Fragmentation and national protectionism

Europe's defence industry continues to suffer from fragmentation on both the demand and supply sides. On the demand side, the 2022 Coordinated Annual Review on Defence (CARD) by the European Defence Agency (EDA) highlights that only 18 % of investments in defence programmes are conducted collaboratively. The 2024 CARD report underscores that EU Member States' joint investment in collaborative defence R&D remains modest. Collaborative defence procurement also remains limited (see below). As the CARD report underlines, 'cooperation remains the exception rather than the norm', and is typically pursued only when it aligns with national plans, benefits domestic defence industries, or reinforces existing strategic partnerships.

Defence companies are largely structured around national priorities, with demand primarily generated by national governments and directed towards their respective national industries. These industries often maintain close links with their governments, which leads to a proliferation of nationally embedded firms operating within relatively small markets. This arrangement results in insufficient production capacity, which is increasingly inadequate in light of current geopolitical challenges. The lack of collaborative investment in defence has tangible financial implications. According to an EPRS study, enhanced cooperation could generate annual savings of between €18 billion and €57 billion. Beyond economic inefficiency, fragmentation also weakens the EU's interoperability. The EDA has repeatedly pointed out that fragmentation impairs Member States' capacity to carry out joint operations – one of the central objectives of the Strategic Compass and of the common security and defence policy.

On the supply side, the EDTIB remains similarly fragmented, particularly beyond the aeronautics and missile sectors. The European Commission has stressed that this structure significantly limits the industry's ability to strengthen its competitiveness, notably by undermining the pooling of research and development efforts and by restricting the benefits of economies of scale in production. This fragmentation generates costly duplication, complicates logistics, obstructs transnational maintenance cooperation, and hampers interoperability. Thus, defence markets remain heavily nationalised, with Member States frequently favouring domestic suppliers to preserve their strategic autonomy, support national industrial capabilities, and safeguard employment.

Trust deficits and strategic culture differences

Efforts to establish a genuine common market for defence are hindered by trust deficits and a lack of convergence in strategic cultures – defined by then EU High Representative for Foreign Affairs and Security Policy, Josep Borrell, as 'a common way of looking at the world, of defining threats and challenges as the basis for addressing them together'. These differences manifest themselves in day-to-day political decisions, divergent prioritisation of threats, and varying degrees of strategic ambition. While some Member States maintain a traditionally Atlanticist orientation with a strong reliance on NATO, others advocate a more autonomous European defence posture. This lack of alignment often results in a fragmented approach to capability planning, procurement, and threat assessment. The 2003 European security strategy already set out the ambition of fostering a common European strategic culture, yet such a culture remains elusive according to experts.

Infighting over leadership roles in multinational capability development programmes is emblematic of these deeper divides. Disputes frequently arise over which state or consortium leads a given initiative, with national champions often prioritised at the expense of pan-European industrial logic. These tensions are intensified by competition over intellectual property rights (IPR), especially in high-tech and dual-use sectors. The reluctance to share sensitive technologies or manufacturing expertise, even within ostensibly cooperative frameworks, undermines trust and limits the scalability of collaborative projects. For instance, at the Paris Air Show in June 2025 Airbus and France's Dassault Aviation openly clashed over governance, workshare distribution and intellectual property control in the Future Combat Air System (FCAS) next‑generation fighter programme, threatening delays unless the dispute is resolved politically. According to Politico , Germany's growing frustration with France over the FCAS has led Berlin to consider alternatives, including cooperation with Saab in Sweden or BAE Systems in the UK, unless a compromise is reached by the end of the year. While France insists it remains committed to FCAS, political uncertainty in Paris and the industrial deadlock between Dassault, Airbus and Indra have increased pressure on Berlin to prepare fallback options.

