The evolution of defence trade

[A.V.]

The years 2000 to 2008 saw a shift in defence industrial partnerships as countries sought alternative sources of defence materiel. Fenella McGerty analyses recent trends in defence trade and considers the shifting shape of the global military markets

The United States' position as the world's dominant military exporter since the Cold War-era is swiftly being eroded by the growth in Russian and European supply.

The hegemony of the US as an exporter of major arms has declined to the extent that, by 2008, Russia had matched the US share of global arms imports at around 27 per cent. This reflects Russia's resurgence in the world markets following the post-Soviet hiatus of the 1990s and early 2000s. Around 2000, the US supplied 40 per cent of the entire world's arms. The decline in the UK share of global imports from 8 per cent in 2000 to 5 per cent in 2008 has been offset in Europe by an increase in the share of total sales for Dutch, French, German, Italian and Spanish materiel.

The source of this increased demand can be found in Asia (40 per cent of global imports in 2008) and South America (8 per cent of global imports in 2008), boosted by welling defence budgets and heightened security threats in countries like India, Pakistan, and South Korea.

South American demand has grown to nearly 8 per cent of global imports in 2008, from 4 per cent in 2000, due to increasing demand in Chile,Venezuela and arguably Colombia. Conversely, the European share of global arms imports has fallen since 2000 as Western European nations have developed their defence industrial bases and consequently demand for foreign arms has declined in favour of indigenous production.

The make-up of the defence industrial landscape will be shaped over the coming years by the rise in emerging defence equipment exporters in Asia (China to a significant extent, although South Korea's export ambitions are notable) and aggressive military export strategies in Russia and China, which will threaten Western dominance in what were traditionally perceived as "guaranteed markets" for Western producers.

The rise of Europe
While the arms import market is limited to four regions of the world, European arms export destinations are far more varied, with trade reaching almost all regions. The second largest arms export market for Europe is Asia. Trade between these two regions is one-sided: Europe imports very little from Asia, with countries such as India, Indonesia, Singapore and South Korea making up the majority of the demand. Exports to this region for many European countries has been on an upward trajectory over the past three years and this trend is likely to continue as Asian defence spending increases and defence industrial bases develop.

South America, despite being regarded as a new frontier in the global market with ever-increasing requirements and procurement budgets, has actually begun to decline as a proportion of total European exports, implying that the relative importance of the region to the export market has fallen, or that other exporters (again, Russia is a notable example) have gained ground.

The continuing political and social instability inherent in countries such as Colombia and Venezuela are a possible reason for this underwhelming volume of trade.

However, countries such as France and Sweden are expected to push into this market over the next couple of years, so the proportion should begin to increase.

Exports to the Middle East fell by two thirds between 2005 and 2008. Defence trade between Europe and the Middle East is dominated by exports to the United Arab Emirates (UAE) from France.

By far the most significant market for French exports in recent years has been the UAE, accounting for 30 per cent of all French arms exports. This trend is likely to continue because the UAE is considering Dassault's Rafale multirole aircraft to replace its 63 ageing Mirage 2000-9s. Furthermore, the UAE lies at the centre of the new strategic arc identified in the 2008 French White Paper - known as the "arc of crisis from the Atlantic to the Indian Ocean" - where security concerns threaten access to natural resources.

Russia and the CIS
Russia imports very little from foreign nations, choosing to maintain a high level of domestic arms production and only using imports to fill any technology gaps that develop. Between 2005 and 2008, only Ukraine and Germany exported major arms to Russia.

In 2009, however, French companies Safran and Thales signed two co-operation agreements with the Russian state conglomerate Rostechnologies, so there is potential for enhanced defence trade between the two regions. Almost 90 per cent of imports to the non-Russian Commonwealth of Independent States (CIS) are from Russia; the other 10 per cent were sourced from Belarus, Germany, Israel and South Korea.

The favourable contract terms offered by Russia means that this pattern of distribution will continue well into the next decade, although further imports from Asia are expected as industries develop there. Asia accounts for the vast majority of the export market, dominated by Russia's exports to India and to a declining degree, China. Beyond this, trade between Ukraine and China is also significant and exports to South America are likely to continue to increase, following trade agreements with Venezuela.

