globalization and its implications for the defense industrial base pub756

8/7/2019 Globalization and Its Implications for the Defense Industrial Base Pub756

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GLOBALIZATION AND ITS IMPLICATIONSFOR THE DEFENSE INDUSTRIAL BASE

Terrence R. Guay

February 2007

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FOREWORD

The forces of globalization present challenges, risks,and opportunities to virtually every industry in everycountry. This includes the sector that traditionally hasbeen more insulated from external pressures than anyotherthe defense industrial base. One of the mostimportant implications of globalization is its effecton the economic competitiveness of countries andparticular industries. Both governments and defensecompanies bear the responsibility for devising prudentpolicies and strategies that capture the opportunitiespresented by globalization, while mitigating the risks.

In this monograph, Dr. Terrence Guay explores howkey elements of globalization have transformed nationaldefense industries around the world, and how these

changes will affect the U.S. defense industrial base in thecoming years. He focuses on elements of globalizationthat are relevant especially to the defense industry:the globalization of capital (nance), production,trade, technology and labor; and the changes in globalgovernance that structure the forces of globalization.He concludes by offering ten recommendations forpolicymakers who have the difcult task of maximizingU.S. economic competitiveness without compromisingnational security.

The Strategic Studies Institute is pleased to publishthis work as part of our External Research AssociatesProgram.

DOUGLAS C. LOVELACE, JR.DirectorStrategic Studies Institute


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BIOGRAPHICAL SKETCH OF THE AUTHOR

TERRENCE R. GUAY is Clinical Assistant Professorof International Business at The Smeal College ofBusiness, The Pennsylvania State University, wherehe teaches international business and the businessenvironment of Europe. He is the author of At ArmsLength: The European Union and Europes DefenceIndustry (Macmillan and St. Martins Presses, 1998),The United States and the European Union: The PoliticalEconomy of a Relationship (Shefeld Academic Press,1999), and several academic journal articles and bookchapters on transatlantic relations, political economy,business-government relations, and security. Dr. Guayholds a BS from Clarkson University, an MBA fromThe Ohio State University, and MA and Ph.D. degrees

from Syracuse University. Previously, he was a facultymember in the Maxwell School of Syracuse Universityand the School of International Service at The AmericanUniversity.


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SUMMARY

This monograph examines the impact ofglobalization on the U.S. defense industrial base. Afterproviding a brief overview of globalizations generaleffects on countries and companies and the currentstructure of the global defense industry, the authorexamines how elements of globalization are shapingthe strategies of defense companies. He focuses onthose elements of globalization that are of particularimportance to the defense industry. They include theglobalization of capital (nance), production, trade,technology and labor, and the changes in globalgovernance that structure the forces of globalization.The author concludes by offering 10 recommendationson how U.S. Government, military, and company-

level policies can preserve the U.S. defense industrialbase during the current era of globalization. Therecommendations revolve around three themes:1) Globalization is blurring the distinction between adomestic and foreign defense company, and policiesthat aim to keep this articial distinction are not helpingeither national security or the defense industrial base;2) workers are a defense companys most importantasset, and policies should be designed to have the besteducated and trained workers designing and buildingU.S. weapons systems; and, 3) the relationship betweenglobalization and technology provides both risks andopportunities, and policies geared toward preserving aperceived U.S. advantage in technology may prove tobe detrimental to both national security and economic

competitiveness.


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GLOBALIZATION AND ITS IMPLICATIONSFOR THE DEFENSE INDUSTRIAL BASE

INTRODUCTION

Globalization is perhaps the most popularterm used to describe changes in the internationalenvironment since the end of the Cold War.Unfortunately, the term now is used so frequentlythat it has come to mean different things to differentpeople. This lack of a precise denition of a termwith wide currency can make it difcult to discussglobalizations effects in a coherent way. However, oneuseful working denition of globalization proposedby the International Monetary Fund is the growingeconomic interdependence of countries world-wide

through the increasing volume and variety of cross-border transactions in goods and services and ofinternational capital ows, and also through the morerapid and widespread diffusion of technology.1 Whileeconomics and technology are perhaps its most tangiblecharacteristics, globalization also includes political,cultural, and ideational dimensions, since each ofthese has a reciprocal relationship with economic andtechnological change. This combination of forces willpresent challenges, risks, and opportunities to virtuallyevery industry in every country for the foreseeablefuture. This includes the sector that traditionally hasbeen more insulated from external pressures than anyotherthe defense industrial base. This monographwill explore how key elements of globalization have

transformed national defense industries around theworld, and how these changes will affect the U.S.defense industrial base in the coming years. It concludes


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by offering recommendations for policymakers whohave the difcult task of maximizing U.S. economic

competitiveness without compromising nationalsecurity. The recommendations revolve around threethemes: 1) Globalization is blurring the distinctionbetween a domestic and foreign defense company,and policies that aim to keep this articial distinctionare not helping either national security or the defenseindustrial base; 2) workers are a defense companysmost important asset, and policies should be designedto have the best educated and trained workersdesigning and building U.S. weapons systems; and 3)the relationship between globalization and technologyprovides both risks and opportunities, and policiesgeared toward preserving a perceived U.S. advantagein technology may prove to be detrimental to bothnational security and economic competitiveness.

GLOBALIZATION

Although some would argue that features ofglobalization like cross-border trade and investmenthave been present for centuries, the proliferation ofpublications on globalizationboth scholarly andmass marketdates to the end of the Cold War. Thecollapse of the bipolar international system, shapedfor almost half a century by political forces, presentedopportunities for numerous alternative explanationsof how a post-Cold War world would be shaped.Francis Fukuyama suggested in The End of History andthe Last Man that the ideas of political liberalism anddemocracy would dominate international political

discourse and spread to authoritarian states.2 SamuelHuntingtons Clash of Civilizations presented a darkerimage of the world dividing among fault lines based


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on cultural, religious, and historical ties, ultimatelyleading to conict between these groups.3 But it was

the economic dimension that seemed to best captureglobal change in the 1990s. In part, it described theattempts by formerly communist countries in EasternEurope, the former Soviet Union, and especially Chinato transition to capitalist forms of economic systems.In part, it represented the increasing prominence ofinternational organizations. The European Community(now European Union, or EU) made EC-1992 abuzzword in many corporate suites and governmentofces around the world, as business executives andpolicymakers planned their strategies for the challengesposed by European economic integration, includingthe creation of a new currencythe Euro. The 1990ssaw the rise of other regional groups including theNorth American Free Trade Agreement (NAFTA) and

Mercosur in South America. Also during this period,the General Agreement on Tariffs and Trade (GATT)was transformed into the World Trade Organization(WTO). Covering a wider range of goods and servicesand with more authority to punish countries inviolation of international trade rules, the WTO helpedto accelerate international trade, while at the sametime serving as a focal point for those groups opposedto both the organizations mission and regulatorypowers.

But the economic dimension of globalization per-haps is symbolized best by the expansion of production,investment, and sales by multinational corporationsinto other countries. According to the WTO, worldmerchandise exports doubled from $1.8 trillion in 1983

to $3.7 trillion in 1993, doubling again to $7.4 trillion in2003, and rising to $10.2 trillion in 2005.4 Meanwhile,the Organization for Economic Cooperation and


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Development (OECD), whose members consist ofthe worlds 30 most prominent market democracies,

reports that the total stock of inward investmentamong its members rose from $1.3 trillion in 1990 to$7.3 trillion in 2004.5 It even has became popular torank the sales of multinational corporations with thegross domestic product (GDP) of countries, apparently(and in many ways misleadingly) suggesting that largecompanies were more powerful than many countries.For example, Lockheed Martins 2005 defense revenuesof $36.4 billion were similar in magnitude to Ecuadors$36.2 billion GDP. However, such comparisons tell usvery little about the real inuence of companies or theirextent of internationalization.

