Western European Union (WEU) Assembly

(vi) Taking the view, therefore, that at a time of increasing rationalisation of the civil and defence industries and a multiplication of collaborative programmes, mutual interdependence is the key to retaining access to strategically important technologies and manufacturing capabilities; (vii) Welcoming the proposed six-nation* agreement for industrial restructuring which emphasises, in particular, security of supply, as an important step in the right direction; (viii) Desirous that WEAG should become a special framework for consultation among European countries in the armaments field; (ix) Noting the efforts being made with a view to establishing, in a WEU framework, an intergovernmental body with agency status in order to manage practical cooperation in this field among European countries; (x) Welcoming the creation of OCCAR by four armaments-producing countries and expressing the wish that it will move closer to WEU and be joined by other states of the Organisation which accept its mode of operation; (xi) Considering that the time has come for a reform of Article 223 of the Treaty of Rome, which would provide a useful means of opening up the defence market in Europe, thereby providing an environment more conducive to fair competition and industrial restructuring; (xii) Noting that a common armaments policy with advanced technology aspects will help to establish a genuine European defence identity and that such a policy would require a revision of Article 223 of the Treaty of Rome, with a view to integrating the production, trading and control of conventional armaments; (xiii) Considering it vital that Europeans build on the mutual trust which already exists between Europe and the United States and continue to give close attention to transatlantic cooperation projects, especially where the United States offers the technologies essential to the future operational capability of European countries;

(xiv) Convinced that it would not be in the Europeans' interest to give the impression of wishing to build a kind of "fortress Europe" while restructuring their industry, at the risk of erecting barriers between Europe and the United States; (xv) Welcoming the fact that the Code of Conduct on defence exports adopted by EU governments in May 1998, albeit modest in scope, contains useful provisions on exports and is consistent with the ethical foreign policy being adopted by some member states; (xvi) Regretting that Europe has lagged behind in recent years with the restructuring of its defence industries, while the United States has forged ahead considerably in this direction, and considering that the present imbalance of arms trade between the industries of the US and Europe must be remedied as quickly as possible; (xvii) Vigorously supporting all initiatives taken by the defence and industry ministers of the six main armaments-producing countries with view to creating more propitious conditions for commercial mergers in the aerospace and defence sector, in the framework of the EADC (European Aerospace and Defence Company), while desiring the development, in conjunction with the European Union, of a status for transnational European companies; (xviii) Welcoming the assurances given by the ministers of these six nations that it remains a matter for the industry whether and how it restructures, given that only the companies concerned can determine what alliances will generate business synergy; (xix) Hoping this invitation to the six countries, which together account for the bulk of the European defence industry, will encourage rationalisation on a scale comparable to that of the United States companies that currently dominate the market; (xx) Considering that, in Europe, the need to restructure is most pressing in the aerospace and defence electronics sectors, dominated by the new American giants; (xxi) Taking account of the social cost of privatising, rationalising and restructuring the European armaments industry and desirous nonetheless that European companies should reach an agreement encompassing the main manufacturers as quickly as possible,

(xxii) Considering that it is in the general interest to help the states of central and eastern Europe to restructure their defence industries in order to promote the stability of those countries during a period of reorganisation, RECOMMENDS THAT THE COUNCIL 1. Encourage European governments to set up consultation structures and procedures for the definition of common defence requirements, and to do so in a WEU framework, within the Eurolongterm Group or the future European armaments agency; 2. Secure enhanced coordination in the field of research, development and technology acquisition between measures taken by WEAO within the EUCLID programme and those adopted by the European Union in the framework of the EUREKA programme; 3. Rapidly set up a European Armaments Agency endowed with a legal status, which would work in cooperation with OCCAR and of which WEAG would be the governing body; 4. Promote the creation as soon as possible of a European Armaments Council bringing together WEAG nations and WEU observer and associate partner countries, which would be responsible for implementing the European armaments partnership, in particular as regards relations with Russia and Ukraine; 5. Decide now to grant OCCAR the status of a subsidiary body of WEU, enabling all WEU countries which accept its mode of operation to participate in its activities in the longer term; 6. Promote, in cooperation with the Council of the European Union, a revision of Article 223 of the Treaty of Rome, with a view to integrating the production, trading and control of conventional armaments, while bearing in mind the need: to uphold the provisions of that Article for specific highly sensitive high-tech products so that countries wishing to maintain their strategic independence, in particular in the nuclear field, may do so; not to divert its application to subsidising other goods either for the purposes of industrial and commercial protectionism or for the purposes of unfair competition; to uphold the objectives of the EU Code of Conduct in the field of armaments;

7. Promote the privatisation and rationalisation of the European defence industry, in particular in the framework of the EADC, while being very cautious about extending this initiative to additional countries, which could make it more difficult to secure the agreement so cruelly needed for the survival of European defence companies; 8. Encourage European governments to develop, within the European Union framework, a "transnational" status for European companies; 9. Strongly urge governments to support the social schemes that will be made necessary by the restructuring measures designed to increase the productivity of the European defence industry, and to involve the European Union in such action; 10. Promote the diversification and conversion of the defence industries of central and eastern Europe countries; 11. Urge governments to create the most propitious conditions for facilitating cooperation between western European defence companies and their central and eastern European counterparts, by developing joint programmes for the benefit of the allied armies and participating in the modernisation of the military equipment of those countries in order to bring them into compliance with NATO interoperability standards; 12. Generate greater synergy between WEU and the European Union in the defence industry field, with a view to framing a European armaments policy in the service of the European Security and Defence Identity. Explanatory Memorandum (submitted by Mr Colvin, Rapporteur) I. Introduction 1. The defence industry is distinct from other industry sectors on two main grounds. Governments are its single biggest customer, and access to its technologies and the security of supplies of defence equipment are vital factors for the defence capability of states. 2. In recent years, defence manufacturers have had to adapt to the consequences of the end of the cold war. The US defence industry was quickly able to carry out the mergers which enabled it to strengthen its dominant position, while European industry suffers from a number of handicaps:

major differences from one country to another, in terms of the degree of production autonomy enjoyed by companies, due to widely varying financial returns and technological capabilities; large state-owned holdings in the capital of some companies, making commercial mergers more difficult; shrinking national defence budgets, the impact of which is amplified by inflation for successive generations of equipment; very strong competition from American manufacturers who, under pressure from the US Government, have increased their productivity, in particular by large-scale restructuring and a very aggressive export policy; increasing pace of technological advance; difficulties with technology transfer. 3. The combined effect of these developments has been to reduce the unit cost of equipment produced in the United States. European governments are frequently faced with a difficult choice between buying American equipment for reasons of cost, or producing their own armaments in order to preserve their autonomy in the field of strategic technologies and supply sources, in many cases at considerable extra cost. To overcome these difficulties, European countries must therefore adapt their defence industries and procurement policies to enable them to stand up to American competition, preserve defence sector jobs and maintain their mastery of defence technologies, without creating a "fortress Europe" mentality. 4. The scale of the adjustments required makes it necessary for states to establish an intergovernmental armaments policy. WEU provides an ideal framework for such European policy, through the Western European Armaments Organisation (WEAO) and Western European Armaments Group (WEAG). The Organisation for Joint Armament Cooperation (OCCAR), the EU and NATO are also involved in this restructuring process. 5. With regard to formulating defence equipment requirements, states wishing to improve interoperability and obtain the best value for money when equipping their armed forces need to harmonise their requirements with their allies, which means both developing cooperation in the field of Research and Development (R&D) and conducting major collaborative programmes. Governments are still sovereign when it comes to defining their defence equipment requirements and a consensual approach is thus required if they are to formulate those needs within Europe, by issuing joint invitations to tender. However, value for money has not been the only criterion for governments' procurement decisions. Equally important are industrial cooperation agreements, employment issues, the desire for autonomy in the fields of advanced technology and logistics and, of course, political agreements. Thus all these factors weigh on their choice of equipment. They must, in other words, resolve the dilemma of achieving value for money, on the one hand, while on the other hand showing de facto some degree of responsibility towards their defence industries, while achieving international competitiveness.

6. The current fragmentation of the European defence industry is an obstacle to the creation of European industrial groupings with an international dimension. It is therefore necessary to rationalise that industry through integrated European companies. Those companies must first and foremost constitute strong, profitable and internationally competitive entities, with access to the necessary financial resources and the best technologies. They must be present on the export market and preferably be involved in dual-use technologies, in order to promote a healthy synergy between military and civil sector activities. The possibility of launching competitive tenders must be preserved wherever possible, in order to reduce costs, improve customer service and stimulate innovation. In the eyes of most partners who are very attached to such competitive tenders, this is a prerequisite for a European cooperation programme, but must not rule out transatlantic cooperation or commercial mergers. 7. To bring about such consolidation of European industry, the initiative must be left up to the firms themselves. There is no shortage of European cooperation on specific projects and major progress has already been achieved with the creation of numerous integrated multinational companies in the fields of aerospace, satellites and sonar. Governments must in turn do their part, particularly in the legislative area, to create the political and economic environment in which such industrial groupings can take place. 8. Developing intergovernmental cooperation in the armaments field and promoting the emergence of strong, competitive defence companies at a European level, quite apart from all economic and industrial objectives, is a way of making the creation of the European Security and Defence Identity easier to achieve. The issues at stake here are operational - for this is indeed the best way of guaranteeing interoperability, or even commonality, of European armed forces equipment - but also political, for a common and autonomous defence capability is a key factor in the ongoing construction of Europe, whose eventual enlargement will include the countries of central and eastern Europe.

II. The existing institutional framework 9. The realisation during the 1990s, in an era of shrinking defence budgets and of competition from American industry, that no European state was in a position any more to meet all its own defence equipment requirements, made a decisive contribution to strengthening intergovernmental and industrial cooperation. The resulting collaborative projects developed within intergovernmental structures (WEU and the EU) on the basis of international agreements or within the European defence industry (EDIG and various joint programmes, particularly in the field of missiles) may help to pave the way for the creation of a European armaments agency, provided that they do indeed lead to a harmonisation of requirements and a rationalisation of production structures. 1. Western European Union 10. WEU is developing armaments cooperation among European countries through the Western European Armaments Group and the Western European Armaments Organisation. (a) Western European Armaments Group (WEAG) 11. Meeting in Bonn on 4 December 1992, the defence ministers of the 13 member countries[1] of the Independent European Programme Group (IEPG) decided to transfer the functions of the Group[2] to WEU. The driving factor behind this decision was to have a single armaments cooperation body in Europe. On the same day, the Council of WEU announced the creation of the Western European Armaments Group (WEAG) as the successor body to the IEPG. 12. The WEU Council of Ministers, meeting in Rhodes on 11 and 12 May 1998, recalled that WEU associate partners and observers which were not members of WEAG were entitled to participate in its activities, on the basis of the arrangements agreed during their meeting of 17 November 1997 in Erfurt[3].

