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Financing Defense: A Testing Ground for Greater European Sovereignty

Analyses - 20 April 2022

The past decade has witnessed a significant evolution of the European security environment. The emergence of new challenges represent opportunities to revive the Union’s strategic autonomy. In this three-part series, Financing Defense in the 21st Century, Nicolas Baverez examines the importance of the defense industry for Europe, and proposes solutions for the continent to maintain a resilient defense industry.

Europe is at a turning point. Russia’s invasion of Ukraine has served as a brutal reminder of the reality of great power politics. Europe must now step up and take charge of its own defense. The importance of finance cannot be understated, as has been attested by the financial crisis, the euro crisis and Brexit, as well as the need for massive investment in digital technology, health, education and the ecological transition. Furthermore, hot on the heels of the Covid-19 crisis, Russia’s aggression has confronted Europe with its strategic dependence and the crucial need to bolster its sovereignty, be it in energy, strategic metals, food or arms.

Over the next decade, the European Union will have to reinvest massively in its security environment.

Over the next decade, the European Union will have to reinvest massively in its security environment, well beyond 2% of GDP. European rearmament is inseparable from the reinforcement of its industrial and technological defense base, the financing of which must be secured as soon as possible. As such, an unequivocal choice must be made to increase strategic autonomy.

It is irresponsible to follow an idealized or naive regulatory agenda that claims to set the standard for morally irreproachable finance but is essentially detached from geopolitical concerns and the defense of democracy. Such an approach must be abandoned in favor of one that integrates the defense industry in the transition to sustainable finance.

Faced with the geopolitical challenges of the 21st century and the threats posed to democracies by new authoritarian empires, it would be a cardinal error to institutionalize a dissociation between the defense industry and sustainable finance. More specifically, it would be:

  • An ecological mistake. Defense is an essential component of the surveillance and conservation of protected areas, as has been illustrated by the deployment of the French armed forces for environmental protection in French Guiana, or for the protection of territorial waters, notably in France’s exclusive economic zone. Furthermore, environmental issues are already a source of tension that could lead to confrontations or even conflicts (think of water use, access to critical resources for the transition to a low-carbon economy, and the impacts of natural disasters on communities).
  • An economic mistake. Defense is a key industrial sector, representing 4,000 companies, 200,000 high-skilled jobs and a turnover to the tune of €15 billion in France. If funding for the defense industry dries up, one of France’s few fields of excellence would be destabilized. Moreover, innovation would be interrupted, which could have significant consequences for military research and technologies that are widely used for civilian applications. Finally, financing difficulties at the top half of the balance sheet would lead to the loss of strategic assets and technologies to European competitors - and even to adversaries.
  • A financial mistake. The loss of market financing would place the entire burden on the shoulders of the state, which is already over-indebted (public debt has increased from 20 to 118% of GDP since 1980) and faced with increasing demands for public investment, in sectors ranging from the climate, health and education to the police and the justice system.
  • A political and strategic mistake. A greatly weakened defense industry would increase our dependence on US military technology and equipment, at a time when America’s democracy is going through an existential crisis and its ability to provide strategic reassurance on the world stage is not what it used to be. Above all, Europe would signal that it is on the path to disarmament, while democracies are being challenged by authoritarian regimes and Russia is engaged in a war of conquest unlike any we have seen since 1945. It would constitute nothing less than an admission of weakness equivalent to the Munich Agreement.
  • A moral mistake. The European Union is a peace and development project, but it also represents freedom and resistance to totalitarian or authoritarian regimes. Europe’s founding fathers were fully aware that there can be no peace without freedom, and no freedom without the capacity to defend it. Europe has always been about more than territory. Monnet, Schuman, Adenauer, De Gasperi all envisioned and built Europe on democratic values, in the name of which they fought against the totalitarianisms of the 20th century. The pacifist posture that democracies are being told to adopt in the face of 21st century authoritarian regimes constitutes a moral error of judgment, just as it did in the face of Hitler’s Germany in the 1930s, and Stalin’s USSR in the 1950s.

To avoid this fivefold error, it is urgent to rethink the relationship between the defense industry, sustainable development, and the European regulatory agenda. Change is needed at three levels.

At the political level, the review of the Union’s Strategic Compass at the European Council of 24-25 March provided the opportunity for a firm commitment to the defense industry and its access to market financing.

At the legislative level, the only limitations placed on the defense industry should come from the international treaties and conventions to which the EU Member States are party. In other words, only arms prohibited by international treaties and conventions that have been signed and ratified by all Member States, as well as exports to countries that are subject to EU sanctions, should be excluded. Furthermore, in the defense industry, ESG standards should be applied under common law rules.

It is urgent to rethink the relationship between the defense industry, sustainable development, and the European regulatory agenda.

The draft directive on corporate sustainability due diligence, on the other hand, should be adapted to limit defense companies’ obligations to upstream activities - i.e. the supply chain and subcontractors - and to exclude downstream activities, which relate to the end use of equipment. This modification would provide useful clarity for financial actors, as the scope of due diligence obligations would be both strict and precise.

At the financial level, support for the defense industry calls for specific tools to complement market financing, which should be free from dangerous and unnecessary regulatory constraints. More concretely:

  • While there are European markets and programs focused on defense specifically, research and innovation remain poorly supported, especially in key areas such as hyper-velocity technology, robotization and artificial intelligence. European states should also ensure that they improve the planning, execution, cost control and timely funding of armament programs. Efficient control of these programs and prompt payment of orders are important factors in financing the defense industrial base.
  • Research and development efforts require equity capital that is not always immediately available to companies. Targeted public instruments could be created, for example through public investment banks such as Bpifrance or in the form of specialized public funds. Such instruments must find the right balance between strategic corporate interests and a professional, demanding framework for defense companies’ financing.
  • Finally, special mechanisms should be devised to enable public authorities to take over from the market when the latter fails. When it comes to exports, for instance, we could imagine a resort to government-to-government contracts, the provision of public guarantees or the granting of export credit insurance, which would render it possible to secure financing by banking institutions.

In short, the defense industry is destined to become the testing ground for bolstered European sovereignty, as well as a new partnership between public authorities, companies and the financial system.




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