These views of globalizationcultural, political,religious, and economicare not mutually exclusive.In Jihad vs. McWorld, Lionel Barber argued economic

globalization and religious and tribal fundamentalismhad become the two dominant forces in global affairs.6The homogenizing effects of capitalism, along withthe fragmenting forces of ethnic, religious, and racialhatreds, were having the effect of undermining thenation-state and democracy. In The Lexus and the OliveTree, Thomas Friedman tried to explain why somepeople around the world are embracing the economicbenets of globalization, particularly increasingconsumerism, while others are threatened by thenegative dimensions of the process, including its effectson the environment and local communities.7

For the purposes of this monograph, the mostimportant implication of globalization is its effect on theeconomic competitiveness of countries and particular

industries. Globalizations impact on the defenseindustry will be addressed in subsequent sections.However, there is an abundant literature aimed at


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advising business and government decisionmakershow to capitalize on the globalization process. In The

Work of Nations, former U.S. Secretary of Labor RobertReich argued that, in an era where companies are nolonger as committed to their home country, publicpolicies need to focus on enhancing education, skills,and training in an effort to make their country anattractive location for investment by either domestic orforeign companies.8 Management consultant KenichiOhmae contended that the forces of globalization weremaking it less useful to talk about national economies,and that the rise of industrial clusters would makeregional economies a more accurate tool for mappingglobal economic development.9 In his 2005 best-seller,The World is Flat, Thomas Friedman argues that theinformation technology revolution has reduced (per-haps even attened) the advantages of the industrial-

ized countries.10

An ever-increasing number of brightand educated workers, particularly in China and India,require only an internet connection to plug and playin the global economy. The way forward, according toFriedman, is to equip more Americans with skills thatwill keep them ahead of foreign competitors. Businessstrategists like Michael Porter contend that countriesstill have some key locational advantages, and thatthey should build upon these diamonds of nationaladvantage to enhance economic competitiveness.11Finally, others such as David Baron argue that the riseof other actors has made it prudent for rms to developnonmarket strategies to engage with governments,nongovernmental organizations (NGOs), internationalorganizations, and other entities whose actions and

decisions impact companies.12To summarize, the economic strands of globaliza-

tion are playing a key role in structuring the global econ-


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omy. How companies in the defense industry (andtheir home governments) respond to these pressures is

the focus of the remaining sections.

DEFENSE INDUSTRY BACKGROUND

United States.

Historically, the engine of growth for the U.S.defense industry was strong domestic demand, fueledby the Cold War. Times were especially prosperousfor the industry from the late 1970s through the late1980s. By the early 1990s, however, the defense budgetwas slashed in search of a peace dividend, andthe defense industry realized that the golden yearsof President Ronald Reagans buildup were over.Military spending declined from $431 billion in 1990

to $322 billion in 2000 (in constant 2003 dollars), withthe steepest decline coming in the mid-1990s (see Table1). Prodded in 1993 by then Secretary of Defense LesAspin, the industry hastened to adjust.13 Layoffs byrms such as Northrop, Hughes, Lockheed, GeneralDynamics, Litton Industries, and TRW marked a spateof downsizings and acquisitions, culminating in themergers of Lockheed and Martin Marietta, Northropand Grumman, Boeing and McDonnell Douglas, andRaytheon and Hughes. A 2003 Pentagon report foundthat the 50 largest defense suppliers of the early 1980shad since become the countrys top ve contractors.14


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1990

1995

PercentChange

from1990

2000

PercentChange

from 1990

2005

PercentChange

from 1990

UnitedStates

$431,282 $336,635 -21.9% $322,309 -25.3% $478,177 10.9%

France 50,040 46,089 -7.9% 43,796 -12.5% 46,150 -7.8%

Germany 51,180 37,852 -26.0% 36,021 -29.6% 33,187 -35.2%

UnitedKingdom

51,479 43,101 -16.3% 40,533 -21.3% 48,305 -6.2%

China 12,3001 14,0001 13.8% 22,2001 80.5% 37,7002 206.5%

India 10,533 10,983 4.3% 15,487 47.0% 20,443 94.0%

Israel 7,677 7,809 1.7% 9,330 21.5% 9,579 24.8%

Japan 37,668 40,483 7.5% 41,755 10.9% 42,081 11.7%

Russia 126,4001 16,0001 -87.3% 14,1001 -88.8% 21,0001 -83.4%

World 1,003,000 768,000 -23.4% 784,000 -21.8% 1001,000 -0.2%

Figures are in U.S.$ million at constant 2003 prices, and exchangerates are for calendar year.1. Estimate.2. Figure is estimate for 2004.

Source: Figures derived from the Stockholm International PeaceResearch Institute (SIPRI), rst.sipri.org/non_rst/result_milex.php and www.sipri.org/contents/milap/milex/mex_wnr_table.html.

Table 1. Defense Spending of Selected Countries.

U.S. rms now dominate the global defense industry:Seven of the top ten defense companies in the worldare based in the United States, including LockheedMartin, Boeing, Northrop Grumman, Raytheon,

General Dynamics, and Halliburton (see Table 2). TheU.S. defense industryor at least the aerospace andelectronics components of itconsolidated quickly,


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but with the strong urging of the Pentagon. Most of themergers occurred between 1993-98, and allowed rms

to either consolidate existing strengths in the defensesector or add a business with steadier revenue streamsto complement their civilian side. Boeings acquisition ofMcDonnell Douglas, for example, helped the companydiversify into the military market. Boeings IntegratedDefense Systems business has an order backlog of over$80 billion, more than any other defense contractorin the world.15 It has done so not simply by buildingmilitary aircraft, but by becoming a prime contractordelivering integrated battle systems that link togetherequipment and systems used by different militarybranches.

USRank

woRldRank

company

2005

defenSeRevenUe1

2005

totalRevenUe1

peRcent of

RevenUe

fRomdefenSe

1 1 Lockheed Martin $36,465 $37,213 982 2 Boeing 30,791 54,845 563 3 Northrop Grumman 23,332 30,700 764 5 Raytheon 18,200 21,900 835 6 General Dynamics 16,570 21,244 786 8 L-3 Communications 8,549 9,445 917 10 Halliburton1 7,552 20,994 368 12 United Technologies 6,832 42,700 16

9 13 Science ApplicationsInternational Corp.2 5,400 7,792 69

10 14 General Electric3 3,500 149,700 2

Figures are in U.S.$million.

1. Defense revenue from KBR Federal and Government division.2. For scal year ending 1/31.3. Defense revenue from GE Aerospace Engines.

Source: Figures derived from Defense News Top 100 (www.defensenews.com/index.php?S=06top100 )

Table 2. Top Ten U.S. Defense Companies (2005).


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Since the late 1990s, major defense contractorshave pursued three strategies: buying relatively small

defense units from diversied U.S. conglomerates(like General Motors and TRW); acquiring defense-related businesses outside of aerospace and electronics(such as information technology or shipbuilding); orexpanding abroad by buying foreign defense rms.The rst strategy has been just about exhausted at thispoint in time. The second strategy is likely to continueto be popular, especially in a post-September 11, 2001(9/11) world where the U.S. Government is spendingconsiderable sums on homeland security, intelligence,and surveillance. It is the third strategy that willpresent the most interesting possibilities in the near-term. Larger European or U.S. companies now haveacquired most of the smaller European defense rms.The next step for U.S. rms in the transatlantic market

would be to acquire or merge with large Europeancompaniesa much more signicant developmentthan the ad hoc alliances and collaborations that oftenarise with large multination weapons systems. Since theobstacles to this strategy are formidable, other optionsinclude acquisitions of and teaming arrangements withcompanies outside of the North Atlantic region. Whilesuch companies typically do not have the same level oftechnological and production experience as Europeanones, other factors (as will be described below) canmake this an attractive option.

Technological change plays an increasinglycritical role in defense industry developments. In thepost-9/11 Global War on Terror (GWOT) era, theU.S. Government is shifting its spending priorities

in ways that emphasize information technology,intelligence, surveillance, communications, and relatedtechnologies. Since such spending requires high levels


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of security, foreign rmseven European onesare at a competitive disadvantage for Pentagon and

Homeland Security contracts, even at the subcontractorlevel. Some defense rms are making the necessarychanges to ll the needs of anti-terrorism and homelandsecurity.16 Northrop Grumman expects its sales to theU.S. Government related to homeland security to be atleast $500 million. The U.S. Department of HomelandSecurity has a faster growing budget than the militarydefense budget, with investments expected to growmore than 10 percent each year until 2009. But mostforeign rms will not be trusted to supply these needs.Still, with a 2007 budget for defense of $439 billion, agure larger than the combined total of the worldsnext 20 biggest military spenders, and weaponsprocurement of $147 billion, the United States is themost lucrative market for defense companiesU.S. or

foreign.17

Europe.