13. WEAG is composed of three panels and an ad hoc group whose task is to examine the possibility of creating a European armaments agency: Panel I has the task of developing the joint equipment programmes needed by WEAG member countries to fulfil their operational requirements. A memorandum of understanding for a feasibility study on the European Future Large Aircraft (FLA) was, for example, signed in the framework of this panel by the French, German, Italian, Portuguese, Spanish and Turkish NADs; Panel II is responsible for strengthening Europe's position in the field of defence research and technology. It is supported by a Research Cell, of which the main instrument is the EUCLID Programme (European Cooperation for the Long Term in Defence); Panel III is responsible for drawing up the principles and procedures for setting up and opening up a European defence equipment market and maintaining and strengthening a defence industrial and technological base (DITB). In this connection, at a meeting in Ostend on 18 November 1996, the WEAG ministers signed the THALES memorandum of understanding, a technical agreement on European defence research laboratories. 14. The National Armaments Directors (NADs) meet twice a year to examine the work of the panels and the ad hoc group. They report to the defence ministers of WEAG member countries. They are assisted by their permanent representatives in Brussels who make up the Staff Group, which in turn is aided by the Armaments Secretariat. (b) Towards a European armaments agency? 15. At a ministerial meeting held in November 1997 in Erfurt, an ad hoc group within WEAG was tasked with drafting a Masterplan for the creation of a European armaments agency (EAA). During the meeting of the Assembly's Presidential Committee on 7 and 8 September 1998 at WEU headquarters in Brussels, the Head of the WEAG Armaments Secretariat, Mr Delhotte, presented the main lines of that Masterplan: "Basic structure: The Masterplan defines and arranges in logical sequence all necessary steps and decisions on the way towards the EAA. An Expert Group would be set up as a working body to perform the described tasks. The WEAG Chair is of the opinion that the Expert Group should "not act as a group of national representatives with national staffing duties, but that they (should) have room for free discussion, exchange of expertise and opinion." The Masterplan follows a phased approach. NADs and Ministers would annually decide on the results achieved. This avoids nations having to fix their positions towards the EAA at an early stage.

The main areas of work are: 1. Measures providing the legal and political framework. 2. Definition of policies and principles for the operation of the Agency. 3. Measures providing the administrative and operative basis. Timetable: The Masterplan allocates preparatory studies and elaboration of proposals by the Expert Group into 1999. NADS and Ministers would comment at their autumn 1999 meetings on the results presented. Based on this input, the Experts Group would streamline and review its findings and would seek agreement from all nations at the autumn 2000 meetings. The legal and procedural aspects would then be finalised, with a view to a possible final decision by Ministers at their autumn 2001 meeting." The draft Masterplan was sent to the NADs on 31 August and they submitted their comments to the WEAG Presidency, represented by Germany, on 25 September 1998. 16. Three questions remain to be resolved among the states concerned: the problem of juste retour: states involved in collaborative programmes generally call for a fair industrial return on their respective investments. The principle of juste retour applied on a programme-by-programme basis considerably hampers implementation of programmes. The aim of an EAA would be to favour an overall juste retour over all the programmes, rather than on individual programmes. While such a mechanism may be acceptable to those countries with large shares in programmes, those with participation rates of only 5 to 15% may be worried about not obtaining a satisfactory return. A possible solution might be to introduce a mechanism in which the juste retour is inversely proportional to the participation rate, on the basis of a ratio which remains to be defined, and to be applied on a case-by-case basis; the defence industrial and technological base (DITB): this could be created by pooling national technological know-how in the armaments sector. To begin with, in view of the different categories of status of the 28 WEU nations, an access procedure specific to each category could be used for exchanges of information. In certain cases where there is a specific interest, such cooperation could be extended to include third countries; the degree of autonomy and the powers delegated to the Agency by the member states: this is a problem which arises when any international institution is created. The States Parties must agree on the decision-making powers to be granted to the Agency, as well as on the decision-making procedures.

17. It would be desirable for all countries to focus their efforts in the same direction, for there are two challenges to be met: European industry must on the one hand preserve its domestic market, and on the other hand try to occupy a share of the international market. Such challenges can best be met by establishing a European armaments framework to which states have delegated a minimum of responsibilities and which interacts with industrial policy. (c) Western European Armaments Organisation (WEAO) 18. On 17 November 1996, the Council of WEU adopted the WEAO Charter at its meeting in Ostend. The same day, a memorandum of understanding on the principles for the operation and administration of WEAO was signed by the defence ministers of the WEAG member countries and those of WEU associate partners and observers. 19. WEAO is a subsidiary body of WEU under Article VIII of the modified Brussels Treaty[4]. By virtue of the legal personality which it shares with WEU, it has structural, administrative, contractual, financial and accounting autonomy. Any dispute with regard to a contract can be settled by arbitration or by an international tribunal, if the parties have signed the arbitration clause[5]. 20. The aim[6] of WEAO is to help promote and enhance European armaments cooperation, strengthen the European defence technology base and create a European defence equipment market, in accordance with policies agreed by WEAG. 21. In order to achieve these aims, the Charter attributes a number of functions[7] to WEAO: defence research and technology activities, defence equipment procurement, studies, management of assets and facilities, and a number of other tasks necessary to the aims of the Organisation.

22. Two participants or more wishing to jointly organise a specific project can do so within the WEAO framework, thereby enhancing cooperation within the Organisation and finding a way round the problem of a lack of consensus which may otherwise hamper such a project. On 28 July 1998, WEAO signed its first two contracts in the field of modern radar technology. These contracts were for studies on signal generators and the role of optoelectronics in radar. They were awarded to a consortium composed of Thomson-CSF RMC (France), DASA (Germany) and GEC Marconi Avionics (United Kingdom)[8]. 23. WEAO is composed of two bodies[9]: a Board of Directors, composed of a representative from each member state, with one vote each, assisted by national experts. The national representatives are either National Armaments Directors (NADs), senior military or civilian officials or their substitutes. The Chairman is elected from among the representatives for a one-year mandate which can be renewed twice. The NADs take decisions by unanimity. The Board of Directors is assisted by a Financial Committee and a Research and Technology Committee. The Board defines WEAO's tasks and general policy, gives guidance to the Executive Body and determines the policy to be applied for awarding contracts. It is responsible for major financial decisions and managing the Organisation. It may set up any committees it may deem necessary; an Executive Body, composed of a General Manager and the EUCLID Research Cell, which is entitled to award contracts on behalf of participating countries. By becoming the sole entity responsible for placing contracts, it has removed one of the major obstacles to the efficient running of joint research programmes, which was the obligation of having the various national authorities launch the contractual procedures. (d) The European armaments partnership 24. In 1996 the WEAG ministers, meeting in Ostend, tasked the National Armaments Directors with a detailed study of the possibilities for creating a "European armaments partnership". One year later, in Erfurt, the WEAG ministers decreed that an interim arrangement adopted by the NADs, entitling EU member countries which were not members of WEAG to participate on a case-by-case basis in panel meetings, had been very successful. They also decided to open up WEAG to WEU associate partners and observers, and agreed the arrangements for the participation of these countries in WEAG activities.

25. WEU observers which are not already members of WEAG[10] can attend all its meetings, if they so wish. However, they cannot veto a decision adopted by consensus by the 13 WEAG countries[11], and full members preserve the right to limit the participation of observers to the discussion of specific agenda items. WEU associate partners wishing to participate in WEAG activities can be explicitly invited to attend the discussions on specific agenda points. 26. The tangible result of that decision was the participation of the NADs of Austria, Finland and Sweden at the last NADs meeting on 13 March 1998 in Berlin. Finland and Sweden are progressively participating in all WEAG's activities, and Austria is considering possible participation. The necessary documentation has been sent to the Austrian authorities and Austrian delegates are already attending meetings of the Staff Group and Panel III. 27. The accession of WEU observer countries to WEAG will nonetheless be a major item on the agendas of the next few meetings of NADs and ministers. A particular issue to be discussed is that of the participation of these countries in the Research and Technology projects managed by WEAG, namely, the ones being implemented under the EUCLID and THALES memoranda of understanding, signed respectively in 1991 and 1996 by WEAG ministers. A draft memorandum of understanding (MOU) entitled SOCRATE has been drawn up by WEAG Panel II to allow the participation of non-WEAG WEU associate partners and observers in WEAG/WEAO R&T projects. The draft is currently being studied by the various countries, and it is hoped that it will be ready for signature by the WEAG ministers in Rome. 28. The provisions of the SOCRATE MOU apply only to Finland and Sweden, but in terms of procedure, it would pave the way for participation by other WEU observers or associate partners, should this be agreed. Among the associate partner countries, Lithuania, Poland and the Slovak Republic have announced that they would like to be involved in WEAG activities and have designated points of contact. Panel Chairmen have received instructions, following the Erfurt decisions, to decide for each item on the agenda whether representatives of these countries may be invited to participate in the discussions. A status report on the matter is being submitted to the NADs and ministers in November 1998.

29. Moreover, WEAG is currently working out a policy to guide its relations with the Russian Federation and Ukraine. During their Berlin meeting in spring 1998, the NADs tasked the WEAG Presidency with preparing informal talks with the Russian Federation and Ukraine, with a view to clarifying WEAG's position and obtaining a better understanding of what these countries hope to gain from a dialogue with WEAG. Both Russia and Ukraine have been informed of this decision. 30. Ukraine has not tried to start direct discussions with WEAG, but on 24 July 1998[12] it submitted a document entitled "Proposals of Ukraine for cooperation with the WEU in military-technical sphere and in the field of armaments". The Russian Federation for its part has indicated that it would like to hold informal talks with WEAG. The matter will be discussed by the NADs, with a view to agreeing on a WEAG policy proposal, to be submitted to the Group's defence ministers. By virtue of the decision taken by the NADs during their spring meeting in Berlin, such a policy must comply with the political strategy and principles of WEU. 2. Organisation for Joint Armament Cooperation (OCCAR) 31. On 1 December 1993, Germany and France decided to create a joint armaments structure. On 7 December of the same year in Baden Baden, the two countries set out the aims and principles of their cooperation. On 7 July 1996, they were joined by the United Kingdom and Italy, and on 12 November 1996, OCCAR was born. On 9 September 1998 in Farnborough, United Kingdom, a Convention was signed by France, Germany, Italy and the United Kingdom "on the establishment of the Organisation for Joint Armament Cooperation". It will enter into force after ratification by the national parliaments.