Divergent regulatory and certification frameworks

Different national standards, export controls, and certification processes constitute another major impediment, increasing compliance costs for industry and limiting cross-border cooperation. Defence procurement legislation is a highly fragmented area, with defence procurement contracts subject to a vast array of different national procurement regimes in EU Member States. These different regimes have discouraged cross-border competition and, as a result, experts find that there has never been a 'genuine pan-European defence procurement market, but rather ... [27 markets] fenced off with regulatory barriers to entry aimed at protecting national defence industries'. Indeed, Article 346 of the Treaty on the Functioning of the European Union (TFEU), which allows EU Member States to derogate from EU rules and adopt extraordinary measures in the trade and production of munitions, arms and war material, has been seen by many Member States as giving them carte blanche to circumvent EU procurement rules.

The fragmentation of the European defence market, coupled with divergent national approaches, has created persistent challenges for the defence industry as a whole. Varying national licensing regimes have introduced complex and burdensome administrative requirements, which in turn have undermined the reliability of supply chains within the EU.

The 2009 Transfer Directive seeks to ease intra-EU transfers of defence equipment by streamlining licensing while preserving Member States' control over national security. It introduced a modified licensing framework that distinguished between general, global and individual licences while streamlining their application. It encourages EU Member States to substitute individual licences with general licences wherever feasible, in order to facilitate smoother transfers within the Union. General licences refer to standardised authorisations granted by national authorities that allow defence companies to transfer specific categories of military equipment or components within the EU without having to apply for an individual licence for each transfer. Although individual licences are still possible, they are meant to be limited.

In 2009, the Directive on defence and sensitive security procurement, which sets out European rules for the procurement of munitions, arms and war material, entered into force. As a 2016 Commission evaluation report notes, most procurement contracts, especially for 'high-value, strategic, complex defence systems', are still awarded without an EU-wide tender; Member States continue to invoke Article 346 TFEU to circumvent procurement rules. The evaluation notes that, while 'the overall text of the Directive is fit for purpose...there is a strong need to focus on its effective implementation, in order to improve its effectiveness and in turn, its efficiency'. This finding is also backed up by an EPRS study. The 2016 evaluation of the Transfer Directive found that, while the Directive simplified procedures for transferring defence products within the EU, its impact was limited by divergent national practices and low uptake of general licences. Certification of defence firms was under-used, and the internal market remained fragmented.

Legislation on export controls is equally fragmented, with each EU Member State being responsible for its own arms export controls. However, all European arms exports are governed by a combination of legal instruments, namely the EU Common Position adopted by the Council, the Arms Trade Treaty, which all EU Member States are party to, and arms embargoes imposed either by the EU or the UN. The EU Common Position requires Member States to assess export licences against eight shared criteria, including considerations such as respect for human rights and the preservation of regional peace and stability. While these criteria provide a common foundation, implementation is decentralised: each Member State retains discretion over licensing procedures and how it interprets the Common Position. The Common Position was amended in 2025 to strengthen controls and accountability over international arms trade.

Additionally, Regulation (EU) 2021/821 establishes a comprehensive EU-wide regime governing the export, brokering, technical assistance, transit and transfer of dual‑use items – which are goods, software or technology that can serve both civilian and military purposes – drawing on internationally agreed control lists (such as the Wassenaar Arrangement) and imposing authorisation requirements (general, global, individual, and for large-scale projects), with stringent provisions on end-use, record‑keeping, and coordination among Member States' authorities.

Although these frameworks provide a degree of convergence, the absence of a harmonised EU export control system continues to generate obstacles for the functioning of a defence single market. Defence production today relies heavily on integrated cross-border supply chains, with components sourced from multiple Member States. If one Member State denies an export licence for a component manufactured on its territory, this can block the export of an entire system assembled in another Member State, creating uncertainty for industry and undermining the predictability of supply chains. The European Commission has recognised this problem, which was one of the drivers behind Directive 2009/43/EC on the intra-EU transfer of defence-related products (see above). However, as noted above, implementation of the directive is lacking.

Lack of demand aggregation and joint planning

In a highly specific market where national governments are the sole customers, EU Member States continue to fall short in coordinating, pooling and aligning their defence planning and procurement, despite the availability of various European mechanisms designed to facilitate such collaboration. As a result, demand remains largely fragmented along national lines, with investment decisions predominantly shaped by domestic agendas and national planning cycles, often at the expense of broader strategic coherence or cost-efficiency.