The rationalization and restructuring of individualEuropean defense companies occurred after U.S.defense industry consolidation. Europes defenseindustry began the 1990s as a collection of nationaldefense efdoms. While the U.S. defense industrywas consolidating rapidly during the rst half ofthe decade, most European rms continued to lookinward. Transnational collaborations that did existgenerally took the form of joint ventures (for productslike missiles) or multinational consortia (like theEuroghter)both of which enabled defense rms

to maintain their national independence. Large-scalecross-border mergers were hindered by the reluctanceof most European governments to see a domesticcompany acquired by a foreign rm.


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By the late 1990s, this situation became untenable.Given the consolidation in the U.S. defense industry, the

political impetus for a European Security and DefensePolicy (ESDP) within the EU, and the fact that othersectors had begun to consolidate to take advantage ofEuropes Single Market Program, European defenserms found themselves under political and economicpressure to consolidate.18 The rst major consolidationoccurred in the United Kingdom (UK) in January 1999,when GEC agreed to sell its defense arm (MarconiElectronic Systems) to British Aerospace. The newentity was renamed BAE Systems (BAE). Nine monthslater, the most signicant cross-border defense unionto date occurred. The rst step, as in the UK, wasnational consolidation. As part of its privatizationin June 1999, Frances Arospatiale joined withMatra to create an aerospace and defense electronics

powerhouse. Four months later, this combined entitymerged with Dasa to form European AeronauticDefence and Space Company (EADS). CASA, Spainsleading aerospace and defense rm, also merged intoEADS. BAE now dominates Europes defense industrywith 2005 defense revenues of $21.0 billion (79 percentof BAEs total revenues), while $9.1 billion (23 percent)of EADSs total $40.5 billion total revenue comes fromdefense (see Table 3).

Prior to the consolidation of Europes aerospacesector into BAE and EADS, Airbus had operated as aconsortium under which the four partners (Arospatiale,Dasa, British Aerospace, and CASA) kept ownership oftheir engineering and production assets. As a result ofthe consolidation, Airbus became owned by EADS (80

percent) and BAE (20 percent). It is important to keepin mind that the two companies are involved in both


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eURopeRank

woRldRank

company

coUntRy

2005

defenSeRevenUe1

2005 totalRevenUe1

peRcent of

RevenUe

fRom

defenSe

1 4 BAE Systems UK $20,935 $26,500 792 7 EADS2 Multiple 9,120 40,508 233 9 Thales France 8,523 12,176 704 11 Finmeccanica Italy 7,126 12,728 565 16 DCN France 3,352 3,352 1006 17 Rolls Royce UK 3,294 11,357 297 19 SAFRAN Group3 France 3,075 12,528 258 22 Dassault Aviation France 2,108 4,063 529 24 Saab Sweden 1,941 2,427 80

10 27 QinetiQ4

UK 1,677 1,973 85

1. Figures are in U.S.$ million. Currency conversions calculatedusing prevailing rates at the end of each rms scal year.

2. At the end of 2005, EADS was 29.9% owned by DaimlerChrysler(Germany), 29.9% by SOGEADE (a French holding companycomprised of Lagardre and the French state), and 5.5% by SEPI(Spanish state holding company). Approximately 34.8% of EADS

shares were held by the public. In February 2007, EADS ownershipwas: DaimlerChrysler (15.07%); consortium of mostly Germanbanks (7.50%); Lagardre (11.25%); French state (11.25%); SEPI(5.50%); Russian state-controlled bank Vneshtorgbank (5.40%);and 44.10% was held by the public. EADS is registered in theNetherlands.

3. In May 2005 Sagem and Snecma merged to become SAFRAN.

4. Fiscal year ending 3/31. Defense revenue is estimate.

Source: Figures derived from Defense News Top 100 (www.

defensenews.com/index.php?S=06top100 ).

Table 3. Top 10 European Defense Companies(2005).

civilian and military business activities, and EADSand BAE sought ways to bring more defense work intoAirbus. However, BAE appears to want to move into


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the defense business on its own. The companys boardof directors recommended in September 2006 that

shareholders approve the sale of its 20 percent stake inAirbus to EADS for $3.5 billion.19 The recommendationwas approved the next month. Proceeds from the salecould provide BAE with the funds to go on a buyingspree of U.S. defense companies. Similarly, otherEADS owners seem to be interested in going separateways.20 In 2006, both Lagardre and DaimlerChryslerannounced plans to decrease their stakes in EADS.Because of the politically sensitive nature of EADS,these reductions had to be done in such a way as topreserve the Franco-German ownership balance.21By early 2007, Germanys control in EADS consistedof DaimlerChryslers 15 percent holdings and anadditional 7.5 percent stake by a consortium of mostlyGerman banks, while Frances 22.5 percent ownership

was divided equally between Lagardre and the Frenchstate. But this more simplied ownership structure couldbe complicated by Spain, which is seeking to expandits own aerospace and defense industries. Madridis interested in doubling its 5.5 percent ownershipshare of EADS, since a greater stake would justifyredistributing more EADS and Airbus work to Spain.22A new actor, Vneshtorgbank, obfuscated the situationfurther in late 2006 when the second largest Russianstate-controlled bank acquired a 5.4 percent stake inEADS through share purchases on the open market.

While the bulk of Europes aerospace and defenseelectronics sectors has consolidated into BAE, EADS,Thales, and Finmeccanica, other sectors have notfollowed suit. These include principally land vehicles,

naval shipyards, and aircraft engines. Europe has 20naval shipbuilders and 23 yards, while the United Stateshas only two companies making warships (NorthropGrumman and General Dynamics) and six yards.23


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Despite the overcapacity in Europe, a result of lessspending by governments on warships, consolidation

has been exceedingly slow since the naval sectorremains divided along national lines.24 GermanysThyssenKrupp acquired Howaldtswerke-DeutscheWerft (HDW), Germanys biggest shipyard, in 2004 andwas renamed ThyssenKrupp Marine Systems (TMS).In October 2004, the French government announcedplans to privatize as much as 49 percent of DCN, andbegan prodding Thales to merge its naval businesswith DCN. Such a union, then, would be in a strongerposition to combine with TMS, which is now Europeslargest shipyard group. This EADS approach tonaval consolidation still has to overcome contentiousissues over ownership and which shipyards (in Franceor Germany) are to be closed. Other shipbuilders inItaly and Spain also would need to be coaxed into

joining a Franco-German shipbuilder. Consequently,the consolidation of the naval shipbuilding sector willlikely take time, despite the clear economic logic ofsuch a move.

Demand for military vehicles has dropped sharplysince the end of the Cold War.25 The German militaryvehicles sector shrunk from 44,000 workers in 1989to just 10,000 in 2000, while Frances GIAT reducedits workforce from 17,000 in 1991 to 7,000 in 2001.Spending by the UK Ministry of Defense on combatvehicles dropped 70 percent between 1990 and 2000.While the industry has responded to the decline indemand with employment reductions, there has beenlittle in the way of company consolidation. In fact, thenumber of manufacturers of light tracked vehicles

worldwide actually increased from 12 to 55 between1993 and 2003. Consolidation has gone furthest in theUK, with BAEs 2004 acquisition of Alvis Vickers (a


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company produced by Alviss acquisition of Vickersfrom Rolls-Royce in 2002 and of GKN in 1998), making

it the only producer of military combat vehicles.In Germany, there are two main producers of landvehicles: Rheinmetall and KMW (the name given toWegmanns acquisition of Krauss-Maffeis militaryoperations). Finally, Frances state-owned GIAT isthat countrys lone producer. While four land vehiclesproducers in three countries (and minor rms in othercountries) may not seem too unreasonable, the UnitedStates, which spends far more than Europe on thesetypes of weapons systems, has only two companies:General Dynamics and United Defense. Thus, thereis an economic logic for further consolidation withinEurope.

International.

Defense companies based in the United States andEurope dominate the global market. Of the 14 largestcompanies based on defense revenues, 10 are fromthe United States (see Table 2). Of the top 30 defensecompanies, 17 are headquartered in the United Statesand 11 are European (see Tables 2, 3 and 4). Of thetop 60 companies, 30 are from the United States, 20from Europe, and only 10 are based in other countries.The global imbalance is even more staggering whenbased on revenue. The top 10 U.S. defense companieshad combined defense revenues of more than $157billion in 2005. The top 10 European companies hadtotal defense revenues of $61 billion, while the top10 companies from outside the North Atlantic region

accumulated only $12 billion in defense sales.