32. The main provisions of this Convention are as follows: Member states "wishing to increase their armaments cooperation in order to improve efficiency and reduce costs; Considering that the attainment of the best ratio between cost (...) and efficiency for current and future cooperative programmes is an absolute necessity (...); Wishing to achieve coordination of their long-term requirements (...) based on the principles of complementarity, reciprocity and balance; Deeming it necessary (...) for competition to be organised (...); Convinced that a strengthening of their cooperation in defence equipment will contribute to the establishment of a European Security and Defence Identity and is a practical step towards the creation of a European Armaments Agency; Wishing to associate other European states which accept all the provisions of this Convention," Article 5 "To enable a strengthening of the competitiveness of the European defence technological and industrial base, the Member States renounce, in their cooperation, the analytical calculation of industrial juste retour on a programme-by-programme basis, and replace it by the pursuit of an overall multi-programme/multi-year balance (...)". Article 6 "When meeting the requirements of its armed forces, each Member State shall give preference to equipment in whose development it has participated within OCCAR." Article 8 "OCCAR shall fulfil the following tasks, and such other functions as the Member States may assign to it: (a) management of current and future cooperative programmes, (...) as well as research activities; (b) management of those national programmes of Member States that are assigned to it; (c) preparation of common technical specifications for the development and procurement of jointly defined equipment; (d) coordination and planning of joint research activities (...); (e) coordination of national decisions concerning the common industrial base and common technologies; (f) coordination of both capital investments and the use of test facilities." Article 15 "1. Each Member State shall have a representative on the Board of Supervisors with the right to vote (...); 2. (...) decisions shall be taken by the representatives of those Member States which are participating in the programme." Article 18 "(...) all decisions referred to in this Convention shall be taken by the Member States unanimously (...)". Article 24 "Subject to the provisions of this Article, contracts and sub-contracts shall generally be awarded after competitive tendering." 33. Article 39 refers to an aspect which is important for the development of this body's activities, stipulating that: "OCCAR shall have full legal personality and, in particular, the power to: (a) contract; (b) acquire and dispose of immovable and movable property, and (c) institute legal proceedings." 34. OCCAR has a two-tier internal structure: a decision-making level, the Board of Supervisors, which defines general policy and supervises the Executive Administration of OCCAR. It meets roughly three times a year in Bonn. It is composed of the National Armaments Directors of the participating states or their representatives, who take decisions by unanimous agreement. A Chairman is elected from among them for a period of one year. The Board is assisted by a Committee for the preparation of the future, as well as by programme committees; an executive level, the Executive Administration, with a management structure composed of a Director, Deputy Director and the requisite support staff. It is divided into three functional divisions (administration; procurements, contracts and finance; preparation of the future) located respectively in Koblenz, Germany, and Rueil-Malmaison, France. The Executive Administration is in charge of implementing cooperation programmes.

35. Since 1 January 1998, a number of Franco- German collaborative programmes have been incorporated in OCCAR. In the future, any collaborative programmes may be integrated in the organisation. The Netherlands and Spain have expressed an interest in joining OCCAR. 36. As was recently recalled by General Zignani, Chairman of the Board of Supervisors of OCCAR: "The two new structures I have described, namely the idea of a European Armaments Agency within the framework of WEAG, and OCCAR, will be going ahead, though at different speeds. It is reasonable to assume that OCCAR will make more actual progress and might, therefore, become the focus for all those countries which are more willing to move towards integration. More pragmatically, OCCAR could be a centre of attraction for other countries - and we, members of OCCAR, hope that this will be the case as soon as possible for the simple reason that in this way, everything will move more swiftly. In any case, the overall direction is essentially the same as that of the Agency, and therefore it is not excluded that the two roads may, in due course, converge".

37. In order to give OCCAR a legal status so that it is entitled to award contracts, the parliaments of member countries are in the process of ratifying the Convention recently signed in Farnborough. However, if WEU member countries so desire, OCCAR could be placed under WEU auspices as a subsidiary body of the Organisation, which would give it the desired legal personality. 3. The European Union (a) Article 223 of the Treaty of Rome 38. Under the Treaty of Rome adopted on 25 March 1957, the production and trading of armaments were exempted from the rules of the common market, due to the desire of member governments to preserve their autonomy in the defence equipment sector. The result was to maintain a highly protected sector which was not subject to the normal competition rules applying to contracts under ordinary law and often in receipt of state subsidies. Article 223 has been included in the different treaties which have succeeded the Rome Treaty. It reads as follows: "1. The provisions of this Treaty shall not preclude the application of the following rules: (a) no Member State shall be obliged to supply information the disclosure of which it considers contrary to the essential interests of its security; (b) any Member State may take such measures as it considers necessary for the protection of the essential interests of its security which are connected with the production or trade in arms, munitions and war material; such measures shall not adversely affect the conditions of competition in the common market regarding products which are not intended for specifically military purposes. 2. During the first years after the entry into force of this Treaty, the Council shall, acting unanimously, draw up a list of products to which the provisions of paragraph 1(b) shall apply. 3. The Council may, acting unanimously on a proposal from the Commission, make changes in this list." 39. There are still a number of differences on the interpretation of this article, according to whether the countries concerned consider that armaments are ordinary goods requiring no special treatment, or whether they consider that the possession and control of the national defence industry is a strategic issue. For the first category of countries, the production of armaments or of materials like steel is governed by the normal rules and procedures and belongs essentially to the private sector. It must therefore also comply with Community rules on free competition and the free movement of goods and services.

40. For the second category of countries, it is important to maintain control over their supply sources, technologies and export policies. The special treatment they give to defence equipment is due to their desire for a high level of autonomy in the field of defence policy. For countries with a small armaments production, Article 223 may be considered as a way of supporting the development of their defence industry, and they may be unwilling to bear the burden of possible restructuring of the European defence industry. However, such countries are not formally opposed to certain items of equipment or components which they do not consider to be strategic, being excluded from the application of Article 223, in accordance with paragraph 2. (b) The POLARM Group (European armaments policy)[13] 41. The EU Permanent Representatives' Committee (COREPER), at its meeting on 26 July 1995, decided to establish POLARM, an ad hoc working group on a European armaments policy. The POLARM Group works under the direct auspices of COREPER. Its initial terms of reference contain three precise tasks. It is instructed to: analyse the report drawn up by the informal Group of Experts responsible for studying the options for a European armaments policy; identify the points in the report which warrant further examination within the European Union framework; make recommendations for further action within the Community framework or within that of Title V of the TEU and, if appropriate, list suggestions for specific measures, without prejudice to the Commission's competence under the Treaty on European Union. 42. POLARM is composed of the permanent representatives to the European Union of the foreign affairs ministries, accompanied by defence ministry experts, of the 15 EU member countries (including the 10 member states of WEU which are also members of WEAG). This makes for some degree of consistency between the policies of the POLARM Group and those of WEAG. The POLARM Group has studied a number of specific issues:

definitions of characteristics specific to the defence-related sector. The Group agreed on a text which was approved on 22 November 1996; possibility of simplifying controls governing intra-EU transfers of armaments (and of other defence-related products); the opening-up of public procurements in the armaments sector. 43. Recently, France and Germany tabled a joint proposal concerning the procurement and transfer of equipment, while the UK proposed another theme, that of "supply guarantees", which it (like France) considers to be a promising area. At the present time, the Group is examining the 15-point action plan proposed by the Commission, which it mentions in Annex II to its report Implementing an EU strategy on defence-related industries (COM (97) 583 final), dated 4 December 1997. Annex I to that report contains a proposal for a common position on the framing of a European armaments policy, which the Commission invites the Council to adopt. This position will be examined by the POLARM Group which might then submit an opinion on it to the Council through COREPER. (c) Group for cooperation in the field of armaments and the harmonisation of European export policies (COARM)[14] 44. The COARM Group is an ad hoc group established in 1991 by the Council of the European Union. Like most of the other groups in this area (CODUN, concerned with UN-related disarmament issues, COSEC, on security, CONOP on non-proliferation etc.), it was placed under the responsibility of the Political Committee. It is composed of representatives of EU member states, most of whom come from the foreign affairs ministries, and of the Commission. The COARM Group has drawn up a list of equipment with five different levels of embargo. After the fall of the Berlin Wall, it adopted a decision in principle on transfers of light armaments in order to avoid arms trafficking. The POLARM Group has also drawn up a document to accompany intra-community movements of armaments, but it is used little or not at all by member states, which prefer in many cases to apply national legislation. Generally speaking, there are a number of differences of opinion within the Group with regard to its objectives. France and the United Kingdom, for example, insist that it should be discussing harmonisation measures and not national policy, a view that is not shared by Germany. The COARM Group's initial results were presented in 1996 to the European Council's Political Committee.

45. COARM is concerned with harmonising export policies with regard to third countries. It initially based its work on the global framework provided by the eight criteria defined in Luxembourg (29 June 1991) and Lisbon (26 and 27 June 1992), before contributing to the drafting of a "Code of Conduct on arms exports" which was adopted by the General Affairs Council of 8 June 1998. This Code of Conduct was based on the eight criteria and on a draft submitted jointly by France and the United Kingdom. It provides for notification of refusals and for a consultation mechanism, the first of its kind to be applied to the export of conventional weapons. The adoption of this code was a new departure in the efforts to define a common EU approach to arms exports, which is an important component of a common foreign and security policy. The Council will make an annual assessment of the implementation of this code[15] . 46. The applicable criteria are as follows: 1. respect for international commitments of EU member states, in particular any sanctions decreed by the UN Security Council or EU, agreements on non-proliferation and other subjects, as well as other international obligations; 2. respect for human rights in the country of final destination; 3. the internal situation in the country of final destination (existence of tensions or armed conflict); 4. preservation of regional peace, security and stability; 5. the national security of member states and the territories whose external relations are the responsibility of a member state, as well as that of friendly and allied countries; 6. the behaviour of the buyer country with regard to the international community, as regards in particular its attitude to terrorism, the nature of its alliances and its compliance with international law; 7. the existence of a risk of equipment being diverted within the buyer country or re-exported under undesirable conditions; 8. compatibility of the arms exports with the technical and economic capacity of the recipient country, taking into account the desirability for states to meet their legitimate needs for security and defence while diverting as few human and economic resources as possible to armaments.