Asia
The growth in Asian arms imports to almost 40 per cent of global arms imports is largely attributable to increasing demand in India, Pakistan, Singapore and South Korea, which has offset the decline in China. Arms imports to China accounted for nearly 11 per cent of global arms imports in 2000, but by 2008 its import demand had shrunk to 6 per cent of the market.

While defence trade in the region is dominated by China, in terms of both exports and imports, India is becoming increasingly significant as an importer.

The regional dominance of Russia has waned over the past two years, threatened by the growth of European influence in the region. For example, Singapore imports from France doubled in 2008 following the delivery of 144 MBDA Aster missiles for La Fayette (Formidable) frigates as part of the USD1.6 billion 'Project Delta'. The US has maintained its presence in the region.

In 2005, Russia and the CIS accounted for 57 per cent of imports, while North/Central America supplied 30 per cent. While North America saw a slight fall in import share, Russian imports have slumped to 37 per cent. A convergence is evident between Europe, the US and Russia's market share.

Oceana
Despite high levels of economic trade between the regions, Australia and New Zealand trade very little with their Asian neighbours when it comes to military equipment.

Limited defence capabilities aside, the non-existence of defence trade between Oceana and Asia would suggest that economic ties and geographic proximity have little to do with the emergence of defence trade.

Both regions chose to import from Europe or North/Central America rather than each other: in the Asia Pacific region, defence trade is more centred around traditional political ties and strategic manoeuvres - otherwise we would see greater trade between Oceana and India, South Korea, China and Russia.

North/Central America
The North American share of global imports has remained constant, as the decrease in Canadian and Mexican demand for foreign arms has been offset by the increase in US imports. A potential reason for this is increased trade between the US and Europe. European defence industrial bases are developing, as evidenced in the increase in the European share of the export market from 29 per cent in 2000 to 39 per cent in 2008.

The spike in imports from Russia and the CIS was caused by delivery of five Mi-8/M-17 helicopters in 2006. In general, Mexico imports from Europe or the US.

Canada's greatest importer by far is the US, which pushes up the North/Central America section in the graph below. Israel accounts for the vast majority of the Middle Eastern imports, while South Africa is the only region in

sub-Saharan Africa that imports to North/Central America.

The US is the biggest importer in the North/Central region and the majority of US arms imports come from Europe. The UK has become increasingly significant in recent years as well as Germany, in line with the high level of economic trade between the US and Europe. The EU is the main destination for general US exports - only narrowly ahead of Canada - and the main source of US economic imports - narrowly ahead of China.

North/Central American exports
The primary export markets for Canada and the US (there is no export data for Mexico) are the Middle East/North African regions and Asia, with the European share growing in recent years following a sharp increase in US exports to Poland, Greece and Denmark in 2007 and to the UK in 2008.

Demand for US/Canadian weapons has declined in the Middle East/North African region while exports to Europe have soared since 2007.

Given the proximity to South America, the high level of economic dependence most South American states have on the US and the significant developments apparent in defence expenditure, arms exports to the continent remain subdued. Increases in Brazilian equipment spending are likely to benefit European markets over the US, while the embargo against Venezuela means that trade here will be lost to Russia.

Limited export growth in South America is likely to continue while European and Asian markets are likely to increase, the former due to shifting attitudes towards US manufactured goods and the latter due to increasing defence budgets and more ambitious capability desires in the regions. Further, it is notable that for a number of decades the US did not look favourably on sophisticated exports to South America because of local instabilities. While that has changed, it obviated a foothold in that region that was exploited by Europe and Russia, and is increasingly being eyed by China.

South America
Recent years have seen a significant decline in imports from Europe, largely due to declining trade with France in 2006, Spain in 2007 and Italy in 2008.

The decrease has been so extensive that 2008 saw Russian imports to the region exceed the cumulative efforts of Europe, following extensive trading with Venezuela. Russian imports to Venezuela have grown by 77 per cent in the years 2006-08 and growth is likely to continue as Russia seeks further export markets outside Asia and takes advantage of the embargo that the US has had against Venezuela since 2006. The presence of heavy embargoes is a major factor shaping defence trade and partnerships in the continent.

Significant imports from France and Italy are expected over the coming years into Brazil, so the European portion of imports should increase leaving the North/Central America market to decline.