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worldrank

company

country

2005defenserevenue1

2005totalrevenue1

percentof

revenuefromdefense

23 MitsubishiHeavy

Industries 2, 3

Japan $2,056 $23,750 9

30 Almaz-Antei 4 Russia 1,568 1,742 9031 Israel Aircraft

IndustriesIsrael 1,560 2,341 67

43 KawasakiHeavy

Industries 2, 3

Japan 1,103 11,249 10

45 HindustanAeronautics 2

India 1,053 1,170 90

46 Elbit Systems Israel 998 1,070 9347 Mitsubishi

Electric 2, 3Japan 971 30,658 3

52 STEngineering

Singapore 922 2,004 46

53 NEC 2, 3 Japan 917 41,041 257 Rafael

Armament

DevelopmentAuthority

Israel 845 845 100

1. Figures are in U.S.$ million. Currency conversions calculatedusing prevailing rates at the end of each rms scal year.

2. Fiscal year ending 3/31.3. Defense revenue from Japan Defense Agency contracts.4. Defense revenue is estimate by Center for Analysis of

Strategies and Technologies, Moscow.

Source: Figures derived from Defense News Top 100 (www.defensenews.com/index.php?S=06top100 )

Table 4. Top Ten Defense Companies OutsideUnited States and Europe (2005).


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6,0

56

caa

da

118

30

1

85

171

11

0

351

568

57

7

365

1,9

71

6,1

21

neh

elad

697

34

2

423

381

19

0

249

339

25

0

840

1,8

68

12,1

76

Ialy

1,5

49

33

4

506

414

18

5

332

310

20

4

827

1,8

58

18,3

69

sede

172

27

5

184

118

45

9

114

271

32

4

592

1,7

60

6,5

07

chi

a

825

2,14

3

1,1

00

707

40

8

472

428

14

6

129

1,5

83

28,0

92

woldtoal

41,9

97

37,24

1

25,9

28

22,0

79

17,33

2

16,1

39

18,2

48

19,83

4

21,9

61

93,5

14

873,9

91

us%

otoal

28.1

%

27.5%

44.9

%

47.0

%

31.8%

28.9

%

28.2

%

29.3%

32.3

%

30.2

%

3

5.2

%

1.FiguresareinU.S.$millionatconstant(1990)pr

ices.

2.FiguresareforSovietU

nionthrough1991andforRussiafrom1992-2005.

3.FiguresareforFederalRepublicofGermanyfor

1981and1986.

Sourc

e:BjornHagelin,Mark

Bromley,andSiemonT.Wezeman,Internation

alArmsTransfers,inS

IPRI

Yearb

ook

2006:ArmamentsD

isarmament

and

Interna

tionalSecurity,Stockholm:Stockholm

International

Peace

Research

Institute(SIPRI);SIPRIArmsTransfersDatabase(www.sip

ri.org/contents/armstrad/a

ccess.

html#

twenty).

Table5.Internati

onalArmsSales:

RankedbyTopElev

enSuppliersofMajorConventionalWeapons(2001-2005).1


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rgi c tai 209ai 1,512

ai 6,933Japan 1,432Singapore 1,165

South Korea 1,639Taiwan 1,927

e 11,283Greece 2,857Italy 1,369Turkey 1,318United Kingdom 2,374

mie 7,233

Egypt 2,274Israel 2,565United Arab Emirates 1,516

oi 1,070t 28,236

Figures are in U.S.$ million at constant (1990) prices.

Source: Bjorn Hagelin, Mark Bromley, and Siemon T. Wezeman,International Arms Transfers, in SIPRI Yearbook 2006: ArmamentsDisarmament and International Security, Stockholm: StockholmInternational Peace Research Institute (SIPRI).

Table 6. U.S. Arms Sales to Selected Regionsand Countries (2001-2005).

Of course, variations among home marketscan account for the decline in market shares. U.S.companies, for example, have had plenty to sell to theU.S. Government, as defense spending has risen sharplysince 2001 (see Table 1). Russian companies, on theother hand, are far more dependent on foreign markets,with the bulk of their arms exports going to just two

countriesChina (43 percent) and India (25 percent).While the U.S. Government bans arms sales to China,that country and India have become important markets


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for many non-U.S. defense companies. Not only are theymajor importers of armaments in their own right (China

and India were the worlds two largest arms importingcountries between 2001-05, accounting for 14 and 10percent of all arms imports, respectively), but they areviewed as rising powers that will have a signicantimpact on international economics and politics over thecourse of the 21st century. Consequently, the UnitedStates has reoriented its relationship with India, andnow is more willing to see U.S. defense rms developcollaborations with their Indian counterparts.26 India,however, likely will treat such overtures with a degreeof wariness, since the country has been on the receivingend of U.S. sanctions in the past, including those placedon weapons and spare parts.

Despite its growing economic importance, Indiawas only the 43rd largest arms exporter over the 2001-

05 period. China ranks 11th, but that is much lowerthan its standing in the 1980s, when its arms exportswere comparable to France, Germany, and the UK. Bothcountries expect to improve in this area in the comingyears, as economic development and the diffusion oftechnology are expected to help domestic companiesproduce more sophisticated armaments that havewider appeal in global markets.

While there are few companies in the world that canmatch the revenues of U.S. defense rms, globalizationis forcing companies to rethink their internationalstrategies in ways that may make U.S. companies moreforeign and international companies more American.This theme is dealt with more fully in the followingsections.


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GLOBALIZATION AND FINANCE

Clearly, one of the most signicant dimensions ofglobalization is the ability to move money to almostanywhere in the world at high speed. As countries haveremoved capital controls, investors large and smallhave more freedom to send their capital abroad andinvest in foreign markets. The defense industry is notimmune to this trend. Of the ve largest U.S. defensecompanies, Northrop Grumman has the largest shareof foreign ownership, with about 7.5 percent of its stockheld by foreigners. Lockheed Martin follows with 7.2percent, Raytheon at 4.6 percent, General Dynamics at3.5 percent, and Boeing at 7.8 percent.27 Many of theseshareholdings are owned by foreign mutual funds,presumably on behalf of smaller investors who havecapital invested in the funds. U.S. defense companies

are among the least international in terms of foreignownership, although state-held rms in Russia,China, and elsewhere often are even less so. Europeancompanies, however, often have large blocs of foreignownership. Foreign shareholdings of BAE, for example,have uctuated around 45 percent in 2006, but were ashigh as 59 percent in 2003.28

The nance dimension of globalization hasfacilitated the ability of companies to list their shareson multiple stock exchanges. DaimlerChrysler becamelisted on the New York Stock Exchange (NYSE) in 1998,thereby meeting a goal to have access to a larger poolof investors. BAE also is considering a NYSE listing.Similarly, in June 2006, EADS announced it was seekinga listing on the Xetra Dax index of Germanys Deutsche

Borse, which would add liquidity to the stock and giveit greater exposure to investors.29 These moves also canincrease nancial transparency, as companies fulll the


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requirements set by different stock exchanges, whichis an attractive feature for some investors.

Such trends in foreign portfolio investment,however, are more than matched by cross-borderows of foreign direct investment (FDI), which haveexploded over the past decade (see Table 7). Accordingto the Organization for Economic Cooperation andDevelopment (OECD), an international organizationcomprised of the worlds 30 most developed economies,FDI ows have increased dramatically since the early1990s. FDI outows from OECD members rose fromabout $200 billion annually between 1990 and 1993 to$410 billion by 1997, $652 billion in 1998, over $1 trillionin 1999, and more than $1.2 trillion in 2000.30 Outowshave dropped sharply from the 1999-2000 boom years,but have been over $600 billion each year from 2001-05. Similarly, FDI inows among OECD members

passed $200 billion for the rst time in 1995, rising to$894 billion in 1999 and just under $1.3 trillion in 2000,before stabilizing in the $500-600 billion range in eachof the past 5 years. The stock of inward investmentamong OECD countries was estimated to be about$7.3 trillion in 2004a huge jump from $1.3 trillion in1990. FDI has a tremendous impact on the recipientcountrys economy. In 2004, U.S. afliates of foreign(majority-owned nonblank) companies employed 5.1million Americans, contributed $515 billion to U.S.GDP, and accounted for 19 percent of U.S. exports and26 percent of imports.31


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cuui

FDI Infows,

1996-2005

cuui

FDI Infows,

2002-051

OECD Members

United States 1,540 391

United Kingdom 653 262

Gr 425 100

fr 403 187

Netherlands 313 91

c 228 65

Si 225 113

Mexico 164 69

Sweden 157 25

I 115 67

J 60 26

Non-OECD

Countries

chi 239

Hong Kong 93Brzi 60

Ii 22

Russia 42

Figures are in US$ billion

1. Figures preliminary for 2004 and estimated for 2005

Source: Organization for Economic Cooperation and Development,Trends and Recent Developments in Foreign Direct Investment, June2006

Table 7. Foreign Direct Investment Flows,Selected Countries.