47. This code of good conduct encourages a more responsible attitude on the part of states with regard to their armaments export policy. The exporting country is bound only to "exercise particular caution or vigilance" or to "take into account" the situation in the country of destination with regard to regional security, compliance with human rights and international obligations. Since it is entirely up to the exporting country to give its own appreciation of the situation, that country is solely responsible for the final decision. Nonetheless, the code is a step forward, in that it defines, albeit somewhat timorously, a number of "principles" which in time could become binding. The code cannot prohibit a member state from exporting armaments to a recipient who has already been refused by another member country. However, since the exporting country must notify the other member states of its intentions, it is likely to come under political pressure from them to refrain from such exports. 4. European Defence Industries Group (EDIG) 48. EDIG, an association under private law, was set up in 1976 to provide a forum for European defence companies to discuss and coordinate their industries. It is composed of the national associations of the defence industries of WEAG member countries, plus those of Austria, Finland and Sweden, which have been observers since 1997. 49. Its purpose is to seek European-level solutions to problems confronting the European defence industry, by: carrying out and coordinating studies on scientific, technological, economic and institutional matters of common interest; advising and submitting recommendations to European governments; defending the interests of its members vis-à-vis WEAG and the European Commission. 50. It is composed of a General Assembly of representatives of the national associations, a secretariat and two standing committees, one for economic affairs, one for legal and technical questions. In addition to its task of providing a forum for and representing European defence industries, EDIG performs numerous studies on the defence sector's present situation and future prospects.

III. Definition of requirements in a European framework 51. It goes without saying that the prime objective of the defence industry is to provide its country with essential strategic armaments, in other words, the equipment itself plus spare parts and munitions. Governments are the single customers of the defence industry. They define the requirements, in particular by means of equipment specifications. If defence policy changes, industry must adapt. 52. European states are currently confronted with three concomitant developments: the desire to create a European Security and Defence Identity makes it necessary to adapt national defence and armaments production strategies; the increased cost of armaments and falling defence budgets in European countries are leading to international cooperation on major armaments programmes, which means that requirements must be harmonised; industrial groupings among the major American defence manufacturers call for a response on the part of the European armaments industry. 1. Strategic requirements 53. Governments, conscious of the fact that the prime objective for their industries is to provide the different countries with a national and European defence capability, are anxious to preserve their prerogatives in this area. The current restructuring of the defence industry in a European framework must therefore lead to production, at the lowest possible cost, of the defence equipment needed for autonomy of supply, while respecting the inevitable interests of certain states, and without neglecting the arms exports which are so important for the support of that industry. 54. Europe cannot achieve a common foreign and security policy without first attaining some degree of political autonomy, which in turn relates to autonomy for the procurement of certain equipment deemed strategic. Two areas are concerned: advanced technology and logistics, to guarantee supplies in times of crisis. 55. Advanced technologies: European states must be capable of producing state-of-the-art equipment. Indeed, they cannot conduct a common foreign policy if they are dependent on the technology of a non-European country, or if they do not have access to advanced equipment. Intelligence acquisition in crisis areas is a good illustration of the importance of having the latest technology. The Torrejón Satellite Centre, for example, provides the reliable data that WEU member states need to independently monitor crisis situations.

56. For most European countries, cases in which they are required to conduct military operations independently of any multilateral framework have become extremely rare and, with the development of industrial cooperation at international level, it is becoming difficult and costly to maintain a purely national strategic equipment production capacity. The solution which will preserve their access to most strategic technologies is that of accepting interdependence among European countries. Indeed, this is the direction that is being taken with the intra-European agreements on security of supply that have been under discussion since the statement on 20 April 1998 by the 3 plus 2 European ministers (United Kingdom, France and Germany plus Italy and Spain). 57. Logistics: security of supply of defence equipment and national and European-level control of that supply are strategic requirements for states. In a crisis situation, they must be sure of having the means to take action. The development of European-level production has the inevitable consequence of making states dependent on each other for the supply of certain items of equipment. When Belgium refused to deliver munitions to the United Kingdom during the Gulf War, it showed how such dependence without interdependence could be abused. States must therefore surround themselves with adequate supply guarantees. They may adopt two kinds of measure, designed either to reduce dependence on non-member states, or else to guarantee the "reciprocal supply of goods among participating states, in particular by simplifying, or even in the long run abolishing, controls on transfers among the countries concerned"[16]. At their meeting on 6 July 1998 in London, the Defence Ministers of France, Germany, Italy, Sweden, Spain and the United Kingdom paid particular attention to the last type of guarantee. 58. Some states may consider equipment to be "strategic" in the sense that they feel they should not be dependent on a third country for its production. It would seem that from a military point of view, the list of such equipment is very short, but that the military staffs are particularly vigilant about munitions supply sources, so as not to find themselves in the situation in which the British found themselves during the Gulf War which triggered a joint inquiry by the House of Commons Defence and Trade and Industry Committees into the UK defence industry. This list preserves governments' control over the items deemed crucial for their independence, while also designating those items of equipment considered eligible for European cooperation.

59. Finally, given the increasingly multilateral nature of operations, it is in the interests of the different states to have interoperable equipment, in order to improve communications between their respective armed forces. Interoperability calls for a high level of cooperation among countries. The supreme form of such cooperation would be common European equipment. This would not only have major financial advantages and guarantee perfect interoperability, but would also entail setting up joint logistics centres with common stocks of spare parts for countries with the same equipment, in order to secure supplies. 2. Research and development 60. Although research and development (R&D) is often presented as a single concept, it in fact covers two distinct notions. Research is an upstream activity carried out independently of programmes being considered for implementation. Joint definition by European countries of research themes is necessary to ensure that there is a good return on the funds invested in research. Development covers all the studies and development work required to implement a programme. Clearly, then, for there to be joint European development, a number of countries must cooperate on major armaments programmes, which in turn is highly conducive to the emergence of a European defence industry. (a) Research 61. European countries have understood that it is necessary for the survival of European companies to cooperate in the research field. This is why the Western European Armaments Organisation (WEAO) is responsible for managing the EUCLID programme (European Cooperation for the Long Term in Defence), which is a genuine research structure. Its role is to provide a European consultation forum in order to define research requirements and then place contracts. Furthermore, WEU member countries have also signed the THALES memorandum of understanding, a technical agreement on European defence research laboratories, in order to facilitate implementation of joint government-funded research programmes and exchanges of information. The EU has also taken initiatives in the form of the EUREKA programme.

62. However, there needs to be better coordination of the EUCLID and EU programmes, and governments must make choices about the way in which research is organised in Europe, in order to make it more productive[17]. Industrial mergers must also be organised so as to improve productivity in this area. As the Titley Report[18] underlines, research efforts must be more focused if European companies are to be able stand up to competition from American firms, and more particularly to compete with them in the technology arena. (b) Development 63. Not only must European countries step up their cooperation in the field of armaments research, they must also organise joint programmes in order to achieve economies of scale. Three conditions must be met for such cooperation to be possible: firstly, several states must feel the simultaneous need to develop the same type of equipment. They must then agree on a timetable and hence also on expenditure, although they do not necessarily need to have the same financial priorities. Moreover, they may not initially be seeking strictly identical characteristics, if only because of the different ways things are done in their respective armed forces; afterwards these states must divide up the development work. Each country will want to obtain a maximum workshare for its national industry, while benefiting from the technology transfer from other states. To foster such cooperation, structures must be set up to allow exchanges of information to take place as far upstream as possible among the military staffs of the different European countries, as well as among government department engineers, for all technical and engineering matters. 64. There is, at present, a European body for harmonising defence equipment requirements, namely, Eurolongterm, which since 1993 has been integrated in WEU. Its task is to elaborate long-term common operational requirements and to formulate outline specifications, which are "very important objectives, but at the same time difficult to achieve"[19].

65. Finally, there is the problem of transatlantic relations in the field of R&D. A restructured Europe in this area must avoid cutting itself off from the United States. Meetings of the NADs from either side of the Atlantic could be used to launch transatlantic collaborative projects and give impetus to governments in the field of research. 3. Procurement cooperation 66. These days it is recognised by all European countries that the best-value-for-money rule cannot be applied unless major adjustments are made to armaments procurement procedures. The "smart procurement initiative" developed within the British MoD which takes all the factors, industrial ones in particular, more broadly into account, has been generally accepted by European countries. Intergovernmental cooperation on defence equipment specifications and procurements helps bring down unit costs, although some of the benefits are offset by the cost of such cooperation. It is generally admitted that no European country on its own is able to finance the major frigate, tank or new generation fighter plane programmes, and that cooperation has become a necessity. 67. For cooperation to be successful, the best possible use must be made of each country's skills on the basis of a common definition of requirements. A 1995 British House of Commons Defence Select Committee report draws attention to the practice of juste retour in government-funded cooperation programmes. Under this system, the project workshare is predefined and contracts are not awarded on the basis of commercial criteria. 68. These days, the main European armaments producers are grouped together in OCCAR and refuse to apply the principle of juste retour, which creates a major point of divergence between them and other European countries which have a less efficient defence industry to protect. There have long been efforts in western Europe to harmonise equipment specifications for collaborative projects, and a lot of work is being done on the subject in WEAG and OCCAR. Encouraging work is under way in WEAG on the setting-up of a European armaments agency and the definition of common procedures for member countries. The WEU procurement bodies will make a useful contribution to harmonising the requirements of European states. The need for such action is acute, but progress is slow.

IV. Restructuring Europe's defence industries 1. Evolution of the European defence industries (a) Status of the European industries (i) Ownership 69. The European defence industry landscape is very complex, since enterprises have widely varying status, ranging from government entities to companies under private law. This is a legacy from the strong cultural traditions of the past. Indeed, the origins of a major part of this sector can be traced back to the military arsenals of the last century, although some of them have since been privatised. Moreover, some countries were anxious to keep certain high-tech sectors under state control in order to maintain their strategic autonomy in certain areas. 70. Today, we find wide variations of status. A number of examples are given below: government entities, such as France's Direction des constructions navales; totally state-owned enterprises such as Bazan (Spain), CASA (Spain), Aerospatiale (France), Giat (France), Finmeccanica (Italy); private-law companies in which the state has holdings, such as Dassault Aviation (France), Thomson-CSF (France), Aermacchi (Italy), DASA (Germany); companies under private law with a wholly private ownership, such as Diehl (Germany), BAe (UK). 71. Although at the present time the status of European defence industries varies, almost all of them are heading towards privatisation. Indeed, this will make it possible for them to join forces in order to compensate for their small size as compared with the American giants. The main alliances over recent years are given in Appendix IV. (ii) Legal status 72. The status of European companies is governed by the legislation of the country in which they have their headquarters. European companies of different nationalities wishing to cooperate require a legal framework guaranteeing equality of the different parties, legal certainty, efficient management of cooperation and finally, uniform applicability in all the states concerned of the status which governs their cooperation.

