Under-investment

The 21 (now 23 including new members Finland and Sweden) EU Member States that are also NATO members of the North Atlantic Treaty Organization have long been guided by NATO's norm of spending 2 % of gross domestic product (GDP) on defence, formalised at the Wales Summit in 2014. Member States participating in permanent structured cooperation (PESCO – all Member States except Malta) have also committed to 'regularly increase defence budgets in real terms' under their PESCO commitments. Introduced in 2017, the PESCO legal framework allows the 26 participating Member States to coordinate investment, build defence capabilities together, and improve the operational readiness, interoperability, and resilience of their armed forces.

Despite these commitments, defence budgets have faced severe under-investment in the majority of Member States over the last decade. The European Commission finds that, if all Member States had spent 2 % of their GDP on defence from 2006 until 2020, this would have resulted in an additional €1.1 trillion for defence. A significant part of the comparatively weak recent EU defence budgets was not invested in the EDTIB, even when an EU product was available. However, no domestic alternative is available for some defence products (e.g. long-range artillery rockets and tactical ballistic missiles) and it is estimated that between 2007 and 2016, over 60 % of European defence procurement budgets was spent on military imports from third countries. This creates additional third-country dependencies. This situation worsened following the 2022 Russian invasion of Ukraine, with 78 % of EU Member State acquisitions of defence equipment between February 2022 and June 2023 imported, 63 % from the USA alone.

Fragmentation

Europe's defence industry suffers from fragmented demand and fragmented supply. In terms of demand, the 2022 Coordinated Annual Review on Defence (CARD) report observes that only 18 % of investment in defence programmes is collaborative. Collaborative defence procurement also stands at only 18 % of total defence procurement. The 2022 CARD report notes that 'cooperation remains the exception rather than the norm', highlighting that a collaborative approach is mainly used when it coincides with national plans, would benefit national defence industries, or consolidates a strategic partnership.

Defence companies are mostly structured to suit national priorities with demand mainly expressed by national governments from their national industries, which profit from close relationships with their respective governments. This has led to a high number of national defence companies, operating in small markets, with insufficient production levels to cope in the current geopolitical environment. This is exacerbated by the fact that 'defence planning remains stuck at the national rather than at the European, or even Atlantic, level,' as acknowledged in the Strategic Compass, which notes that EU defence initiatives must become integrated in national defence planning for them to be effective. The lack of collaborative defence investment has financial consequences – an EPRS study estimated that more cooperation could save between €24.5 billion and €75.5 billion a year. It also limits the EU's ability to act: the European Defence Agency (EDA) finds that fragmentation has negative consequences for Member States' ability to conduct joint operations, an explicit aim of the Strategic Compass and of the CSDP.

On the supply side, the industry is also structured nationally, with permanent fragmentation in the EDTIB, especially outside the aeronautics and missile sector. According to the Commission, this 'greatly reduces its ability to improve its competitiveness through pooling of R&D and economies of scale in production'.

This fragmentation leads to costly duplication, renders logistics and transnational cooperation on maintenance more difficult and hampers interoperability. A case in point is that, for the most costly European defence project – rather than cooperating on just one programme for the development of a sixth generation fighter jet, estimated at over €100 billion – two programmes are in parallel development. The first is the so-called Future Combat Air System (FCAS) involving Germany, France and Spain. Rather than participating in this programme, Italy launched a separate fighter jet development programme with the United Kingdom (confusingly also referred to as FCAS), which Japan later joined to form the so-called Global Combat Air Programme. Often intense infighting over who leads major parts of major multinational capability development programmes and over intellectual property rights exacerbates the situation.

Critical raw materials and semiconductors

The European defence industry depends on a large range of critical raw materials required to produce defence equipment. While the EU does produce some critical raw materials domestically, like hafnium, it generally relies on imports from third countries, some of which are considered systemic rivals, such as China. An example of this is the supply of natural graphite. Graphite is one of the defence industry's most-used materials, found in military aircraft, helicopters, aircraft and helicopter carriers, amphibious assault ships, corvettes, offshore patrol vessels, submarines, frigates, tanks, infantry fighter vehicles, artillery, and missiles. Europe is highly dependent on China for its supply of natural graphite, given that it produces most of the world's supply (69 %).