While FDI is expanding at a rapid pace for manycompanies, defense rms in general have beenlatecomers to this process. The United Nations


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Conference on Trade and Development (UNCTAD)ranks the transnationality of companies based on

their foreign assets, sales, and employment as apercentage of the companys totals in these areas.Interestingly, under UNCTADs measure, only twomajor defense companies rank among the worldstop 100 nonnancial transnational corporationsBAE Systems (ranked 17th) and United Technologies(ranked 49th). Although this measure does not takeinto account a companys global supply chain, itshould not be too surprising that defense companies,which long have focused on their relationship to theirhome government, have a much higher percentage oftheir assets, revenues, and employment based in theirhome country. Nonetheless, the trend for virtually alldefense companies in the United States and abroad isto extend their international operations. Consequently,

the remainder of this section focuses on aspects ofFDI that are of particular importance to the defenseindustry.

Mergers and Acquisitions.

The globalization of capital has contributed tothe growth in cross-border mergers and acquisitions(M&A) in nearly every sector, including defense. Inmany OECD countries, they account for more thanhalf of total FDI. Cross-border M&As to and fromthe 30 OECD countries amounted to $1.3 trillion in2005far more than the $281 billion in 1995 (see Table8).32 Global M&A activity (i.e., accounting for OECDand non-OECD members) was estimated to total $1.9

trillion for the rst half of 2006the highest half-yearvolume on record, including the dotcom boom in the1990s.33 Many of the deals have been nanced with cash


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reserves, including two-thirds of those occurring inthe rst quarter.34 This is one consequence of the cost-

cutting and balance sheet strengthening that companieshave undergone as a result of increasing internationalcompetition. Much of the M&A activity, particularlyin Europe where deals have outpaced the UnitedStates in 2006, is within industries. Such horizontalintegration, which seeks to build efciencies throughcost-cutting and economies of scale, has been slowerto come to Europe. But 2006 has seen Germanys Eonbid 29 billion for Spains Endesa in the utilities sector,and Enel of Italy seek to acquire the water and powercompany Suez of France (effectively blocked when theFrench government persuaded Gaz de France to mergewith Suez instead). Increasing integration within theEU, including the restructuring that was expected withthe introduction of the Euro, is helping to spur this

M&A activity.

Outward Inward

1995 134.1 146.5

2000 1,166.4 1,135.8

2003 321.3 337.8

2004 418.8 441.3

2005 670.8 626.9

Estimate2006

566.9 554.3

Figures are in US$ billion.

Source: Organization for Economic Cooperation and Development,Trends and Recent Developments in Foreign Direct Investment, June2006

Table 8. Cross-Border Mergers and Acquisitionsto and from OECD Countries.


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Within the defense industry, there is moreopportunity for M&A activity in Europe than in

the United States. As described earlier, much ofthe consolidation of the U.S. defense industry wascompleted by the mid-1990s. There was not much sig-nicant movement in Europe until the late 1990s. Therst wave of consolidations led to British Aerospacesacquisition of GEC and the formation of EADSthrough the uniting of French, German, and Spanishaerospace companies. It is very likely that a secondround of M&A activity is about to begin. Europes landvehicles and shipyards are ripe for consolidation, andEADS has made overtures to Thales. A union betweenthese two companies would give EADS a dominantpresence in defense electronics, but Thales has resistedthese overtures, despite encouragement from FrenchDefense Minister Michle Alliot-Marie to create a

single European satellite maker.35

However, thereis industrial (and political) logic to the unication ofThales with Italys Finmeccanica, since both companieshave closer relationships to the Pentagon and UKDefense Ministry than does EADS. Other companiesare restructuring in preparation for M&A activity. Inearly 2006, MBDA, Europes leading missile maker andco-owned by EADS (37.5 percent), BAE (37.5 percent),and Finmeccanica (25 percent), announced plans tocut 10 percent of its staff prior to embarking on a freshwave of cross-border consolidation.36

While still small when compared to the numberof mergers among U.S. companies, there havebeen signicant transatlantic deals that have beenfacilitated by increased capital mobility. In March

2005, BAE agreed to buy the U.S. combat vehicle andarmaments manufacturer United Defense Industriesfor $4.1 billion.37 The largest acquisition in BAEs


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history, nanced in part by the sale of stakes inseveral European joint ventures (including those with

Finmeccanica and Saab) worth about $1.9 billion, madethe companys U.S. arm the fth-largest defense rm inthe United States. Ironically, this deal came a year afterBAE thwarted General Dynamics attempt to acquirethe UK armored vehicle maker, Alvis, by offering ahigher bid, thereby engineering a national rather thantransatlantic consolidation in land vehicles.38

Defense industry M&As have followed a distinctpattern. The rst phase consisted of regional mergers(rst in the United States, followed by Europe) thatled to the formation of large companies in the defenseaerospace and electronics sectors. The second phaseappears to be unfolding in two ways: consolidation inthe land armaments and naval sectors, as well as largerms buying smaller ones on the opposite side of the

Atlantic Ocean.But it is talk of a big transatlantic aerospace

and defense industry merger that has captured theimagination of many executives and governmentofcials. Perhaps the most attractive European rmfrom the U.S. perspective is BAE. General Dynamics,Boeing, and Lockheed Martin all have negotiatedwith BAE, but the deals fell apart when BAE refusedto sell its protable and fast-growing North Americanoperations.39 BAE sells more to the U.S. Governmentthan any other non-U.S. company, which would makeit a valuable acquisition for a U.S. defense contractor.BAE Systems Inc., the U.S. subsidiary, has seen its salesgrow 250 percent in 5 years, and has made more thana dozen acquisitions since 2000.40 The U.S. subsidiary

also employs 45,000 of BAEs 100,000 workers.41 In fact,BAE is trying to be so American that it is on track tobe one of the top 20 corporate donors in the current


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and 2005 to stipulate that the acquisition of more than25 percent of the voting rights in a German company

producing armaments, ammunition, or cryptographicprograms has to be reported to the Federal Ministryof Economics and Labour.43 The Ministry then has theright to prevent the investment if necessary to safeguardimportant security interests. The list of coveredactivities was expanded in 2005 to include companiesproducing and developing engines and gear systemsfor tanks and similar armored military vehicles. InDecember 2004, the French government presented11 sectors (including: businesses relating to certaindual-use items and technology; cryptology services;weapons, munitions, and explosive substances formilitary purposes; and activities involving design orequipment supply contracts with the French DefenseMinistry) for which foreign investment would require

government authorization. Under the new rules, priorauthorization is needed for investment not only inarms manufacturing, but in all companies operating inthe interest of national defense. Russia, too, is in theprocess of drafting legislation regarding the protectionof strategic sectors from foreign ownership. Theproposed law would cover a few closed sectors andcontain a list of approximately 39 sectors, includingarms and defense-related sectors as well as nuclearenergy and aerospace industries, in which foreigninvestors would need government authorization toacquire more than 50 percent ownership.