73. It was in response to this need that the status of "European Economic Interest Grouping" (EEIG) was created. It has the following advantages: it makes provision for a private-law legal entity valid throughout the European Union; it is halfway between a simple cooperation agreement and a company, which has the advantage of contractual flexibility; it gives the EEIG a specific legal personality, which enables it to increase its means of action; it ensures that there is total equality among the different parties. This last aspect, while it is revealing of the spirit behind the EEIG concept, is not always perceived as an advantage. 74. However, the EEIG status cannot in the long run replace what could become a true European commercial company, for it does not guarantee all the prerogatives that come with company status, such as: direct exercise of management powers; holding of shares (lack of a capital structure); takeovers of other companies; capacity to freely recruit its personnel (limited to 500 employees). 75. Such a structure can only manage cooperation among partners of equivalent strength for reasons of the financial solidity of its members. Now that the financial and business risks faced by defence companies have increased due to the development of competition, the EEIG status, although in the past it has provided a framework for numerous collaborative programmes such as Euromissile or Eurosam, is no longer sufficiently well adapted to the requirements of industrial alliances. 76. In order to move beyond the stage of simple cooperation on a project-by-project basis, companies have had recourse to other legal structures: the creation of companies under the law of one of the participating states: given the convergence of the company law of the different European Union countries, the choice of nationality of the company is no longer of great importance. It would seem that the "simplified joint stock company" status introduced by the law of January 1993 is currently favoured by industrialists. Indeed, such a status provides for true economic and financial autonomy, decision-making powers and borrowing capacity, in accordance with the size of each partner's shareholding. This is the framework in which mergers of existing companies or lines of business are conducted. In the latter case, joint subsidiaries are set up by several companies subject to different laws; another legal framework for establishing alliances among European companies is that of "holding companies". This is the framework that was chosen for the partnerships between Aerospatiale and DASA and Matra and BAe. In this case, each partner organises the relevant branch of activity into a company under national law, and brings this company into the holding company set up for that purpose. The latter, which comes under national law, may itself be controlled by another holding company, and so on. This system of a "cascade" of holding companies has a number of advantages. It : preserves the apparent national identity of each company, which complies with certain political requirements; shares production according to the qualities and expertise of each partner; brings sales and export policies under a single management, and also takes due account of differences in national export legislation; limits the risk of hostile takeovers of the structure thus created. In spite of all these advantages, the system is unwieldy to manage, calls for constant political-industrial negotiations and may lead not only to a loss of efficiency, but also to situations in which economic rationality has to be sacrificed in order to balance the interests of the different partners.

77. In a nutshell, the EEIG status offers all the advantages of a structure under Community law, but not all the advantages, so necessary today, of a company. Moreover companies, even holding companies, remain incorporated in national law and subject to national political constraints, while at the same time suffering from the diversity of export and tax legislation in particular. 78. Although industry has not waited for politicians to define an appropriate framework for its cooperation and alliances, the need for a transnational European company status has now clearly emerged, to the extent that Europe really wishes to give itself the means of in-depth and efficient restructuring of the European defence industry.

(b) Industrial cooperation 79. In the last few years, major European armaments firms have been actively negotiating and creating joint venture companies. Many of the programmes are managed by OCCAR (Organisation for Joint Armament Cooperation), which involves France, Germany, Italy and the United Kingdom. These programmes are: the joint venture Euromissile, which was created in 1972 by Germany's Daimler-Benz Aerospace (DASA) and France's Aerospatiale SA. Since the mid-1970s, and to this day, its Milan and Hot anti-tank weapons and the Roland surface-to-air system have been highly successful. Milan, which was initially developed for the French and German infantry, is now in service in 41 countries all over the world. The new-generation weapon Milan 3 has been in service since 1996. The Hot anti-tank system was developed by Euromissile for the French and German armies for use on land vehicles and helicopters. Hot was officially selected in 1997 by France and Germany to be mounted on the new Franco-German Tiger helicopter. The new Roland M3S surface-to-air system is suitable for anti-air defence missions in all deployment conditions. The French and German Forces have selected the Roland M3S system. The success of the programme speaks for itself: 10 of the 14 European NATO member countries have equipped their forces with Euromissile systems. Euromissile makes a major contribution to the standardisation and interoperability of Europe's armed forces, and is a leading partner all over the world; the Polyphem missile system is under development for Germany, France and Italy by the Euromissile consortium consisting, respectively, of DASA, Aerospatiale Missiles and Consorzio Italmissile. The optic fibre-guided Polyphem missile is intended for two kinds of mission: isolated strikes from light land vehicles against long-range targets or from small ships or helicopters against land-based targets; Tiger Helicopter: Eurocopter is an integrated European joint venture formed in 1992 through the merger of the helicopter divisions of the French company Aerospatiale and the German company Daimler Benz Aerospace (DASA). A declaration of intent concerning the purchase of 160 Tiger attack helicopters was made public in May 1998. The Tiger is currently being industrialised in two configurations, an anti-tank helicopter and a combat-support helicopter. For the moment it is armed with Hot missiles; the Helios satellite, the first military reconnaissance system to be developed in Europe, was jointly funded by the French, Italian and Spanish governments. France has had only limited success in securing partners for its Helios observation satellite system. Italy and Spain joined the two-satellite Helios 1 programme, which has been operational since mid-1995, but the Helios 2 follow-on, to be available early next decade, is for the time being a Franco-Spanish effort only, Germany having abandoned the programme. The second satellite programme (Horus), was planned as a Franco-German programme to utilise the technology being developed for civil sector radar remote-sensing satellites. However, France has withdrawn from this programme. Eurosam is a Franco-Italian joint venture created by the French companies Aerospatiale and Thompson-CSF and the Italian firm Alenia/Finmeccanica in order to develop the anti-missile programme FSAF (Future Surface-to-Air Family), which is organised around the Franco-Italian missile Aster. This family has a naval component, the PAAMS (see Horizon programme below) and a mobile land component to be mounted on vehicles which is currently under development; the Horizon air defence frigate project involves France, Italy and the United Kingdom. The programme covers the ship and secondary weapon systems, and the Principal Anti-Air Missile System (PAAMS). PAAMS is a new surface-to-air missile system, developed essentially to provide medium-range air defence and anti-missile protection for high-value units, such as aircraft carriers or merchant tankers, in the vicinity of the escort. The Horizon International Joint Venture Co., the prime contractor designated for the programme, has been given a November deadline to finish the cost-control studies. The joint venture firm is owned by the French firm Direction des Constructions Navales (DCN) International, the British firm GEC-Maritime Ltd., and the Italian company Orrizonte SpA. The operational specifications for the frigate were set out in the "Trilateral Staff Requirements" document signed in 1992. However, the partners encountered major difficulties in their efforts to reach agreement on the operational capabilities of the missile system; GIE Eurodrone is a management branch of the Franco-British company Matra BAe Dynamics and the German firm STN Atlas Elektronik. Brevel is a reconnaissance and target location UAV (Unmanned Aerial Vehicle) being developed by GIE Eurodrone under contract from the German and French defence ministries. Its main missions are to provide reconnaissance data and to detect and provide accurate position data on enemy targets for the artillery; the PzH 2000 (Panzerhaubitze 2000) is the 155 mm self-propelled howitzer developed by Wegman and Co. GmbH for the German army. Expectations are rising within the company that the PzH 2000 will become a European standard. The Italian and German Governments have signed a letter of intent to cooperate in joint howitzer production. Among other important prospective partners are Denmark, Sweden, Norway and Finland; the United Kingdom, France and Germany are involved in the trilateral Multi-Role Armoured Vehicle (MRAV) development project, but during 1998 new doubts emerged about its timing, industrial participants and technology workshares. No contract has as yet been awarded and the governments have not yet signed the memorandum of understanding necessary to launch the programme.

80. Above and beyond the programmes managed by OCCAR, there are a number other multilateral armaments projects under way in Europe: the FLA (Future Large Aircraft) programme combines the resources of Europe's major aircraft manufacturers. The FLA is a new military transport system designed to meet the needs of the 21st century. A military subsidiary of Airbus Industrie would be in charge of managing this programme, in which the main partners would be Aerospatiale (France), Alenia (Italy), British Aerospace, CASA (Spain) and Daimler-Benz Aerospace (Germany), supported by three associate partners, Flabel (Belgium), Ogma (Portugal) and Turkish Aerospace Industries. The programme is currently in its "pre-launch" phase. This phase will end when a tender is submitted to the customer nations in early 1999, at which time the European authorities will be evaluating tenders in addition to the one submitted by Airbus Industrie. The success of the FLA is seen by many industrialists and European political leaders as essential for the future of the European aerospace industry; the European Fighter Aircraft (Eurofighter) may be considered as a model of European cooperation. It brings together Germany (33% of development expenditure), the UK (33%), Italy (21%) and Spain (13%). Initially, the goal of the project was to produce 765 aircraft, but the figure will probably be reduced, although the United Kingdom remains committed to 232 aircraft. The Eurofighter, baptised "Typhoon" in September 1998, is optimised for air-to-air combat with a secondary ground attack capability. Current Eurofighter partners are Alenia of Italy, British Aerospace (BAe), Spain's CASA and Germany's DASA (Daimler-Benz Aerospace); NH industries consists of the French and German Eurocopter units plus the Italian firm Agusta and the Dutch company Fokker Aviation. The NH-90 will be the second major new European military helicopter to go into production. On the eve of the signature of the first order for the Tiger, the French, German, Italian and Netherlands governments formally announced a commitment to place an order for 154 NH-90 helicopters. The programme is managed by the NATO Helicopter Management Agency (Nahema); Trigat is a European missile programme involving France, Germany and the United Kingdom. The development of the Trigat (medium-range) continues, but France has withdrawn from the Trigat LR (long-range) project. Belgium and the Netherlands joined the Group as associate members in 1989. The missiles are being developed by the Euromissile Dynamics Group, a consortium composed of Aerospatiale (France), MBD/UK (United Kingdom) and Daimler Benz Aerospace (Germany); France and Germany are moving ahead with an effort to turn military expertise in the field of laser technology into a commercial venture. The Franco-German laser centre, CLFA (Centre de Laser Franco-Allemand), was inaugurated in May 1998. This joint research and development centre is housed by France's military procurement agency DGA (Délégation Générale pour l'Armement); after nearly eight years of bickering and delay, France, Germany and the United Kingdom are launching production of the classified Cobra (counterbattery) radar project. The system is designed as a mobile, long-range, battlefield-deployable radar capable of simultaneously detecting multiple artillery, mortar and rocket projectiles. Production is scheduled to run over four years.