Even more significantly, China supplies 100 % of the EU's heavy rare earth elements. Rare earths are essential in, among other things, the production of night-vision devices, precision-guided weapons systems, navigation systems and drones. In 2020, China threatened to end rare earth supply to three US defence contractors providing weapons to Taiwan. While this threat did not materialise, it shows that China could deny supply to European companies selling to China's strategic competitors. For example, Dassault's sale of fighter jets to Indonesia and India could pose a problem. On a more positive note, in January 2023, a Swedish state-owned mining company announced the discovery of the largest known rare earth deposit in Europe in the far north of Sweden.

Microchips are also critical components, and are ubiquitous in defence materiel ranging from military aircraft to missiles. A Javelin missile system contains about 200 microchips. The EU itself, however, produces less than 10 % of global supply. Given this low production, the EU imports 'nearly all' microchips used in the Union, mostly from Taiwan, making the EU vulnerable to supply chain disruption and potentially to trade disputes. This dependence on Taiwan is a major strategic vulnerability, especially since the majority of these chips are produced in a single factory located less than 200 kilometres from the Chinese mainland in a highly volatile region. All of these supply issues are exacerbated by the global supply chain crisis following the COVID‑19 pandemic and Russia's war on Ukraine, which, among other things, has led to an price rises, supply shortages and increased delivery times.

Lack of manufacturing capability

Russia's war on Ukraine laid bare Europe's armament challenges, with low production capacity even for the most basic of equipment, such as ammunition, as the EDTIB is 'geared to peacetime production'. Given the increased needs for defence materiel, exacerbated by EU Member States' deliveries to Ukraine, and the long lead-times for manufacturing defence equipment, increased manufacturing capacity is required. 'European defence contractors have long been 'used to a situation of modest demand, relatively low unit numbers per system, and long lead times for development'. Severe under-investment in defence has resulted in both capability and industrial gaps in the EU. Russia's war on Ukraine prompted an urgent need for ground-to-ground ammunition, artillery ammunition and missiles, which the Council has recognised (see below). According to news reports, the combined ammunition manufacturing capacity of the EU‑27 is insufficient to meet current substantially increased demand.

This lack of manufacturing capacity is exacerbated by the European defence industry 'build-to-order' system. Traditionally, defence contractors in Europe avoid producing arms without pre-orders, due to the high price of manufacturing, leading in turn to long waiting times for advanced defence capabilities. The main issue is the large capital investment and years needed to create new plants. The defence industry would require solid, long-term orders to make investment worthwhile. Simply ramping up overnight is not an option. According to one expert, 'European industry cannot ramp up production without a long-term prospect of sustained demand'.

Investing more, better, together and European

In the Strategic Compass and the Versailles Declaration, Member States committed to spend 'more and better on defence'. For many Member States, Russia's aggression against Ukraine was a 'wake-up call' for their defence budgets; a combined defence budget of €240 billion was achieved in 2022 and an estimated €290 billion in 2023. Commission President von der Leyen estimates that the combined 2024 defence budget for all 27 EU Member States will rise to €350 billion. Investing more and better will pose a range of challenges. Indeed, a Delors Institute expert notes that there is a real risk of uncoordinated defence budget increases leading to more fragmentation through a focus on national priorities and unnecessary duplication of effort.

Other experts note that a real risk to satisfying the short-term capability needs will be investing too much in non-European off-the-shelf defence equipment, as in the long term this may undermine the EDTIB and create additional dependencies on external actors in the long term. As an example, Poland has signed deals with South Korea to buy 1 000 K2 tanks, 672 self-propelled howitzers and 48 FA‑50 light combat aircraft, rather than purchasing European defence products. According to Daniel Fiott: 'Europe's initial response to the war on Ukraine may have actually increased its strategic dependencies on external partners', which the 2022 CARD report also finds.

The Commission has significantly stepped up its efforts to incentivise joint spending on defence following Russia's full-scale invasion of Ukraine. Shortly after the 18 May 2022 publication of the defence investment gap analysis, a Defence Joint Procurement Task Force (DJPTF) was set up, which supports coordination and assistance in closing very short-term procurement needs.

Two months later, the Commission presented a proposal for a short-term joint defence procurement initiative, the European Defence Industry Reinforcement through Common Procurement Act (EDIRPA). This encourages cooperation in defence procurement between Member States and enhances the competitiveness and efficiency of the EDTIB. The co-legislators adopted the €310 million budget EDIRPA on 18 October 2023.