The United States also is showing increasingsigns of protectionism with respect to FDI. In 2005,Chinas national oil company CNOOC sought to

acquire Unocal, but withdrew its bid once vociferousopposition was mounted within the United States. Inearly 2006, Dubai Ports World (DPW), a ports operator


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based in the United Arab Emirates, sought to acquireBritish-based P&O. The acquisition, which would have

placed six U.S. port terminals under DPW, faced evengreater criticism from Congress and a large segmentof the public. Much of the criticism was targeted atthe Committee on Foreign Investment in the UnitedStates (CFIUS), the secretive inter-agency panel thatreviews deals for potential national security problems.In response to the DPW controversy, Congress hassought to revise the procedure for reviewing foreignacquisitions of U.S. companies for security purposes,with House and Senate committees passing ratherdifferent bills in spring 2006. Among the proposalsare the development of a secret ranking system basedon a countrys relationship with the United States,including each countrys adherence to non-proliferationcontrol regimes and potential for trans-shipments or

diversions of militarily sensitive technologies, and moreCongressional oversight over CFIUS investigations.44Business groups, including the Organization forInternational Investment (OFII), which representsU.S. subsidiaries of foreign companies, have lobbiedCongress to not make regulations so stringent thatthe United States becomes an unattractive locationfor foreign investment.45 U.S. Secretary of HomelandSecurity Michael Chertoff suggested that the emotionalresponse to the acquisition threatens to damage thecountrys economy.46 Likewise, U.S. Treasury SecretaryJohn Snow and Bruce Josten, Executive Vice-Presidentat the U.S. Chamber of Commerce, expressed concernthat the reaction by lawmakers would send a signalthat foreign investments from certain parts of the

world, particularly the Middle East, are not welcome.In an era of ever-increasing cross-border deals, the

issue of whether national security will be adversely


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affected by the acquisition of U.S. assets will becomemore prominent. In March 2006, Frances Alcatel

reached an agreement with US-based Lucent to mergethe companies. While EU regulators and the U.S.Department of Justice and Federal Trade Commission(FTC) have approved the $36 billion merger, the CFIUShas yet to give its opinion. This merger does have asignicant national security dimension, since one ofLucents subsidiaries is Bell Labs, which has done muchwork in ballistic missile technology, submarine sonar,and communications satellites. The French governmenthad similar concerns about Alcatels sensitive militarycontracts, which were relieved when the companyssatellite business was acquired by Thales in exchangefor 1.7 billion and an increase in Alcatels stake inThales to 21.6 percent.47

Toshibas proposed acquisition of Westinghouse

will be scrutinized since the combined entity wouldbe the worlds largest nuclear power company. Thescrutiny is in part due to the Japanese companystarnished reputation in U.S. security circles. Toshiba gotinto trouble in 1988, when the United States banned U.S.Government procurements of Toshiba products andbanned imports of products from a Toshiba subsidiaryfor selling submarine-silencing equipment to theSoviet Union in violation of an international agreementamong countries, including Europe, the United Statesand Japan, to keep high-tech equipment with militaryuses out of the communist bloc.48 One consequenceof the DPW case is that companies may now believetheir deals must get approval from a broader range ofnational and state politicians, including key members

of Congress as well as governors, since approval fromformal channels (i.e., CFIUS, Department of Justice,and FTC) may not be sufcient.49


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Such actions in the United States and elsewhereprompted the OECD, in its 2006 report on trends and

recent developments in FDI, to conclude that, [w]hilemany developing and emerging economies continueto take steps to open their economies to internationalparticipation, the international security situationand fears of negative consequences of globalizationhave prompted the governments of several OECDcountries to review their FDI regulations. . . .Withoutcontesting sovereign nations right to regulate, thereis a risk that regulatory action may sometimes exceedwhat is needed to safeguard essential interests and bemotivated by protectionist motives.50 Care, therefore,must be taken to ensure that FDI even in defense anddefense-related industries is not deterred unless thenational security screen has met the highest standard.

Political obstacles exist on the European side as

well, particularly in areas like shipbuilding and landvehicles. Before being acquired by BAE, United Defensereportedly presented a takeover bid to GermanysRheinmetall, while General Dynamics was interestedin purchasing the 49 percent stake in KMW held bySiemens. However, the German government opposestakeovers of German military vehicles producersby U.S. companies.51 Additionally, the ownershipstructure of the military vehicles industry in Germanyand France makes international acquisitions difcult.Two families hold controlling stakes in KMW andRheinmetall, which serves to prohibit hostile takeoversand reduce the pressure for maximizing shareholdervalue. In France, state-ownership makes the acquisitionof GIAT all but impossible. Only BAE is a serious player

in transatlantic mergers in the land vehicles area, andit emphasized this position with its acquisition ofUnited Defense. With General Dynamics the only U.S.-


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owned producer of land vehicles, it is unlikely that thePentagon would permit the companys takeovereven

if there were a European company with whom such amerger would make strategic sense.

Privatization.

Another trend stimulated by globalization andwhich impacts foreign investment is the privatizationof assets formerly held by governments. Whilethis trend has affected companies in virtually allindustries, it has been somewhat slower to come tothe defense industry, which is not too surprisinggiven the delicate relationship of this sector to nationalsecurity. Nonetheless, European governments startedto privatize segments of their defense industry inthe mid-1990s, shedding control over some defense

companies partly to meet the nancial criteria of theEUs common currency, and partly due to ideologicalchanges that were shaped by increased internationalcompetition.

The trend has since progressed to other countries,with the case of India presenting both opportunitiesand challenges for U.S. defense companies.52 In March2006, India appointed private sector Indian companiesas prime contractors for rocket launchers. Until now,defense integration work has been done by governmentcorporations or by overseas suppliers. About 70 percentof Indias defense capital budget is spent abroad becauseof the limitations of its public sector, and because FDIin private sector defense companies was banned until2002. However, the government decided in 2005 that 30

percent of the value of foreign defense contracts over3 billion rupees (about $66 million) should be offsetby purchases, investments, and technology transfer


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including the Department of Defenses (DoD) abilityto circumvent competitive bidding rules in emergency

situations. Consequently, sole-source and other non-competitive contracts awarded by the Pentagon haveincreased 54 percent since 2000, from $65 billion to$100 billion. Although instances of fraud and waste areprevalent, including a nding by Defense Departmentauditors that Kellogg, Brown & Root (a Halliburtonsubsidiary) had billed the government $1.2 billion forquestionable charges, a Congressional Budget Ofcestudy suggests that outsourcing is still a net benet forthe Pentagon.

The liberalizing forces of privatization have hadmixed effects around the world. While the United Stateshas moved toward more subcontracting of previouslygovernment operated services, and some Europeancountries have sold off state defense assets, other

countries have been slowereven reluctantto initiatesuch actions. Indonesias parliament in 2004 passed abill requiring the countrys powerful military, knownas the TNI, to divest all the businesses it controlledwithin ve years. However, by the summer of 2006,the government had resigned itself to the fact that onlysix or seven of the TNIs 1,500 businesses would besold off.55 Amnesty International has singled out Chinafor selling a considerable amount of conventionalweapons and small arms to repressive regimes andparties involved in civil wars.56 Many of the companiesinvolved in the arms trade are companies establishedby the Peoples Liberation Army and the police stateagency, which benet from the revenues.

The privatization and liberalization pressures

of globalization also have their limits when theyconfront government-led industrialization strategies.In February 2006, Russia merged all of the countrys


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aircraft manufacturers (including Tupolev, Ilyushin,and Mig) into one state-run holding company (the

government intends to retain a 75 percent stake) to becalled Unied Aircraft Corporation (UAC).57 The newcompany will also incorporate Irkut, a publicly tradedcompany that is partly owned by EADS. Reecting themultidimensionality of globalization, Russia is alsolooking outward to develop strategic ties with foreignpartners. Airbus is in talks with the Russian governmentto create a $25 billion life-time partnership thatwould include developing new aircraft, orderingparts for the A-350 airliner, converting passenger jets to carry cargo, and nancing a new-generationaircraft program. Although the Russian government,as mentioned above, views aerospace as a strategicsector, it presented legislation that would loosenrestrictions on foreign participation in aircraft projects,

including up to 49 percent ownership stakes (up fromthe present 25 percent limit).58 This is characteristicof Russias current economic development strategy,which typically begins with domestic industryconsolidation with signicant government inuenceover the new entity, and then is followed by anopening to foreign partners with minority stakes.The hope is that domestic consolidation, followedby foreign investment and technology transfer, willrevive an aerospace industry that made one-quarterof the worlds aircraft during the Cold War years, buthas since faltered (the export of some MiG and Sukhoimilitary aircraft notwithstanding).

Production.

Another important dimension of globalization is amore complex level of international production. One


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of the motivating factors for companies to expand FDIis to have access to sources of production in multiple

locations. The reasons are both economic and political.Companies, searching for a different mix of workers,new markets, and technological developments, aremore willing to manufacture parts of their productsabroad. One benet is reduced costs, since producingsome or all of a product abroad may give rms costadvantages vis--vis their international competitors.While international economic competition is drivingmost of this process, politics also plays a key role in somesectors, particularly those that provide opportunitiesfor producing higher value-added goods, technologytransfer, good paying jobs (relative to what domesticrms typically pay), and higher levels of exports.Additionally, and especially pertinent to defense rms,production abroad may be necessary to win contracts

and sell products in other countries. The defenseindustry, and those sectors related to it like aerospace,electronics, and information technology (IT), is amongthe more prominent sectors that are driven by theseforces. While multi-nation weapons projects originatedin the 1960s, and were motivated primarily (but notexclusively) by political reasons, the scale, cost, andcomplexity of such programs today make cross-bordercollaborations an economic necessity.

