawn between defence export success and UK prosperity.
Defence exports are important, but the touted relationship with the prosperity agenda borders on hyperbole, given that the UK’s 2016 defence exports of £6.2 billion represents a minuscule one per cent of total (civil and military) exports of £514 billion (latest 2014 data). Putting aside this stark comparison, there is no doubting the fact that the UK defence industrial base is a repository of high engineering skills that produce frontier technology systems. Its impressive capability includes innovational sub-systems that have dual use applicability to commercial manufacturing, a motive force for economic growth.
The UK defence economy employs an estimated 350,000 employees, and houses eight defence contractors that are listed among the world’s top 100 arms exporters. BAE Systems, for instance, is a major defence multinational company, and is held to be the third biggest exporter in the global arms market. Moreover, it is a market that is growing. In 2016, it was worth £68 billion, representing the second highest level of sales in the last decade, and growth of 4.5 per cent is expected in 2018.
Beyond the short-term, the strength of future overseas arms sales will be partially anchored to the expansion of the UK’s domestic market, not least because Ministry of Defence (MOD) procurement is planned to rise from £16 billion in 2017/18 to £19 billion by 2025/26. On the back of this demand buoyancy, UK defence exports are expected to perform strongly. The Defence and Security Organisation (DSO) offers the following ringing endorsement of the sector, highlighting that ‘the UK is one of the world’s most successful defence exporters, averaging second place in the global rankings on a rolling ten-year basis, making it Europe’s leading defence exporter across 2007-16’. The obvious implication is that UK defence export performance is robust, providing a powerful impetus to domestic prosperity through the fostering of output, income and employment.
The global defence market
Yet, the UK’s defence export performance is not what it seems. In 2015, the country’s share of the global defence market was estimated to be 12.8 per cent, around £7.7 billion in value terms. However, a year later the share had fallen dramatically to nine per cent, with the 2016 export value declining to just £5.9 billion.
Rightly, DSO cautions against reading too much into annual changes, because arms exports are notoriously changeable in the short-run due to their inherent ‘lumpiness’. Worryingly though, a trend of decline is now apparent, with the value of UK defence exports falling three years in succession, from 2013 to 2016. Of further concern is the clustering of the country’s arms sales around just two regions. Across 2015 and 2016, the Middle East accounted for approximately 50 per cent of total UK defence exports, which, when combined with North America, represents a vulnerable 73 per cent of total UK arms exports. Europe accounted for 14 per cent of exports, and Asia-Pacific, the world’s fastest growing region, just 13 per cent. Africa and Latin America accounted for a minuscule 0.5 per cent each.
UK defence exporters face intense competition across all the world’s regions, but as a high income, high technology arms exporter, the UK will invariably be pitted against similar high-end American, Russian and European competitors in discerning markets. There is, however, a new threat on the horizon. From nowhere, China has become a prolific arms exporter. Its overseas sales expanded 6.5 times between 2000 and 2015, achieving the remarkable feat of becoming the world’s third biggest arms exporter with a 5.9 per cent global share over the five-year period, 2011-15.
Over the same time period, American and Russian exports dominated the international arms market, with shares of 33 per cent and 25 per cent, respectively. The UK was ranked sixth, with a global share of 4.5 per cent. Although 43 of China’s customers are clustered in low-income traditional markets belonging to Asia, Africa and South America, Beijing’s global customer base now includes 14 states that are upper middle/high income countries. China’s encroachment into these higher income states represents an ominous threat. In a time of widespread global austerity, China’s relatively low cost, acceptable quality and increasingly high tech systems, including drones, missiles, satellites, and even submarines, should be ringing alarm bells in the boardrooms of the UK’s major defence exporting companies.
Strategic alliances and compliance
The recent less than sanguine UK arms export performance confirms the obvious - that the international arms market is fiercely competitive. It reflects the imperative of continuously investing in product and process technologies to refresh export capabilities and evolve dynamic comparative advantages. Yet, costly investment into research and development is not easy when margins are under pressure and long-term market conditions are uncertain. Beyond these economic pressures, common to all exporters, there are other factors that differentiate defence from more open civil markets.
