Why Britain’s defence industry may regret Brexit

Rishi Sunak wants to put Britain’s defence industry on a “war footing”. The UK prime minister’s pledge to increase defence spending to 2.5 per cent of GDP in response to the war in Ukraine and other threats is welcome news for companies like BAE Systems and the legion of other organisations that make up Europe’s largest defence sector.

Even before Sunak’s intervention, their order books were bulging as governments around the world stepped up spending. Shares in BAE Systems, Britain’s leading contractor, have surged 40 per cent over the past 12 months — far ahead of the broader UK index. 

Hopes of an advance on one key front, however, look likely to be frustrated. The EU is similarly rushing to bolster defence budgets and industrial resilience, but Brexit means Britain’s industry could be excluded. Ursula von der Leyen, European Commission president, told an industry conference this year that as part of the bloc’s first ever defence industrial strategy it was important to “spend more, spend better, spend European”. The initiative is subject to suggestions from member states. It remains to be seen exactly how the rules will work in practice, but it has already set alarm bells ringing among UK executives.

“It’s a good thing that the commission wants to talk about the defence industry, but there is concern about the setting of broad political targets as part of the new strategy,” said one.

The strategy has set a target to procure at least 50 per cent of its budget from European defence suppliers by 2030 and 60 per cent by 2035. The ambition is to boost the bloc’s resilience in part by reversing the trend of member states buying foreign-made equipment. Although US weapons are the main target here, it will also hit UK industry. British companies will only be able to participate on the same third-country basis as other non-EU members.

In the four years since Britain’s departure from the EU, the UK industry has in effect already been shut out of certain activities such as the nearly €8bn European Defence Fund — third-country companies can only benefit from funding if they meet certain conditions and operate on EU soil. But the worry is that the strategy’s political intent will be more far-reaching and exclude UK companies from new programmes. 

“Ukraine has demonstrated that industrial capacity is a considerable part of a nation’s national security,” said Kevin Craven, chief executive of ADS, the UK industry trade group.  “The point is that there is an opportunity cost for the UK defence industry in not being able to participate in the future EU defence industrial strategy.”

One particular concern is that existing industrial partnerships may be stifled. BAE generates more than 40 per cent of its annual sales from the US but the company remains a large player in Europe, in part through collaborative programmes. It is one of the main shareholders in MBDA, the European missile champion. Many smaller UK companies in the supply chain are also involved. 

Brussels insiders say that while there is a lot of sympathy for UK industry, the rules for companies from third countries are clear. They also point out that it was at the UK’s insistence that the EU-UK defence and security relationship was excluded from the 2020 Brexit negotiations.  

Long-standing defence observers, however, argue that there is also a cost to the bloc if it unilaterally excludes UK industrial involvement. Before Brexit, the UK accounted for about 20 per cent of all military capabilities within the EU, according to the International Institute for Strategic Studies.  Several European companies, including Airbus and Leonardo, also have large operations in the UK. There is some uncertainty how these might be treated under the new EU defence strategy. 

One senior UK industry executive says: “This is about the health of the European defence industrial base. What we want to avoid is mutually assured disruption.”

Russia’s invasion of Ukraine has proven to be a watershed moment for European security and for Europe’s defence industry. The war has led to close co-operation between the EU and the UK in their efforts to aid Ukraine’s armed forces. There is some optimism that closer industrial co-operation may yet be possible if the two sides can agree on a defence and security pact. If policymakers in both camps can accept that defence is more about the geography of Europe than political demarcations, the door may not remain shut to UK industry forever.

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