One example is the Galileo projecta jointundertaking by the EU and the European SpaceAgency to be Europes alternative to the U.S. GlobalPositioning System (GPS).59 Galileo was given the go-ahead in May 2003 by European governments whoagreed to fund the 3.2 billion project. The target is to

have 27 satellites fully operational by 2008. However,Galileo is not a solely European project, as China hasagreed to invest 200 million in the collaboration,


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and India and Israel among other countries are alsolobbying to participate. Such countries are barred

from collaboration on GPS since it is largely a militarysystem run by the Pentagon. The EU views Galileo as amove away from dependence on the Pentagons GPS,and a step towards a common defense. It is telling thatnon-European countries have been included in, or mayyet join, Galileo. Their involvement reduces fundingrequirements from European defense budgets. The U.S.GPS system is closed to outsiders for security reasons.Corporate participants in Galileo include EADS,Thales, Alcatel (France), Inmarsat (UK), Finmeccanica,Aena (Spain), and Hispasat (Spain) in Europe, pluscompanies from a dozen other countries.

But the aerospace industry is perhaps themost competitive when it comes to developing aninternational production base. Aerospace is leading

other segments of the defense industry in developinga global base of production. Boeing and Airbus, theworlds two dominant aerospace companies, seemto regard the world as their playing eld, and as theUnited States and Soviet Union did during the ColdWar, they are ghting economic proxy wars throughthird parties.

While civilian aircraft outsell the military variety,there are technological spillovers that are increasinglygoing from the civilian to military direction. Bothcompanies experienced their best order year in 2005,and the growth of developing countries played a majorrole.60 In 2005, Airbus booked 526 plane orders in Asiavalued at $39.4 billion, while Boeing sold 381 planesvalued at $45.5 billion. China alone agreed to purchase

150 aircraft from each company. Carriers in China,India, and other Asian countries accounted for morethan 40 percent of the 2,057 airplanes that Airbus and


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Boeings 727 was non-American. By the mid-1990s, thishad increased to 30 percent in the 777 model. Going

forward, at least 70 percent of the 787 Dreamliner willbe built outside the United States, mostly in Japan.63

Airbus has not given up on Japan, even though itsmarket share there is only 1-2 percent. In February 2005,the company appointed a new head for its Japanese unitand vowed to break Boeings monopoly in the worldssecond largest civil aviation market, aiming for a 50percent market share by 2010.64 Given these obstacles,Airbus is responding to Boeings seeming strangleholdon the Japanese airline market and is cooperating withthat countrys aerospace industry with a wider Asianstrategy. Airbus executives envision the transformationof Airbus from a European champion to a globalcompany that can challenge an increasingly globalBoeing.65 Given Boeings strategy of building ties with

major Japanese companies, a plausible Airbus responsewould be to develop alliances in China. The companyalready has a joint venture there (an engineering centerwith a local aircraft manufacturer), and the Chinesehave been offered a ve percent risk-bearing shareof the new A350 model (designed to compete withBoeings 787). Airbus foresees similar collaborationwith local partners in India and Russia, both of whichare expected to experience strong growth in air trafcin coming years.

Given the stakes involved in the Boeing-Airbusrivalry, in terms of market share, exports, technologicalinnovation, and prestige, it is not surprising thatgovernment ofcials in the United States and Europeare working on their respective aerospace companys

behalf in Asia and other markets. U.S. Governmentofcials and their European equivalents play an activerole lobbying on behalf of their company. In early 2005,


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Britain, France, and Germany placed political pressureon Poland to buy Airbus aircraft valued at about $500

million for its state-owned carrier Lot.66

The leaders ofeach country at the time (Tony Blair, Jacques Chirac,and Gerhard Schroder, respectively) made the caseto the Polish government that the decision would bean implicit test of the countrys European credentials.In the end, under heavy pressure from U.S. ofcials,Poland chose to purchase seven Boeing 787s. By the endof the year, after even heavier lobbying by Europeanofcials, Airbus closed a deal to sell 150 A320 aircraft(worth almost $10 billion) to Chinese airlines, morethan the 70 planes (listed at about $4 billion) thatBoeing sold.67 Such intensive lobbying efforts are notalways successful. The French government has beenunsuccessful in persuading Norway, the Netherlands,South Korea, or Singapore to purchase the Dassault-

built Rafale ghter aircraft.68

The Europeans even are trying to build an aerospace

presence in the United States. According to EU tradecommissioner Peter Mandelson, the Airbus superjumboA380 will likely have more U.S.-built components thanthe Boeing 787.69 He also has claimed that Airbus buysabout $6 billion worth of U.S. goods a year, supporting140,000 jobs in 40 states. Airbus, in an effort to improveits image in the United States, took out a full two-pageadvertisement in the May 7, 2004 Washington Post. TitledAmerica is on board the A380, the advertisementlisted hundreds of U.S.-based suppliers, highlightedthe economic impact of Airbus in the United States,and stated that U.S. companies will produce half ofthe Airbus A380. Despite Boeings dominance in the

United States, the U.S. defense market is very attractiveto Airbus, and EADS even plans to build a factory inLouisiana to build air-refueling tankers, should it win


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an Air Force contract.70 If this project goes forward,Airbus would supply green aircraftcompletely

unequipped A330s assembled in Toulouse, whichwould be tted out at the U.S. plant.71

The intense rivalry between Airbus and Boeingpresents opportunities for other rms to play this totheir advantage. Italys Finmeccania has pursued sucha strategy to its benet. According to the Wall Street

Journal, Finmeccanica . . . reects the increasinglyglobal aerospace industry, where internationalpartnerships abound and rivals are interlaced throughcommon suppliers.72 For example, the Italian companysupplies Boeing with components for the 787, workswith Lockheed Martin and Northrop Grumman on the Joint Strike Fighter, and collaborates with LockheedMartin and Textrons Bell Helicopter unit on the MarineOne eet of presidential helicopters. Finmeccanica

also partners with Airbus on the A380, with BAE andEADS on the Euroghter, with Frances Alcatel onsatellite and space products, and with BAE and EADSon missiles. But the strategy of trying to develop closerelations with both Boeing and Airbus does carry risks.Part of the EUs response to the WTO case led by theU.S. (discussed below) is that the Italian governmentprovides aid to Boeing projects through Finmeccanica.Attempts by Airbus and EADS to bring Finmeccanicainto a tighter relationship, including offering the Italiancompany a ten percent stake in Airbus in 2000, havenot been successful.

U.S. defense companies that are more reliant ondefense sales, such as Lockheed Martin, NorthropGrumman, Raytheon, and General Dynamics, are

not under the same kind of pressure to expand theirinternational production base as are Boeing andAirbus. Their international strategy tends to take the


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form of collaborations that, for political and economicreasons, allocate development and production among

companies from different countries. While suchcollaborations are almost entirely between NorthAmerican and European companies, this may changeas other countries (thanks to Boeing and Airbus)develop greater capabilities in aerospace technologyand production.

For investment reasons already discussed, andlabor reasons that will be outlined below, productsupply chains now integrate multiple countries. Theglobalization of production is, in part, a response byrms to lower costs in an increasingly competitivemarketplace. Host countries see many opportunitiesfrom attracting FDI, and the increasing statelessnessof multinational corporations makes production ina variety of countries a necessary strategy. Boeing

is a good example of a U.S. defense company thathas developed increasingly intricate global supplychains. Boeing used to design and engineer allof its aircraft models itself. But with the new 787Dreamliner, Boeing has scoured the world to nd thebest possible suppliers (or partners in the upgradedterminology).73 Boeings new global partners number just under 100, far fewer than the 500-700 utilized inthe 777 aircraft; but each has a much higher degreeof responsibility for their portion of the work, as wellas the overall project. Similarly, Airbus counts 18,000suppliers in 30 countries (including 100,000 workers inthe United States) involved in the construction of theA380 superjumbo aircraft.74

Boeing and Airbus have two motivations for such

strategies. The rst is to increase efciencies by seekingthe best suppliersregardless of location. The secondis to persuade prospective buyers (such as nationally-


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owned airlines) to purchase their planes. For thesuppliers, and more specically, their governments,

this is an opportunity to build an aerospace anddefense industrial base. In June 2006, Airbus selected asite in Tianjin as the best location in China to assembleaircraft.75 Airbus forecasts that China will ordermore than $230 billion in new aircraft by 2023. Sincethe centrally-controlled ordering process is highly-politicized, Airbus is betting that building aircraft inChina (and the technology transfer that goes with it)will strengthen its position vis--vis Boeing. For China,this is part of an industrial strategy to build its aerospaceand defense sector since, as discussed earlier, there areclose links between the two.