81. At the beginning of 1998, the governments of France, Germany and the United Kingdom signed a Memorandum of Understanding (MoU) for the project definition phase of a joint future military satellite communications system, Trimilsatcom. The project, due to start in 2005, involved a three- or four-satellite constellation. Unfortunately, the UK Government's decision on 12 August 1998 to withdraw cast serious doubts on the organisation of the programme. (c) Economic differences: defence budgets of European states 82. There are two reasons for the decline in European defence budgets: the disappearance of the threat from the East; the financial crisis confronting a number of states. 83. In spite of this significant decrease in defence budgets, there is a disparity between these European budgets (fig. 1), which explains the different industrial capacities (fig. 2). The United States defence budget is also declining, but it remains higher than those of European countries (fig. 3). Indeed, the budgets of Germany, France, the United Kingdom and Italy together represent only 47% of the American budget for the period 1993-97. This explains the domination of the international market by American companies. Figure 1: Defence budgets including pensions in millions of US$ for Germany, France, Great Britain and Italy for the period 1993-97 (not available electronically) Figure 2: % of defence budgets including pensions devoted to equipment expenditure for the period 1993-97 (not available electronically) Figure 3: Defence budgets of European countries (Germany, France, Great Britain, Italy) and the United States (not available electronically)

2. Comparison with the United States (a) The new structure 84. Due to the end of the cold war and the impact on airlines of the Gulf War, aerospace and other defence equipment companies experienced major decreases in orders. European firms lost ground to American companies which were more successful at adapting to the new market structure. The European defence industry is more fragmented than its US counterpart, with six civil aircraft manufacturers (as opposed to one in the US), six fighter aircraft manufacturers (two in the US), three helicopter manufacturers (three in the US), twelve missile producers (four in the US), six major military electronics suppliers (four in the US) and five satellite contractors (four in the US). The number of major American prime contractors involved in the design and production of defence systems has dropped from over 20 in 1980 to four at the present time. 85. The American Administration plays a more limited role than European governments in this sector and focuses essentially on promising areas of activity, in particular in the aeronautics sector: the Federal Aviation Administration has an annual budget of more than US$ 2 billion for aeronautical research. According to EU estimates, 70% of NASA's annual billion dollar aerospace budget can be considered as subsidising the American civil wide-body aircraft industry, which is four times more than the equivalent support provided by the EU and its member states; the American Department of Defense has announced an annual figure of US$ 20 billion for R&D, tests and aerospace evaluations, which must be added to the amount spent in the civil aircraft sector. 86. The US industry benefits from the Administration's experience in the field of export support. The Advocacy Center provides assistance to US Government representatives for their contacts with third countries, in order to help defend American commercial interests. Although this centre is not specifically dedicated to the defence industry, the latter nonetheless derives considerable benefit from it on what is an increasingly global and competitive market.

87. American industry has another major advantage in its single market and legislative framework. It is supported by one government's policy, unlike European industry which must contend with a great diversity of national policies. The annual American defence procurement budget is US$ 80 billion, twice that of the EU. Of those 80 billion, 35 go to R&D, compared with US$ 12 billion for R&D in Europe. The combined space budgets of NASA (US$ 12 billion in 1995) and the DoD (US$ 10 billion in 1995) are ten times the European space budget. (b) A US view - the two-way street 88. In 1984 the US held 25% of the world defence market and 56% ten years later. The US is the driver of new technologies in major areas. Individual firms we spoke to for our current inquiry told us of the importance of avoiding a "fortress Europe" approach that might jeopardise access to the US. 89. US laws set requirements for domestic content in procurement (the "Buy American" Act) and provide tax exemptions for export. However, the 1997 Defense Authorisation Act allowed the Pentagon to remove some "buy American" provisions. As part of the 1997 US Quadrennial Defense Review, working groups have been examining technology areas in which the US might collaborate with France, Germany and the United Kingdom. 90. Industry witnesses told us, however, that the US defence equipment market remains a protected market, providing some people in Europe with arguments in favour of seeking similar protection around Europe. In 1995, the value across all European Union countries of defence imports from the US was six times higher than that of exports to the US. As one firm put it to us, the "two-way street" in European and American trade is "still pretty limited to one-way traffic". However, it would not be in the European interest to give any hint of building some sort of "Fortress Europe" while industry in Europe is restructured, because that could create barriers in the US. 91. We were told that the situation will not stop with the consolidation of a European and US industry; European rationalisation will be an important step but not the end of the process. As a global industry, firms will negotiate mergers and joint-ventures with companies in the US and with companies in Europe, as such relationships make economic sense. An important benefit of the greater economies of scale from European rationalisation, however, would be to allow the particularly high costs of bidding credibly in the US to be shared, and consequently to increase the west-bound traffic on the "two-way street" to the US".

3. Central and eastern European countries (CEEC) (a) The current situation in the defence industries of the CEEC 92. A distinction must be drawn between the situation in Russia and Ukraine, and that in the central European countries. (i) Industrial capacity in the armaments sector 93. Most of the former military-industrial complex (MIC) that was the legacy of the Soviet empire is to be found in Russia and Ukraine (72% in Russia, 9% in Ukraine). At the end of the 1980s, some five to seven million people in these countries were employed directly or indirectly by the armaments industry[20]. The Soviet MIC was characterised by dual civil and military production as a result of Soviet policy at the time. There are three distinct levels of organisation within the armaments sector: applied research institutes, engineering studies departments and production plants. Such fragmentation is an impediment for this industry which is in the process of grouping the different levels together, in both geographic and structural terms, in the form of limited companies. 94. It is very difficult to estimate the defence budget of the Russian Federation. The devaluation of the rouble as a result of the financial crisis in Russia means that the figures must be treated with even more caution. The apparent annual growth of the Russian defence budget expressed in the local currency must be adjusted for inflation. According to SIPRI, total military expenditure amounted in 1997 to US$ 24 billion, as compared with US$ 240 billion in 1989. In 1996, 70.4% of the budget was spent on wages and 16.4% (or roughly US$ three billion) on equipment expenditure, essentially for land forces, against 41.6% in 1997[21]. 95. The declining defence budget and government orders led to a sudden and massive drop in production. Although the MIC is working at reduced capacity due to the lack of private and public investors, it is nonetheless anxious to preserve its entire production capacity, although this will not, in the long run, prevent a real ageing of its technologies. The only path to survival today would be to open up more to the civil market by means of diversification. Government aid is being provided to assist with the implementation of this difficult task, particularly in the shipbuilding sector, 90% of which is devoted to military activities.

96. Among the central European countries, the Czech Republic, Poland and Romania have autonomous production capacities and advanced technology, but they face the same problems as Russia, due essentially to the lack of investors. (ii) Export capacity 97. Exports are difficult to evaluate due to the large number of unofficial sales. The value of Russian armaments exports was reported to be US$ 3 billion in 1996, and US$ 1.5 million in 1998. 98. Russia is still the leading exporter to the CEEC as a legacy of the Warsaw Pact and the fact that the armies of these countries have equipment from the former Soviet Union, but its position is threatened by these countries' efforts to tighten defence and armaments ties with the NATO countries. 99. Russia has kept other traditional buyers such as Syria, Iraq, India, China and Iran. The equipment it exports to developing countries is often less technologically advanced than that produced recently by western countries. 100. Striking examples of Russian exports in recent years are: eight SU 29 training aircraft to Argentina, twelve Mi-24D Hind-D fighter helicopters to Bulgaria, ten Mi-17 Hip-H helicopter to Columbia and twenty to Egypt, twenty-four FGA Su-27S Flanker-B aircraft, together with 200 licences for Su-27K Flanker-B aircraft to China, forty Su-30M Flanker aircraft and 1420 air-to-air missiles etc. to India, 200 T-72 tanks to Iran, etc. It should be noted that much of this equipment came from the former Soviet army stocks. Thus not all these sales contributed to maintaining the Russian MIC, or to paying the wages of the people working for it. In 1996 Ukraine, for example, sold 320 T-80UD tanks to Pakistan, for a value of about US$ 550 million[22]. 101. In this situation of scarce domestic and export outlets, a new market is developing for the renovation and modernisation of existing equipment. European countries have a useful role to play here. (b) Industrial cooperation with eastern Europe (i) The need to promote cooperation

102. European countries are aware of the need to promote cooperation with the CEEC for political and economic reasons: political: since these countries are our direct neighbours, cooperation with them in all areas, including that of armaments, enables Europe to strengthen internal political stability and exert a legitimate influence in these countries with a view to the future enlargement of the European Union; economic: such cooperation opens up this market to our civil and military products. It is also in the interests of the CEEC themselves, in that they benefit from technology transfers, funding sources and the acquisition of modern management methods. (ii) The different types of cooperation 103. Direct and indirect takeovers, or holdings in the MIC: European companies are not very interested in this type of operation. Indeed, although there is a production capacity in these countries, it is indebted, organised along the lines of the Soviet model and has no more regional market outlets. 104. Programmes for the renovation and upgrading of equipment have led to genuine cooperation. They enable a number of CEEC to incorporate in their own equipment up-to-date instruments produced by western technology and interoperable with those used by NATO forces. Although this market is currently dominated by Israel, major collaborative projects are also under way with a number of European partners, two of which we will mention as examples. 105. The Future Large Aircraft (FLA), already mentioned above, involves Russia and Ukraine, on the one hand, and Belgium, France, Germany, Spain, Turkey and the United Kingdom, on the other hand, with Portugal as an observer. This project, to which Russia and Ukraine (and also Germany) are particularly attached, proposes creating the FLA on the basis of the Antonov 70. Although there are genuine political reasons for this project, its real advantages as compared with a purely European Airbus-based project are more questionable.