EDA data from 2020 show that Member States spent only €7.9 billion on collaborative equipment procurement, which is 18 % of total defence equipment procurement – far below the 35 % benchmark agreed within the EDA framework in 2007 and the related Permanent Structured Cooperation (PESCO) commitment. More up-to-date data are unavailable due to persistent gaps in data sharing by Member States. The 2024 CARD report notes that the pressing need to address capability shortfalls rapidly has prompted a rise in national off-the-shelf acquisitions, which, while expedient, have contributed to a temporary decline in collaborative procurement efforts. These are often viewed as more complex and time-intensive. To counter this trend, the European Defence Industry Reinforcement through Common Procurement Act (EDIRPA) was introduced to encourage joint procurement among Member States, yet collaborative procurement remains far below the EU goal – as enshrined in the European defence industrial strategy (EDIS) – that, by 2030, Member States should procure 40 % of defence equipment in a collaborative manner.

In terms of planning, rather than having one integrated tool for defence planning, the EU has established several overlapping processes. Since 2008, the EDA has used capability development plans (CDPs) to identify future capability needs and recommend how European forces can meet them. The latest CDP review in 2023 outlined 14 priorities across five military domains (land, air, maritime, space, cyber) and eight priorities under strategic enablers and force multipliers. The EU also launched PESCO in 2017, which introduced 20 legally binding commitments and initiated 83 collaborative projects, 75 of which are still ongoing. The CARD by the EDA provides an EU-level overview of defence landscapes and identifies collaborative opportunities.

Further initiatives include the European Defence Fund (EDF), launched in 2017 with an €8 billion budget for 2021-2027, which incentivises joint defence research, innovation, and capability development. The 2022 Strategic Compass called for further adaptation of EU defence planning and annual defence ministerial meetings on EU initiatives. Most recently, the Defence Industrial Readiness Board, being set up under the European defence industry programme (EDIP), aims to coordinate procurement plans, align industrial capacities with strategic priorities, and set common production objectives, particularly for critical capabilities.

However, EU defence planning remains difficult and fragmented. Experts note that 'defence planning remains stuck at the national, rather than at the European or even Atlantic level', primarily due to a lack of political will. This is particularly problematic as coordinated action on strategic enablers – often too expensive for smaller Member States alone – is essential to reduce reliance on US assistance, whose future support and its size cannot be taken for granted.

Insufficient budgetary incentives

Despite significant steps taken by the European Commission since Russia's 2022 invasion of Ukraine to incentivise joint procurement, budgetary support and financial incentives remain insufficient to fully address Member States' reluctance to collaborate. EDIRPA allocated €300 million to incentivise Member States to jointly procure urgent and critical defence capabilities. The forthcoming EDIP, still under negotiation, is set to provide €1.5  billion for 2025-2027 to enhance the competitiveness and resilience of the European defence industry and support joint procurement.

To address this gap, in March 2025, Commission President Ursula von der Leyen unveiled the ReArm Europe Plan/Readiness 2030, a strategic proposal aimed at enabling up to €800  billion in defence investment and firmly anchoring Europe's shift towards joint responsibility for its own security. The plan reflects Europe's entry into an 'era of rearmament' and focuses on speeding up and scaling up collective defence spending through coordinated financial mechanisms.

The plan is structured around five key pillars, each designed to strengthen Europe-wide collaboration in defence spending and procurement:

Together, these pillars aim to make joint procurement financially attractive and viable, enhance strategic coordination, and foster a more integrated European defence market – encouraging Member States to align spending plans and invest collectively rather than individually.

Public procurement in the defence industry

To make aggregated procurement effective, contracting models must also be chosen carefully. Defence contracts largely fall into three categories, each with distinct advantages and drawbacks:

- cost-plus contracts reimburse all actual costs plus a profit margin,

- fixed-price contracts specify a lump sum and shift cost risk to the contractor,

- target-cost contracts strike a balance by sharing risks and rewards between government and contractor.