While allocating production or assembly operationsto foreign companies has become a requirement tomake sales abroad, the sharing of technologies makes

this an extremely sensitive issue. Understandably,DoD does not want state-of-the-art technologies to fallinto the hands of potential adversaries, and so (alongwith Congress) places limits on what technologiescan go abroad and to which countries. This putsdefense companies in a very awkward positionifshared technologies fall into the wrong hands, rmswill be in trouble with the Pentagon; if restrictions ontechnology sharing are too tight, it will be difcultto consummate a sale to a foreign government. Thisissue has irritated participants in the F-35 Joint StrikeFighter (JSF) program.76 Originally designed to satisfythe requirements of the U.S. Air Force, Navy, andMarines, the $276 billion program was too expensivefor the United States to undertake on its own. Eight

countries agreed to participate in the program, withthe expectation that their nancial contributions wouldpermit them to have access to the planes technology


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(especially computer codes that would enable upgradesto be done without U.S. help), so that they can support

and maintain the aircraft during its 30- to 40-yearservice life. By the end of 2006, Australia, Canada,Denmark, Italy, the Netherlands, Norway, Turkey, andthe UK need to sign agreements committing them toproduction, but nearly every participant has threatenedthat their participation in production is dependent onsharing of technology. The United States insists thatthe JSF, whose design, development, and productionis managed by Lockheed Martin with substantialassistance from Northrop Grumman and BAE, willconsist of two versions: one for the United States andone for export. The UK, which already has committed$2 billion in development money to the JSF programand plans to buy 150 of the planes, is particularly upsetabout this outcome. Given its support for the wars in

Iraq and Afghanistan, the British government feelsthat their country is entitled to the highest levels oftechnology transfer and has threatened to pull out ofthe project if it is not treated as an equal partner.77

Despite the pressures of globalization, politicalobstacles still can distort the economics of armamentsproduction. EADS is demanding that the Britishgovernment guarantee the company a greater shareof defense and aerospace contracts in exchange forits continued investment in the UK, now that BAEhas sold its 20 percent stake in Airbus.78 Given thatEADS trails BAE and even Thales and Finmeccanicain terms of defense sales in the UK, London may haveto show more interest in EADS if it wants to ensurethat thousands of its citizens will continue to have

jobs supplying EADS with Airbus wings and otherproducts.


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participating in the Joint Strike Fighter and otherprograms. This example highlights the tensions that

may arise in devising policies to address components ofglobalization (e.g., technology, trade, and production)that have disparate effects on a particular industry.Technology even has changed the composition ofdefense industry rankings, with nontraditionalrms like L-3 Communications, Science ApplicationsInternational, and Computer Sciences Corp. nowamong the top U.S. rms in terms of defense revenues.

One consequence of increased international tradeis a corresponding increase in demand for naturalresources and raw materials. Global economic growthin recent years, particularly in booming economies likeChina, has increased the demand for commodities.During the summer of 2006, oil reached $78.40 a barrel,nickel surpassed $26,000 a ton, and copper topped

$8,000 a tonall records in nominal terms.80

The defenseindustry, which uses many of these commodities,particularly specialty metals, has borne increased costsas a result of the competition with other industries forsupplies. Boeing, for one, is engaged in an acceleratedeffort to improve productivity to combat the impacton its protability from rising prices for aluminum,titanium, carbon ber, and copper.81 Lightweightresilient metals such as titanium have wide applicationin aircraft, tanks, and armored vehicles. Such concernprompted the Pentagon to launch an investigation intowhether metal prices could affect the price of large-scaleweapons systems.82 In Congress, a version of the 2005defense bill raised concern over increasing reliance onforeign sources of supply for weapons programs, and

the House armed services committee recommendedthat the Pentagon review stockpiles to ensure themilitary had proper access to those materials.


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In response to these trends, China has opted toincrease its trade and investment ties with Africa, which

is home to many minerals used in industrial production,including oil. In fact, Chinas rapidly expandingeconomy has made it the worlds second largest oilimporter behind the United States. China-Africa tradehas nearly quadrupled since 2001, catapulting Chinato become the continents third biggest trading partnerbehind the United States and France, and there aresome 900 Chinese investment projects in Africa.83 About78,000 Chinese workers are in Africa, many working onoil, mining, and infrastructure projects. Oil companiesSinopec and CNOOC have made major investments incountries like Nigeria and Angola, and Africa suppliesalmost a third of Chinas oil imports.84 To the extentthat China may be a major national security concern forthe United States over the course of the 21st century,

Beijings efforts to secure supplies of oil, raw materials,and other commodities on the world market will impactthe costs for U.S. defense rms (and the prices that thePentagon and other buyers will be forced to pay). Ofcourse, Chinas weapons exports to Africa, such as the12 military aircraft sold to the repressive government ofZimbabwe in 2005-06, represents an entirely differentset of U.S. national security concerns.85

While increased global economic activity has ledto increased competition for certain industrial inputs,in many cases it also has forced down the prices ofnished goods. Some of these goods are, in turn, inputsinto weapons systems, thereby lowering the prices ofthese products. For example, at-screen panel priceshave dropped by 25-30 percent in the 12 months to July

2006 due to global oversupply.86The global arms trade is not governed by WTO

rules, since a country cannot be prevented from taking


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actions that it considers necessary for the protectionof its essential security interests. But the same forces

of globalization that have facilitated the trade ofnonarms goods and servicesmultinational supplychains, complex transportation logistics, penetrationof new markets, and innovative nancingalso havehelped the weapons industry. A more complicatedissue is the trade of dual-use goods, or goods that can beused for both civilian and military applications. In thesummer of 2006, the United States proposed to tightencontrols on the export of high technology goods toChina.87 While China obviously was disappointed bythe Department of Commerces plans, U.S. industry isexpected to mount a strong protest, arguing that foreigncompetitors are not bound by the same restrictions ontransfer of civilian technology.

Like the foreign investment trends discussed

above, the effects of increasing international tradeows affect defense companies in multifaceted ways.But perhaps the most intriguing is the increasinglycomplex manner in which they are interconnected. Ifrms want to enhance their opportunities to diversifytheir sales base by penetrating foreign markets, simplybuilding weapons and related products in their homecountry will no longer cut it. As a result, one option isto build alliances with strategic partners. This strategyhelps defense companies offset the disadvantage of notbeing a native rm.

For example, European governments are showinga growing inclination to procure weapons fromEuropean companies, which is upsetting some U.S.defense rms that often could rely on steady sales to

U.S. allies. Airbuss military subsidiary beat Boeingand Lockheed Martin to win a 20 billion contractto supply seven European countries with 180 new


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military transport aircraftthe A400M.88 The A400M,due into service in 2009, is the rst time Airbus has

undertaken an all-new project in the defense market.89

But the most important test for Airbus came in January2004, when the UK Ministry of Defence opted to spend$23 billion on refueling aircraft from EADS.90 The 27-year contract was a major blow to Boeing, which has anear monopoly on tanker aircraft, and to BAE, whichhad teamed up with the U.S. rm in the expectationthat they would win the competition. The EADS-headed consortium included Rolls-Royce, which willmanufacture the tankers engines, and Thales, whichwill produce much of the avionics in factories inBritain. Losing the UK contract would have effectivelyshut Airbus and EADS out of the tanker market. Whilethe actual factors determining the outcome of thedecision may never be known, it is likely that national

industrial issues played a major role. The Airbus-ledteam, AirTanker, emphasized that its A330s are builtpartly in the UK, and half of all new planes and 90percent of conversions of the old aircraft used for theirbid will be built in the UK. AirTanker claimed that7,500 jobs would be added or sustained if their bid waspicked, while Boeings team could claim just 5,000.

LABOR

Globalization has impacted labor, too. Highly-skilled workers are sought by technology and otherhigh-value-added rms, especially those in the defensesector. In many cases, globalization has made theseworkers more mobile than ever before, and in those

globalization and its implications for the defense industrial base pub756

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