106. GLONASS, the Russian positioning system, could become a multinational Russian-European programme, making Europe less dependent on the American GPS. The role of European industries would be to modernise and augment the existing Russian system. 107. One of the priorities of the CEEC governments is to assist with the conversion for civilian purposes of the former Soviet MIC. However, this will be difficult to achieve without western help. For this purpose the European Union has set up its "Phare" and "Tacis" programmes, in particular to finance such projects. While western help does exist, it comes essentially from public sources, and very little from the armaments industry. Indeed, for the abovementioned reasons, companies cannot invest unless they have political and economic visibility. Only rarely, therefore, are there instances of private-sector cooperation with the CEEC in this area. (c) A potential market for European industries 108. The CEEC represent a potential market for European exports. This market has three characteristics: the production capacity of the CEEC, as we have seen, is not adapted to the requirements of the world armaments market; CEEC defence equipment needs to be upgraded or replaced in the very near future in order to comply with NATO interoperability requirements. It is unfortunate that the European countries were unable to convince CEEC buyers that European equipment must comply, just as American equipment does, with NATO standards; Russia, Ukraine and, to a lesser extent, central European countries, have major difficulties with financing their defence equipment expenditure. 109. The characteristics of this market are such that Europeans are more inclined to sell to it (for example by granting licences), than to invest in it. It is regrettable that European companies do not engage more frequently in collaborative projects on this market, but the proposed membership of European countries in a European armaments agency will make this easier.

110. Finally, although cooperation is desirable from the political point of view, it remains extremely risky for European companies, since they run the danger of having to provide the bulk of the funding and technology, without receiving any long-term return on their investments. 4. Recent initiatives 111. In December 1997, the governments of France, Germany and the United Kindgom declared their agreement on the urgent need to restructure the aerospace and defence electronics industries, leading to European integration based on balanced partnership.[23] The three governments called on these industries to set out a clear plan and timetable for action by 31 March 1988. While it was primarily for industry to work out the structure required, the governments undertook, for their part, to implement the necessary measures in national policies in order to facilitate such restructuring. 112. Although the trilateral statement was aimed at the industries of the three countries, the four companies involved in the Airbus project (including CASA of Spain) produced a joint response which clarified a number of preconditions for restructuring and the issues that would have to be resolved: (a) support at government level for restructuring that is driven by shareholder values and based on providing value for money, rather than open to government control or shaped by juste retour; (b) governments producing a consistent set of requirements for industry to meet. It would be helpful, they said, if in future, European governments were not running three concurrent fighter aircraft programmes; (c) a single, consistent procurement process across the countries involved in collaborative programmes, rather than having to deal with, say, three or four different procurement processes; (d) ensuring that, whatever happens in Europe, the "two-way street" in defence trade with the United States is not impaired; (e) continued governmental support for defence exports, and a restructured European industry that would not impair the ability of different European countries to export; (f) security of supply; (g) a "slicker" regulatory framework in Europe that makes mergers easier and the process clearer.

113. On 20 April 1998, the Defence Ministers of France, Germany and the United Kingdom - plus Italy and Spain, which had also subsequently supported the December trilateral declaration - agreed on the need for action in five key areas: security of supply: establishing governmental agreements which would provide commitments that countries could depend on each other to provide the necessary defence equipment and components, if restructuring led to elements of an equipment's production being physically concentrated in another partner's country; exports: similarly, ensuring companies will be able to export major systems if they include subsystems manufactured in other partner nations; R&D: greater collaboration between countries to cut down on wasteful duplication in R&D; security of information: establishing systems for securely handling any classified information passed by individual countries to newly formed joint companies; intellectual property: establishing a legal framework for transferring national intellectual property rights to newly-formed joint companies. 114. On 6 July 1998, the defence ministers of the six major European armaments producers (France, Germany, Italy, Spain, Sweden and the United Kingdom) signed a letter of intent "spelling out the details and establishing an organisation and timetable for the tasks involved". This document was the start of an ambitious process, making it necessary to set up several experts groups, with the task of defining the measures to be taken in these six "key areas"[24], in which common rules must be worked out in order to facilitate the creation of transnational companies. 115. On 22 April 1998, Industry Ministers of the five countries also met to consider the industry submission. During this meeting, the ministers resolved to work urgently on the issues on which industry had sought guidance from the governments, and to respond by the summer to coincide with the time industry said it needed to resolve other issues with its shareholders. They also invited the Swedish Government to take part in the initiative. When all six Ministers met again on 9 July 1998, they called for industry submissions on remaining outstanding issues by the end of October 1998, including shareholder structures and rights.

116. At this meeting in July they agreed on a joint declaration of which the main items are the following: the Ministers agreed that Governments should have no direct influence on the management of a future European Aerospace and Defence Company (EADC). They also confirmed their support for the guidelines agreed between the partner companies: the EADC should be run on a commercial basis by a single management structure, should have access to the private capital markets and be listed on the Stock Exchange and should not be dominated by any individual blockshareholder; the Ministers expressed the view that the company ought to remain a European enterprise and not come under the control of third parties or dispose of specified strategic, particularly defence-related assets without Government approval. The Ministers decided that safeguards would need to be in place to ensure this; the Ministers recognised that it is necessary to coordinate more closely their policies of support for research and development and to find out new appropriate procedures related to the EADC without interfering with the commercial decisions of the EADC by being designed with the aim of modifying the distribution of centres of excellence. The governments also recognised the need for appropriate export assistance to the EADC and will therefore investigate the possibilities for harmonisation of national schemes; the Ministers welcomed the work that has been done on export control procedures within different European fora. The Letter of Intent signed on 6 July 1998 by the Defence Ministers will also accelerate this necessary process; it is primarily for industry to work out the structure required. The Ministers confirmed that the Governments will, within the framework of national policies and, where necessary, jointly, continue to work together to facilitate restructuring and to take appropriate measures; the Ministers also stressed that the creation of the Airbus Single Corporate Entity is of central importance. It is a significant step towards a broader integration of military and civil activities within the future European Aerospace and Defence Company. The Ministers therefore looked forward to new progress in the Airbus SCE discussion and called upon industry to ensure that the new Airbus company is fully in place by the target date in 1999.

117. Not all sectors of the defence industry are amenable to European nationalisation. For example, in the field of aircraft engine production, European manufacturers have very firm strategic agreements with the main US manufacturers and the cost of undoing such alliances has so far stopped any progress with consolidation in the aircraft engine industry in Europe. So far there have not been the drivers for rationalisation of land-system suppliers which come from having common requirements between nations, and the current MRAV is the first truly collaborative land-system project in Europe. In many ways, the lower unit costs of vehicles compared with aircraft mean that it has been possible to recover the development costs from national orders alone, although this area is now ripe for change. We conclude that, in Europe, the need to restructure is most pressing in the aerospace and defence electronics sectors; it is in these sectors that the new American giants dominate. (a) Privatisation and mergers 118. In parallel to the efforts being made by governments to create the most propitious conditions for mergers among European defence companies, as reflected in the joint statements made by the ministers of the six major arms-producing nations on 6 and 9 July 1998, extremely important negotiations on the same topic are currently under way in the industries themselves. There is a broad consensus on the general objectives, such as grouping together companies from the civil and military aerospace sectors into an integrated European company, EADC, but a number of important questions remain to be settled: scope of activity: there is agreement on the eventual incorporation of fighter planes, but the question of integrating transport aircraft, satellites, ballistic missiles and maintenance is still under discussion; capital structure: the criticism from BAe and DASA is aimed essentially at the public ownership of Aerospatiale's capital; which path to take for the creation of the EADC: top-down mergers or successive groupings among the different lines of business?

119. Defence industries in different European countries have different levels of public ownership which, in some cases, may lead to different levels of productivity. At one end of the scale, those in Germany and the United Kingdom comprise mostly private enterprises. The UK Government has indeed recently increased the proportion of the shareholding in BAe and Rolls-Royce that may be foreign-owned, from 29.5% to 49.5%, with individual foreign owners now able to take up 15%. France, Italy and Spain have much in public ownership but have active privatisation initiatives. France has the biggest element of public ownership, and it is important that the privatisation programme should be quickly implemented, to enable the European transnational restructuring advocated by the six European ministers to take place. 120. The recent decisions taken by the French Government are a move in the right direction. To begin with, in May 1998, the Government decided to encourage a merger between Aerospatiale and Dassault Aviation to promote the implementation of a French aerospace industry strategy, with a view to the alliances that it would appear necessary to establish in the near future among the major European players, in order to create a strong, competitive entity. The second step was the Aerospatiale/Matra rapprochement which was made public last July. The aim is to create a private company "Aerospatiale/Matra Haute Technologie" which would be listed on the stock exchange, in which the State would own less than 48% of the shares. These regroupings among French companies very recently led to the creation of an Aerospatiale-Dassault-Matra Group under the name of "France-Aerospace". This should make it possible to conduct discussions among European firms, essentially BAe and DASA, with the aim of setting up the future European Aerospace and Defence Company (EADC). Furthermore, the creation in France of a major pole for professional electronics and defence activities around Thompson/CSF should pave the way for European mergers in this area.