The EDIRPA work programme was adopted in March 2024 to support common procurement projects in three areas: ammunition, air and missile defence, platforms and replacement of legacy systems. The Act in Support of Ammunition Production (ASAP), with a budget of €500 million, was signed into law on 20 July 2023. It aims at facilitating the expansion of ammunition production capacity throughout Europe. The purpose of this regulation is to make the Union defence industry more capable and responsive, guaranteeing timely supply of missiles and ammunition throughout Europe. In March 2024, the results of the ASAP call for proposals were announced covering projects in five areas: testing and reconditioning certification, missiles, shells, explosives and powder. Member States' production capacity for 155 mm ammunition is expected to reach 1.4 million shells per annum by the end of 2024.

In March 2024, the Commission put forward the EDIP, with a proposed budget of €1.5 billion, as a first means of delivering the EDIS in 2025-2027 (at the time of writing, EDIP was in the preparatory phase in Parliament pending a final decision on committee referral). Within the EDIP framework, the Commission further proposes to extend the intervention logic of EDIRPA in the procurement of equipment in order to promote collaborative procurement.

It also proposes to set up a new (voluntary) legal framework – the structure for European armament programme (SEAP) – to facilitate and scale up Member State cooperation throughout the defence-equipment lifecycle, from development to maintenance. The SEAP should function 'as a vehicle to underpin and strengthen defence cooperation, including in the context of PESCO, if so agreed by Member States'.

To guarantee coherent EU action, the EDIS proposes a Defence Industrial Readiness Board, which would include representatives of the Member States, the EU High Representative and the Commission. The board should carry out the EU defence joint programming and procurement function called for in the defence investment gap analysis.

Furthermore, a trial European military sales mechanism is envisaged, to raise awareness of the availability of the EDTIB's defence products (through a centralised, up-to-date catalogue of defence equipment developed by the EDTIB), and to facilitate the procurement process, including 'government-to-government' purchases.

The EDIS also stresses that the EDTIB should become more resilient and responsive. This means increasing EU industry capacity to meet Member States' demands in time and scale. To do so, the Commission proposes to expand the ASAP intervention logic beyond ammunition and missiles. The Commission would also support the build-up of reserved surge manufacturing capacities ('ever-warm' facilities) through the EDIP, to maintain production capacity during less demanding times (e.g. by providing funding for machine tools and relevant staff costs), and explore options for the possible repurposing of civilian production lines for defence production purposes in times of crisis.

The Commission also proposes, within the EDIP framework, a possible fund to accelerate defence supply chain transformation (FAST), which would aim at 'facilitating access to debt and/or equity financing for SMEs and small midcaps' involved in the industrialisation of defence technologies and/or production of defence production. The Commission would use repayable grants under the EDIP to offer ongoing support for the industrialisation of defence cooperative actions that were first funded by the EDF.

The European defence industry has already taken some measures to address the new strategic reality. For instance, Rheinmetall, Germany's largest defence contractor, announced plans to build new ammunition production facilities in Germany, and acquired Expal Systems to enhance its manufacturing capacity for artillery and mortar ammunition. Upon finalising the acquisition, Rheinmetall will be able to increase its production of 155 mm artillery ammunition to 600 000 rounds per year, from the current 450 000 rounds.

European Defence Fund

The €8 billion European Defence Fund incentivises joint defence research, innovation and capability development by directly investing in the EDTIB. The mid-term review of the MFF allocated an additional €1.5 billion to the fund. This builds on two earlier programmes: the €500 million European Defence Industrial Development Programme (EDIDP); and the €90 million Preparatory Action on Defence Research (PADR).

The results of the 2021, 2022 and 2023 EDF calls for proposals are a positive sign of things to come: in the 2021 round, the selected 61 collaborative defence research and development projects were awarded a total of €1.2 billion in funding. Notably, the successful proposals involve 18 entities from 8 EU Member States and Norway on average, and half of the capability development proposals selected will be established within the PESCO framework. In the 2022 round, €832 million was invested in 41 defence projects, with an average of 22 entities from 9 EU Member States plus Norway participating per project, with 11 of the selected proposals linked to PESCO. The results of the third EDF work programme for 2023, with another €1 billion in funding, involve an average of 17 entities from 8 Member States, with 14 projects linked to PESCO. The 2024 EDF call for proposals has a budget of another €1.1 billion. With the adoption of the fourth work programme, total EDF financing for EU collaborative defence R&D, including its precursor programmes, amounts to approximately €4.7 billion since 2017 (€3 billion EDF plus its precursors, the €500 million EDIDP and the €90 million PADR).