All three approaches are prone to inefficiencies due to information asymmetries, moral hazard, and strategic behaviour during contract negotiation and execution.

The persistence of fragmentation and national prerogatives in European defence markets cannot be understood solely through the lens of legal derogations or institutional inertia. Instead, it reflects a more fundamental structural reality: defence is not a conventional economic sector, but one shaped by the state's unique triple role as owner, regulator, and primary customer. As a public good, defence is provided by states, and coordinated – rather than centralised – at EU or NATO level. The defence industry is unique because it produces sensitive products (such as armaments, strategic enablers, and dual-use goods) subject to national export controls, which the Council is aiming to harmonise. Due to the strategic nature of defence products, procurement contracts are often subject to tailored procedures that may not adhere strictly to the standard principles of open competition applied in other sectors. As a result, the market exhibits both monopsonistic (on the demand side) and oligopolistic (on the supply side) characteristics.

This mutually constrained relationship between seller and buyer is what Wang & Miguel (2013) call a 'sole-buyer-and-sole-seller case', where the government's limited supplier base reduces its bargaining power, while contractors are similarly constrained by their reliance on government contracts. If a defence company refuses to accept a fixed-price contract, the government may face significant challenges in identifying a suitable replacement. This limited supplier base can constrain the government's bargaining power. At the same time, defence contractors are also constrained, because their primary/only customer is the government. This means they are highly dependent on (domestic) government contracts for survival. If they refuse to accept certain contractual conditions, they risk losing future procurement opportunities.

Public procurement typically relies on fixed-price or cost-plus contracts, each influencing project costs and taxpayer burden, potential for innovation, and profitability. On the one hand, fixed-price contracts set the terms of a project, outline the seller's obligations exactly, and establish the final price of goods or services. Any exceeding costs are the responsibility of the seller. On the other hand, under cost-plus contracts, the buyer reimburses the seller for all the actual costs incurred, plus an additional amount for managing the project. The profit usually equals a percentage of the contract's full price. To maintain oversight, the seller is generally required to share detailed cost and pricing data with their customer.

Given the considerable uncertainty in the defence investment landscape, cost-plus contracts are more desirable from the seller's (industry) perspective, as they guarantee profitability through a fixed fee or percentage revenue above project costs. This is particularly important. To mobilise private capital effectively under such risk, governments can offset part of the burden through cost-plus contracts, mark-ups in fixed-price contracts (acting as a risk premium), or by taking on the role of major shareholder. As a result, cost-plus contracts may also support innovation and the development of cutting-edge technologies that would otherwise be too risky to finance. However, the customer (government) may prefer fixed-price contracts, as these ensure predictability of expenses and incentivise the seller to rigorously control costs, impeding artificial cost inflation and windfall profits. They can be particularly effective at facilitating fair pricing when buying commercial off-the-shelf products where costs per unit tend to be comparatively low and/or well known, but may be less applicable for developing innovative and complex systems because of the unpredictability involved in the process. Wang & Miguel propose a budget-based cost-plus scheme that aligns government and industry incentives by ensuring transparent cost disclosure, curbing opportunistic behaviour, and fostering both fairness and innovation through balanced risk-sharing.

Furthermore, industrial policy can encourage investment in the defence sector. At the moment, the European defence industry is fragmented and supply-constrained. Governments face limited defence industrial production capacity due to decades of under-investment, whereas the perceived threat level has dramatically increased since the start of the Russian war on Ukraine, pushing European countries (as member states of the EU and NATO) to urgently rearm to ensure sufficient defence-readiness and deterrence. This seasonal demand contingent on external threat runs contrary to the long-term and aggregated demand signals required by defence companies to scale up and maintain high production capacity. It also conflicts with the long timelines needed to develop cutting-edge military technologies and implement large-scale projects, such as sixth generation fighter jets, or space capabilities.