121. A vast restructuring movement is under way in Europe. The Italian aerospace company Alenia Aerospazio and its Spanish counterpart CASA are undergoing privatisation through their European alliances. Indeed, GEC/Marconi and Alenia Difesa have announced an alliance between GKN/Westland and Agusta. The German industrial landscape has also undergone changes following the takeover by BAe and DASA of Siemen's defence activities and the acquisition by MBD of shares in LFK. A detailed list of consolidation operations that have taken place and alliances that are under way can be found in Appendix IV. (b) Dual-use technologies 122. Dual-use technologies are technologies with both civil and military applications. We note that it is crucial for the efficacy of modern armaments to draw on state-of-the-art technology. At the same time, the share of R&D in defence budgets is increasing all the time. It is therefore in the interests of states to pass on more of the costs for research to the civil sector and to benefit from its human and material resources, as well as from any investments which may already have paid back. 123. In France, the civil sector accounts for 80% of total R&D expenditure, and 80% of research scientists and engineers. The United States alone represents 70% of world military R&D expenditure, against 20 to 25% for China, France, Germany, Russia and the United Kingdom together, while it accounts for less than half of world civil R&D expenditure. It is therefore in Europe's interests to exploit technologies developed in the civil sector, particularly in an era of shrinking defence budgets. 124. Such a policy has become possible and worthwhile for two reasons: the growing synergy between civil and military technologies; the fact that the technological capacity of the civil sector is sufficiently well advanced to satisfy most of the technological requirements for defence equipment. 125. There are other advantages, in addition to lower research costs, to be gleaned from developing dual-use technologies:

the military sector can benefit from technological progress in the civil sector in certain fields such as information technology and telecommunications; longer production runs of equipment, which can then be adapted for civil or military purposes, lead to lower unit costs and economies of scale; the possibility for an industry sector to link up civil and military equipment sales makes for a more efficient export policy. 126. In fact, governments need only encourage firms to develop the practice they already apply of producing simultaneously for the civil and military sectors. This is a form of diversification which enables them to improve their return on investments. The table below shows the percentage of turnover achieved by a number of companies in 1997 in the defence sector[25]. BAe UK 71.4% Aerospatiale France 19.6% DASA Germany 32% CASA Spain 42% MitsubishiHeavy Industries, Japan. 10.5% 127. A major beneficiary of the development of dual-use technologies is the electronics sector, which already has a share of some 30 to 50% in the cost of sophisticated weapons such as missiles, fighter planes and helicopters, tanks or frigates, and this share is growing. Indeed, the electronics in a 1960s tank accounted for only 10% of the cost, compared with 50% in a modern Leclerc-type tank. 128. Studies are currently under way on creating a major European defence aerospace company on the basis of the current Airbus Group. This company could then make the most of its dual-use technologies, while strengthening its position on the export market. (c) Armament markets 129. A number of nations operate policies, designed to protect their national defence industries, which do not allow overseas suppliers access to their markets for certain classes of equipment. Placing defence equipment contracts, unlike those for other goods, is exempt from the EU's open market regulations, and between 1988 and 1992, intra-European defence trade amounted to only 3-4% of total defence procurement expenditure in the Community26. One could be concerned that a proposal to reform Article 223 of the Treaty of Rome was discussed at the 1991 Intergovernmental Conference leading up to the Maastricht Treaty but was rejected. If firms are able to merge and restructure in response to the December 1997 trilateral statement (currently backed by six governments), with as a result fewer and less significant 'national champions', the stage would in any case be set for a more open market. There are, nevertheless, remaining inequities that would have to be resolved before a truly open European market for defence products were possible. Reform of Article 223 would still provide a useful means of opening up the defence market in Europe, thereby providing an environment more conducive to industry restructuring.

130. Offsets involve equipment vendors providing compensation to foreign purchasers for a perceived opportunity cost to the economy of the purchasing nation, and may take the form, for example, of providing subcontract work in the purchasing nation or allowing them to assemble the equipment locally under licence. The goal remains to promote a genuinely open defence equipment market in Europe, given offsets' continued use internationally. European MoD's policy is to seek offsets in a pragmatic way which seeks to minimise their impact on value for money, while ensuring that their industry is not unfairly penalised. The value of offsets can sometimes exceed the purchase price of the equipment itself if, for example, local subcontract or assembly work is for production runs to satisfy wider international markets as well as the country receiving offset. A recent US Commerce Department report noted that the United States made US$ 5.2 billion worth of offset agreements with European countries in 1995, and that 21 of the 25 agreements involved offsets worth more than the value of the equipment supply contracts themselves27. 131. Defence exports allow manufacturers to offer lower unit prices made possible from longer production runs. They also bring influence (and responsibilities) for European countries in those parts of the world which they export to. They create wealth, with a favourable balance of payments. Clearly, if more defence equipment is in the future to be provided by transnational European enterprises, and assembled from components from more than one country, it will be important that export policies of the countries involved should be sufficiently similar. It would not be acceptable, for example, for one country to prohibit exports outside Europe against the wishes of the other partner nations. Similarly, it would be unacceptable if potential exports by a country, blocked because of an ethical exports policy, were instead picked up by other European exporters. The German and French governments have had a long-standing and reportedly successful protocol for clearing exports of equipment manufactured, in part, in the other country. The EU common Code of Conduct for defence exports adopted by governments in May 1998 contains similar provisions, which we welcome, although we recognise some of the limitations on its enforceability.

APPENDIX I List of acronyms BAe: British Aerospace CEEC: Central and eastern European countries COARM: Group for cooperation in the field of armaments and the harmonisation of European export policies COREPER: EU Permanent Representatives' Committee DASA: Daimler-Benz Aerospace SA DITB: Defence Industrial and Technological Base EAA: European Armaments Agency EADC: European Aerospace and Defence Company EDIG: European Defence Industries Group EEIC: European Economic Interest Grouping EUCLID: European Cooperation for the Long Term in Defence EUREKA: Research programme within the framework of the EU FLA: Future Large Aircraft FSAF: Future Surface-to-Air Family IEPG: Independent European Programme Group MIC: Military Industrial Complex MOU: Memorandum of Understanding NADs: National Armaments Directors OCCAR: Organisation for Joint Armament Cooperation PAAMS: Principal Anti-Air Missile System POLARM: EU ad hoc Group on European Armaments Policy R&D: Research and Development SOCRATE: System Of Cooperation for Research And Technology in Europe THALES: Technology Arrangement for Laboratories for Defence European Science WEAG: Western European Armaments Group WEAO: Western European Armaments Organisation APPENDIX II Organisations involved in armaments Western European Union (WEU) WEAG: Western European Armaments Group Succeeded the IEPG in 1992. Within it are: the Staff Group composed of representatives of the National Armaments Directors (NADs); the Eurolongterm group composed of military staff and subdivided into four branches: Air Force, Navy, Army and Signalling. WEAG's role is to: promote the development and definition of common defence equipment requirements; encourage the opening-up of national defence markets to competitors; promote a rational use of financial and technological resources; strengthen R&D cooperation and the DITB.

WEAO: Western European Armaments Organisation Subsidiary body of WEU created in 1996. It provides a framework for the pratical cooperation programmes decided by member states. It is subject to international law and has its own legal personality. It currently manages joint research activities (The Euclid programme). OCCAR: Organisation for Joint Armament Cooperation On 9 September 1998, Germany, France, Italy and the United Kingdom signed a Convention making OCCAR an international organisation with its own legal personality. In the future it will manage cooperation programmes among its member countries. Third countries may participate in its programmes, providing that they respect its management rules. EAA: European Armaments Agency This project was drawn up within WEAG at the initiative of the NADs and of WEAG Ministers, with a view to setting up the EAA by the end of the year 2001. The EAA is to become a European body for cooperation in the field of defence equipment. It would work in increasingly close cooperation with OCCAR and bring together WEAO and WEAG. The latter could become the EAA steering body. European Union POLARM: EU ad hoc Group on armaments policy. It was set up at the initiative of COREPER in 1996 and consists of experts from the defence and foreign affairs ministries of member countries. Its task is examine and define potential EU activities, within its scope of competence, in the field of European armaments policy. COARM: Group for cooperation in the field of armaments and the harmonisation of European export policies. Set up by the EU Council in 1991, this Group consists of representatives of the foreign affairs ministries of member states. Its work so far has focused essentially on harmonising member states' armaments export policies vis-à-vis third countries. EDIG: European Defence Industries Group This private-law association is based in Brussels and brings together the national defence industry associations of WEAG member countries. It plays the part of technical expert and adviser to the different European institutions.

Notes 1 Adopted unanimously by the Committee. 2 Members of the Committee: Mr De Decker (Chairman); MM Schloten, Marten (Vice-Chairmen); MM Alloncle, Baumel, Beaufays, Mrs Beer, Mr Blaauw, Mrs Calleja, MM Cioni, Cox (Alternate: Lord Judd), MM Davis, Díaz de Mera (Alternate: López Henares), MM Horn, Dhaille, Leers, Lemoine, Mrs Lentz-Cornette, MM Magginas, Mardones Sevilla, McNamara, Medeiros Ferreira, Micheloyiannis, Mitterrand, Mota Amaral, Lord Newall (Alternate: Townend), MM Pereira Coelho, Polenta, Robles Fraga (Alternate: Puche Rodríguez), Lord Russell-Johnston, MM Selva, Speroni, Valk, Valkeniers, Verivakis, Zierer, N... Associate members: MM Godal, Kiratlioglu, Sungur, Yürür. N.B. The names of those taking part in the vote are printed in italics. * France, Germany, Italy, Spain, Sweden and the United Kingdom. 1. The 10 WEU full members plus Turkey, Norway and Denmark. 2. The IEPG was set up in 1976 in Rome, with the task of making more efficient use of budgets in the fields of research, development and procurement, to increase standardisation and interoperability of equipment, facilitate cooperation and maintain a solid European defence industrial and technological base. 3. "If it is decided that an observer or an associate partner shall participate in a specific armaments project, the nation concerned shall take part in that project on the same basis as full members, including the contribution of an appropriate financial share". The Council also agreed "the modalities for the participation of interested WEU observers, which are not members of WEAG, in all WEAG meetings". (Erfurt Declaration, Ch.VI) 4. WEAO Charter, Section III. 5. WEAO Charter, Annex III. 6. WEAO Charter, Section II. 7. ibid 8. Air et Cosmos "L'Europe de l'Armament" (Armaments Europe), 29 August 1998. 9. WEAO Charter, Section IV. 10. Austria, Finland, Ireland and Sweden. 11. Belgium, Denmark, France, Germany, Greece, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Turkey and the United Kingdom. 12. WEU C (98)165. 13. Document SN 4742/96 Rev.1, DG E, General Secretariat of the Council. 14. ibid 15. Extract from the press communiqué of the General Affairs Council, 25 May 1998. 16. Extract (in translation) from a French Ministry of Defence publication of 6 July 1998 concerning the signature by the British, French, German, Italian, Spanish and Swedish Defence Ministers of a letter of intent on providing a framework for developing measures to assist industrial restructuring in the defence sector. 17. For example on the basis of international institutes such as the Saint Louis Institute, a Franco-German research body. 18. Challenges facing defence-related industries, report of 26 February 1997 by the European Parliament Committee for Foreign Affairs, Security and Defence Policy. 19. Keith Hayward, Towards a European weapons procurement process, Chaillot Paper, June 1997, page 23.

20. Investing in Russian defence conversion: obstacles and opportunities. 21. SIPRI 1998. 22. Ibid. 23. Trilateral Statement, 9 December 1997 (MoD Press Notice 208/97) 24. A sixth field on harmonising military requirements was added to the five "key areas" defined in April 1998. 25. International table of companies working for the defence sector. DGA (Direction Générale des Armements, the French military procurement agency). Source: Titley Report, September 1998. 26 EU Commission Communication COM Defense Trade 1997. 27 US Department of Commerce Report Offsets in Appendix.