Firstly, arms sales are characterised by strategic alliances and client-state partnerships. The US is the world’s dominant exporter, and enjoys long-standing customer networks based around defence treaties and alliances. Breaking into these markets is therefore very difficult. For instance, Japan, after decades of self-exclusion from the arms market, is now actively seeking to export through the nurturing of strategic partnerships across the world. Yet, notwithstanding Tokyo’s new internationalism, Japan remains steadfast in its commitment to procure the majority of its advanced weaponry, including the F-35 combat aircraft, from the US. This demonstration of loyalty to Washington is probably a counter-balance to Tokyo’s strategic dependence on the 1960 US-Japan Treaty of Mutual Cooperation and Security. By contrast, Saudi and Asian states demonstrate great variability in arms sourcing decisions, preferring to rotate and placate competing overseas suppliers on the basis of geo-strategic equity.
A further significant arms trade constraint is the degree of US Original Equipment Manufacturer (OEM) technology integrated into Western weapon systems. Use of US technology will need to be compliant with American ITAR (International Traffic in Arms Regulations), and any contravention will lead to the imposition of huge penalties, potentially running to hundreds of millions of pounds. The practical effect of ITAR is that Washington can veto export of military platforms containing US proprietary technology unless clearance is obtained. If such approval is not granted, or not sought, then the US will not hesitate in embargoing affected third country exports. This happened as recently as 2015, when South Korea attempted to export T-50 trainers to Uzbekistan.
A further imperfection of the arms market is the insatiable appetite by arms importers for defence offset. Normally, this relates to direct offset, whereby a recipient state seeks technology transfer to accelerate local defence industrialisation. However, some buying states may prefer indirect offset, requiring vendor investment to be channeled into commercial endeavour to support broader economic and industrial development objectives. Offset is often viewed as a ‘win-win’ arrangement, and thus has become de rigueur for defence exporters. Whilst weapons capability is the principal qualifier for closing a sale, the attractiveness of the offset package is increasingly a critical discriminator in the mix.
UK defence companies are well aware of the importance of offset. Nevertheless, they are reluctant to release technology to secure a sale, viewing the process as akin to voluntarily offering-up, often to potential future competitors, their company’s technological heritage, accumulated through generations of engineering creativity and innovation. Yet, the global arms market is a ‘buyers’ market, meaning that offset is obligatory, not discretionary. UK exporters will fail to win orders if offset is not offered, or offered, but unattractively. Arguably, the attitudinal approach of business development executives needs to be reset so that a new vision is instilled which recognises the mutual benefit arising from convergence of vendor and recipient offset goals. This will only happen if exporter-importer long-term objectives are calibrated to ensure that technologies transferred match recipient country development levels, rather than the latter’s industrial and technological aspirations. If such a ‘convergence’ strategy is followed, then the chances are that UK exporters will become ‘locked’ into key overseas markets.
In summary, the challenges facing UK defence exporters will not diminish in the years ahead, but what is clear is that the global arms bazaar in no way reflects Adam Smith’s perfectly open and liberal market structures. Defence is an imperfect market, and, as such, the success of UK defence exports along with their contribution to the prosperity agenda is closely associated with the degree of government support. In France, corporate offset decisions go all the way to cabinet; they are that important. Yet, rarely does this happen in the UK. Equally, the UK has nothing comparable to the support Washington gives to US arms exporters through its Foreign Military Sales (FMS) initiative.
In less direct ways, the UK government can support arms exporters through interventions in related defence export activities, such as minimising delivery risk, defining key roles for defence contractors in international arms collaboration programmes, maximising value for money (for UK taxpayers) via enhanced training and through-life government-to-government contracts. However, perhaps the most important consideration is the acceptance by Whitehall that defence exports represent the culmination of years, and sometimes decades, of corporate marketing effort. It is therefore imperative that economic diplomacy, necessarily embracing arms sales, is viewed as a strategic policy tool to win the hearts and minds of friendly foreign states.