European Defense: A Vital Industry at Risk 

The Ukrainian tragedy is forcing Europe to speed up the resolution of this inconsistency. It goes without saying that the defense industry must fully comply with standards related to governance, the fight against corruption, the energy transition and gender equality. At the same time, however, it is vital to ensure that it is not sidelined from market financing, due to a poorly controlled regulatory agenda or pressures from certain parts of civil society. There can be no sustainable development without security, which remains the primary condition for freedom.

In this series of three articles, Institut Montaigne will revisit the importance of Europe’s defense industry, and the risks it might face from the sustainable finance agenda. We will also formulate proposals to ensure that, faced with the need to strengthen its defense, Europe maintains an industrial base that guarantees its strategic autonomy.

A crucial industry with unique features

The defense industry has specific dimensions that are important to address. It is firmly embedded in the sphere of sovereignty, which means that the state plays a crucial role in the development of projects, export orders and authorizations, and sometimes even in company capital. As such, it depends directly on political will. This reality extends to the industry’s financing, either in the form of shareholders - as is demonstrated by the provisions on investment control - or in the (largely sovereign) form of taking risks.

In defense, business life cycles are long, ranging anywhere from 10 to 25 years, which implies two strong constraints. On the one hand, there is the "non-obsolescence" requirement, which reinforces the second requirement, of design performance: because the equipment must last, it is imperative that it uses technologies that are both innovative and robust. In other words, the defense industry must be at the forefront of innovation.

At the same time, these long lifecycles and the importance of innovation contribute to the sector’s financing constraints. Industry players must be able to rely on sufficient equity capital, debt maturities that are consistent with the length of the development cycle and, for subcontractors in particular, financing that understands the nature of the programs and the ordering institutions.

The European defense industry is a key economic pillar, representing annual revenues of €100 billion and around 1.4 million direct and indirect jobs. Beyond these numbers, many of Europe’s flagship industrial companies have developed dual activities - both civilian and military - with obvious synergies between the two, particularly in research and development. France holds a leading position, with €15 billion in revenues for an industrial and technological base that counts ten major corporate groups, over 4,000 companies, and more than 200,000 highly technical jobs. Defense is a vehicle for France’s strategic autonomy, especially because it provides and deploys nuclear deterrence.

Paradoxically, the financing of the European defense industry has encountered increasing obstacles over the last few years, even as the continent faces growing threats to its security. The progressive tightening of funds can take many forms: shrinking liquidity; the delisting of public companies; diminishing access to equity and debt finance; complications and growing costs in export financing; refusals by historical banking partners to contribute to the cession of family businesses.

The gradual closure of the defense industry’s financing tap affects both large firms and SMEs, companies working solely for defense markets and those with dual activities. This phenomenon can be witnessed across Europe, including the United Kingdom. It involves all financial players, from banks to markets and investment funds.

There is a risk that this trend is getting out of hand, as Europe strives to make sustainable finance the new norm - without having clearly defined what this entails. At a time when everything must become "sustainable", and when the fight against greenwashing mandates regulatory control, the defense industry risks becoming a collateral victim of the sustainable finance agenda. More precisely, if institutions view all financed activities through the lens of sustainable development objectives and prefer a simplistic reading of SDG 16 (promoting peaceful and inclusive societies) over ancient wisdom (si vis pacem, para bellum), defense activities would be excluded on principle. In parallel, the draft directives on corporate sustainability due diligence, which would require companies to report on customers’ use of products, could prove incompatible with the sale of military equipment. It is worth recalling that the latter is already subject to specific controls - notably a general prohibition regime that demands prior authorization by states.

Because it remains a poorly understood and specialist domain, the field of defense is struggling to navigate national and European public debates - that is, until the day circumstances compel us to hold a wider debate on these issues. . For the same reasons, the industrial aspect of defense issues remains peripheral to our economic and regulatory reflections. This is a dangerous periphery which, if we are not careful, may lead to the defense industry’s eviction from market financing, due to inadequate regulation that would amplify the legal and reputational risks faced by financial actors. This breakdown would have major consequences. First, it would trigger a spiral of devaluation for companies in the sector. Second, it would jeopardize the development of major projects and innovations that cannot rely on public funds alone. Third, it would ruin the ability of the defense industry to attract the talent and intellect that it cannot survive without. Finally, it would heavily impact the competitiveness of European companies in comparison to their foreign counterparts. In a world where force is visibly wielded, it would condemn Europe to remaining an actor that is unable to guarantee its own security and control its own destiny.

Copyright: INDRANIL MUKHERJEE / AFP