Analysis: Defense in firing line as Europe begins budget cuts

By Peter Apps, Political Risk Correspondent

LONDON (BestGrowthStock) – For European policymakers desperate to cut spending, the defense budget looks an appealing option. But military chiefs and arms firms will lobby hard, arguing that jobs and geopolitical clout are on the line.

In the early going of the financial crisis, defense budgets were under little pressure and indeed were often seen as part of a wider economic stimulus effort. But with the focus shifting to austerity and rebalancing books, that dynamic will change.

“In the short term, defense is an obvious area to cut,” said Jonathan Wood, global issues analyst for the London-based consultancy Control Risks. “It doesn’t have the same political dangers as cutting social spending.”

Britain’s new government is already pushing through a comprehensive defense review, making it clear that military budgets will come under particular pressure. Other European governments have frozen key decisions.

Across the continent, the main choice will be whether to scale back or axe major projects — warships, aircraft, new vehicles — or cut manpower including sometimes bloated conscript or formerly conscript armies.

“My worry is that they do precisely the wrong thing and keep the numbers while cutting the kit we really need, particularly heavy airlift and helicopters,” said Giles Merritt, director of Security and Defense Agenda, a Brussels-based think tank.

That could hit the value of firms such as BAE Systems (BAES.L: ), Finmeccanica (SIFI.MI: ) and EADS (EAD.PA: ).

“Valuations for European defense stocks continue to look attractive, (but) this alone will not be enough to drive these stocks upwards,” wrote Morgan Stanley analysts. “Near-term news flow around European defense budgets is likely to be negative.”

But the companies are fighting back.

THREATS OVER JOBS

“At worst, firms like BAE can threaten that they might move their domicile somewhere else — and you know what that would mean for jobs,” said defense analyst and former lobbyist Robin Ashby.

That may mean which projects survive could depend as much on domestic electoral politics as strategic need.

For example, Britain’s junior coalition partner Liberal Democrats are generally cautious on defense spending but enthusiastic about it in their keystone southwestern constituencies.

Policymakers are also hamstrung by the costs of cancelling pre-committed projects. Short-term costs — payroll, fuel — are easier to cut, but risk leaving costly equipment unused and wasted.

Immediate commitments such as Afghanistan also make it politically dangerous to be seen as cutting support for troops.

“Short-term projects aimed at keeping soldiers safe will get priority,” said Alastair Newton, once a diplomat and civil servant responsible for spending cuts and now a political analyst for Nomura. “Other projects will be more vulnerable. There will be a lot of swapping between budgets.”

Britain’s Foreign Office and Ministry of Defense would particularly look at how they could use funding from the Department for International Development (DFID) that looks to have been ringfenced, he said.

On one level, analysts perceive a drive to high-tech new solutions: drones, satellites, robots and cyberwarfare. But powerful vested interests protect the status quo.

Most analysts agree there are multiple savings that could be made. Britain’s Parachute Regiment and Royal Marines could be combined into one elite unit, for example, Ashby suggests. All three services — army, navy, air force — could even be merged into one.

HITTING EUROPE’S CLOUT

But virtually no one expects defense chief to back that idea since they are desperate to protect their key jets, ships and regiments. “They are not only protecting their services, they are protecting career structures,” says former lobbyist Ashby.

A nascent protectionism — at least in the short term — means few expect any drive to set up new multinational projects as governments hunker down to try to protect domestic industry.

“I think it will get worse before it gets better,” said former European Defense Agency chief Nick Witney, now a senior policy fellow at the European Council on Foreign Relations.

“I think after 18 months or so… the logic of pooling effort and resources will reassert itself, I hope.”

That could see France and Britain, the two military powerhouses of the European continent, come together with projects on tanker aircraft.

In the meantime, which projects live or die might also heavily depend on what stage they are at. The A400M cargo aircraft is regarded as sufficiently advanced to be relatively safe, Witney says, while the chances of funding a helicopter program — still at a much earlier stage — are more remote.

Europe might be finding making defense cuts is tough, but the United States — by far the world’s biggest defense spender — is expected to struggle even more as it starts to look at its own military budget as operations in Afghanistan wind down.

“The military-industrial lobby… is much more entrenched in the American political system than in the European so it’s less likely to see as serious a hit,” said Ian Bremmer, president of political risk consultancy Eurasia Group.

That means Europe will be cutting defense spending faster than anywhere else at a time when emerging powers — particularly China and India — are building.

Some argue that short-termist policy-making could further reduce the continent’s dwindling global clout.

“This is part of a much larger story,” said Nomura’s Newton. “It’s been a bad year for Europe. They were more or less sidelined in the Copenhagen climate talks and the euro zone crisis has really undermined them. This will play into that.”

(Additional reporting by Tim Hepher in Farnborough and David Brunnstrom in Brussels; Editing by Mark Heinrich)

Analysis: Defense in firing line as Europe begins budget cuts