Having limited regional capabilities, major defence exports tend to be with neighbouring South American countries, with the major exception being the 2008 delivery of four EMB-145 airborne early warning and control (AEW&C) aircraft from Brazil's Embraer to Greece. Further penetration into the European market is likely as offset obligations from significant deals over the next two years - for example the FX-2 programme - enhance indigenous capabilities.

High levels of Foreign Military Financing (FMF) allocations from the US to Egypt, Israel, Jordan, and, to a certain extent, Morocco and Bahrain, mean that defence imports to the Middle East and North Africa are distorted and heavily biased towards the US.

FMF contributes to the nations' defence budgets, but the monies must be spent on US-produced goods. Even beyond these countries, however, defence trade with the US is prevalent in many Middle Eastern countries - namely Saudi Arabia and the UAE where economic ties exist. In 2008, the US accounted for 17.5 per cent of Saudi Arabian economy-wide exports and 13.6 per cent of total imports.

The Middle East/North African region has not imported defence materiel from Oceana or South America over the past four years. Russia's perseverance in countries such as Algeria, and willingness to trade with Iran, has led to growth in the Russia and CIS category above, seemingly at the expense of Europe and North America. Russia accounted for 71 per cent of all major arms imports to Iran between 2005 and 2008.

Israel is by far the dominant arms exporter in the region - indeed the ninth greatest exporter in the world in 2008 - trading with 35 countries globally while any other exporters in the region deal with an average of three countries.

The overbearance of European and Asian exports in the above chart is a reflection of the extent of the reliance that the Israeli export market has on the regions.

Defence industrial base development
A country will often start with heavy reliance on a major supplier. The bipolar world that emerged after the close of the Second World War led to clear lines of demarcation, and - in the majority of cases - reliance by nations on either the US or the then-USSR (or indeed a major European nation) to meet materiel requirements. Such reliance was a feature of materiel markets for around three decades after 1945.

The country will then turn to other economic trading partners as an alternative source of arms imports, be those regional or of colonial influence. Bolivia, for example, relies on Brazil (regional dependence) for arms imports, while Venezuela traditionally relied on Spain (economic dependence) as a source of major weapons.

Most countries are still in this phase, with a highly dependent relationship on a dominant supplier - France, Russia, the UK, and the US - with arms imports from economic and regional trading partners beginning to rise.

Through such trade, a country may begin to develop a primitive offset policy or participation strategy that allows some local construction or technology transfer. At this second stage of development, there is limited benefit through employment in the defence industry as well as the emergence of basic capabilities.

Thailand is arguably at this stage, with a nascent offset policy allowing limited technology transfer leading to low-level capabilities. At this stage, any arms exports will be limited, owing largely to surplus inventory stock rather than indigenously produced materiel.

As a country develops capabilities, the tendency is to then look towards markets where more sophisticated equipment can be acquired on favourable terms: often this opportunity can be found in Russia and occasionally the Middle East.

Many countries in the Middle East itself appear to be in this phase - moving from traditional economic trading partners in Europe and the US towards Russia - for example Iran, Iraq and Syria.

At this stage, a country may have developed an advanced industrial participation strategy, with technology transfer and development of local maintenance capabilities.

The country now has a greater degree of self reliance and is able to export arms to regional dependents. Development of a capable defence industrial base (through technology transfer from supplying nations, or long-term research and development (R&D) investment) typically leads to defence trade with more advanced markets, such as those of the EU member states (particularly so if historical trading links existed) on a relatively equal footing.

The equipment imported at this stage is likely to be more sophisticated and the value/volume of exports will increase. Australia and Singapore are two such examples at present.

The final phase is the indigenous development and export of high-value, high-technology equipment and systems. It is arguable that Western European countries - to a greater or lesser degree - have reached such a stage.

There are, of course, wider factors that accelerate or retard such a course of development, notably individual national strategies; national abilities; and general economic development.

In theory, the speed at which a country can reach the final stage of defence industrial development depends on factors such as the strength of economic growth, the extent of human capital, the political will to have highly advanced indigenous capabilities, and wider geopolitical factors.

Fenella McGerty is Jane's Defence Economics Analyst, based in London

article courtesy :- janes defence weekly