In January 2024, the Defence Equity Facility was launched as a result of a joint initiative between the European Investment Fund and the European Defence Fund. With the help of this tool, private funds supporting cutting-edge dual-use technologies with potential defence applications will be able to receive investment totalling €175 million.

Experts from the Centre for European Policy Studies (CEPS) note: 'The European Commission should raise the bar for EDF eligibility from the current 'three entities from three Member States' rule. The involvement of more Member States would lead to the better integration of armaments supply chains ... which would subsequently allow for improvements in interoperability'. This could be further encouraged by providing an EDF bonus for the joint operation of commonly developed equipment. Center for Strategic & International Studies experts and an Egmont analyst suggest significantly expanding the size of the EDF, given the huge future needs.

Permanent structured cooperation

The EU PESCO initiative further benefits the EDTIB, as it provides a legal framework for deeper defence cooperation between its 26 Member States (all EU Member States except Malta) and 20 legally binding commitments to, inter alia, achieve higher levels of defence investment and larger defence innovation budgets. The more visible parts of PESCO are the 68 multinational projects in fields such as space, maritime, cyber, air and strategic enablers. Importantly, there is a significant bonus if EDF projects are organised within the PESCO framework, further incentivising cooperation.

According to the PESCO secretariat, projects are forging ahead,. Of the 60 PESCO projects in December 2022, 20 were 'maintaining their ambition to deliver by 2025.' Two projects were fully operational (European medical command and cyber rapid response teams). However, six projects had fallen behind in their goals to achieve concrete results by 2025, while 15 projects faced delays, due to 'lack of planning, both financial and practical in terms of project timelines'. Some 3 % of PESCO projects had a high chance of failure.

The PESCO Annual Projects Progress report published in July 2023 notes that PESCO projects demonstrated notable progress in 2022 throughout their lifecycles. A positive upward trend is apparent among the 60 projects under review. Notable accomplishments include three projects in the final completion phase and 12 successfully advanced to the next lifecycle phase. Despite staying in the same lifecycle phase, an additional 43 projects have made noteworthy progress by meeting their interim objectives. PESCO achieved a significant milestone in 2022 when 18 projects reached their project execution year. A total of 22 projects are scheduled to be fully operational by 2025. Nonetheless, due to the need to address essential project management components, eight projects need particular examination.

Experts generally view PESCO progress with more scepticism, describing a 'lack of purpose', as participating Member States fail to define which force package/capabilities they are aiming for through PESCO. They also see a 'culture of non-compliance' as Member States continue a national focus in their defence planning and fail to comply with their commitments. The Council acknowledged in November 2022 that Member States have made progress to 'varying degrees' in their implementation. In November 2023, the Council adopted a recommendation assessing the progress made in fulfilling the more binding commitments under PESCO. It underlines that the 26 PESCO members have maintained their upward trajectory in defence spending, with a 12 % increase in 2023 and additional increases anticipated in 2024‑2025. Additionally, 25 % of the total defence budget allotted to defence investment in 2022 went to speedier acquisition of capabilities and stock replenishment, mostly using off-the-shelf items in an effort to find quick fixes. To complete all 20 more binding commitments by 2025, the Council urges participating Member States to accelerate their implementation.

Defence innovation

At their March 2022 meeting in Versailles, EU leaders committed to significantly enhance defence expenditure, invest in critical and emerging technologies and innovation for security and defence, and to foster synergies between space, civilian and defence innovation and research. These commitments were repeated in the Strategic Compass. Significant developments have already taken place in boosting EU defence innovation. In February 2021, the Commission put forward an action plan on synergies between defence, space and security, which seeks to increase complementarity between relevant EU programmes such as Horizon Europe and the EDF to profit from the disruptive potential of technologies at the intersection between space, defence and civil uses. In addition, on 15 February 2022, the Commission adopted a roadmap on critical technologies for security and defence, outlining how the EU can enhance research, technology development and innovation in critical technologies and how to reduce strategic dependencies. Among other things, it invites Member States to contribute to the Observatory on critical technologies set up within the Commission, and encourages dual-use research and innovation at EU level.

In its first round of selected proposals (2021 EDF call), over 5 % of the budget was allocated to emerging disruptive technologies (the EDF Regulation specifically allocates 4 % to 8 % of its annual budget to such technologies). For instance, developing. a next-generation electro-optical sensing device. In the 2022 round, 4.5 % of the budget was dedicated to funding projects on disruptive technologies, e.g., a defence research project on adaptive camouflage solutions for soldiers. On 17 May 2022, an EU defence innovation hub (HEDI) was launched within the EDA to enhance innovation and catalyse new activities in collaboration with Member States and EU stakeholders, one of the first concrete deliverables of the Strategic Compass. The Commission also introduced a €2 billion EU Defence Innovation Scheme (EUDIS) under the auspices of the EDF. It will help EU innovative companies in their early stages and mature businesses by providing customised innovation tracks to lower barriers to entry and facilitate commercialisation of their ideas.

The Observatory on Critical Technologies announced in February 2023 the identification of risks related to autonomous systems and electronic components. Specific technology roadmaps were also created to reduce these risks and find remedies. The Observatory of critical technologies for civil-defence-space industries published Classified, detailed findings on electronic components. A second report is expected to focus on autonomous systems. The Observatory focuses on how these two technologies can be applied to EU defence, space, and related civil value chains, as well as present and future gaps, dependencies, and associated risks. The creation of mitigation strategies to lessen the critical dependencies and ongoing supply chain monitoring are the next steps. In February 2024, the establishment of the Strategic Technologies for Europe Platform was agreed to further support the EU technological sovereignty and investments in critical technologies with an additional €1.5 billion for defence investment, particularly in companies helping preserve a European edge on critical technologies. Despite these notable signs of progress, CEPS experts worry that 'innovation is taking a backseat to more urgent matters'. They note the focus has shifted to 'replenishing, replacing and reinforcing' instead of defence innovation, which may lead to the EU losing its technological edge and increase third-country dependencies.

European Peace Facility

For the first time in EU history, mere days after Russia invaded Ukraine, the Member States agreed to jointly finance the provision of lethal weapons to a country at war. Funding for the move comes from the European Peace Facility (EPF), an off-budget fund worth €17 billion in current prices, including a dedicated Ukraine Assistance Fund (UAF). At the time of writing, support for Ukraine under the EPF amounts to €6.1 billion. The EPF can be used to fund the common costs of CSDP missions and operations, support peace operations and strengthen the capacities of third countries. The latter opens the door for significant procurement of military equipment, thus strengthening the EDTIB. Support increases to €45.5 billion including Member States' bilateral commitments. On 21 May 2024, the Council approved the use of windfall profits from immobilised Russian assets 'for further military support for Ukraine, as well as its defence industry capacities and reconstruction'. An initial €1.4 billion in profits from Russian frozen assets has been disbursed and channelled through to the EPF. Additionally, Members of the European Parliament recently approved a €35 billion undesignated loan (meaning Ukraine can spend it on weapons) using Russian immobilised assets as collateral as part of a G7 initiative to provide €45 billion in loans to Ukraine.

On 2 March 2023, Ukraine sent a request for assistance to the EU for the supply of 155 mm artillery rounds. On 20 March 2023, the Council recognised the specific urgent need for ground-to-ground and artillery ammunition, and missiles, in light of the Russian war on Ukraine. The goal was set to provide Ukraine with 1 million rounds of ammunition by March 2024. To do so, it agreed on a three-track proposal on ammunition (delivery from existing stocks; joint procurement from industry; increasing production), which was endorsed by the European Council on 23 March 2023. According to the HR/VP, 524 000 rounds were donated by March 2024 (52 % of the objective) and around 70 % by September 2024. Former Commissioner Breton stated that pledge to 'provide' 1 million rounds of ammunition was fulfilled; he includes the manufacturing capacity of the EU, from which Ukraine has purchased ammunition rounds in addition to Member States' donations. According to High Representative Josep Borrell 'more than 350,000 ammunitions have been supplied [purchased by Ukraine from the EDTIB and already delivered] by March 2024'.