The Sipri annual report published last December revealed that the global arms industry had declined for the third year in a row. There has been progressively slowing demand for weaponry following the end of the Cold War, and that demand has dropped further as a result of NATO’s shrinking world budget since the onset of the 2008 financial crisis. Amid this disappointing backdrop, one market stands out in terms of achieving revenue growth in recent years: Russia.
The defence budget
The US is the most prolific in terms of weapons manufacturing and sales, with a defence budget that is bigger than 15 countries combined (see Fig. 1) – an incredible ranking for any industry. While the US will continue to dictate the global industry by means of its sheer size (see Fig. 2), this formidable market is now under pressure. “The decline in arms sales in the US, in our analysis, is mostly due to the decrease in the operations budget, so that directly affects the industry because these budgets also buy weapons and services”, says Dr Aude Fleurant, Programme Director at Sipri, a research centre specialising in arms and the military. Namely, the 2011 Budget Control Act that was introduced in order to reduce the budget deficit of $2.1trn by 2021 has had a detrimental impact on arms sales in the US.
While revenue in the US has fallen, Russia’s arms industry is doing increasingly well. But despite its increase of the global market share, Russian producers now face a possible hindrance as a result of the country’s recent economic woes. Currently, the state budget is experiencing considerable pressure due to Western sanctions and the drastic fall of the rouble. The implications for the arms industry are yet to be seen, but perhaps they will not even come about. “There might be ring fencing of the defence investment in order to pursue the effort in modernising the Russian defence industry, because the Russian objective is to upgrade and update the defence industry so that it can become more competitive on the international stage and more efficient – but they have not actually met these objectives yet”, explains Dr Fleurant. Tensions with Ukraine and last year’s annexation of Crimea give further validation for Moscow to maintain its current defence strategy and continue to bolster its capabilities, in spite of the state’s fiscal crisis.
A number of countries prefer to purchase Russian or Chinese equipment over US counterparts, not only due to much lower prices, but also because of traditional alliances
Sales in Western Europe, on the other hand, have been mixed, largely as a result of the varying defence programmes and budgets of each state. Furthermore, unlike the collaborative efforts made towards economic integration, the same has not been achieved for security. The UK, the world’s second largest producer – like the US – has experienced a drop in sales. While French firms Dassault and DCNS, have climbed the ranks of Sipri’s top 100 arms-producing companies report for 2013.
Further reflecting the heterogeneous nature of the European market are Spain’s Navantia and Italy’s Finmeccanica, which have both fallen in Sipri’s rankings. The performance of Navantia and Finmeccanica correlates with the mounting fiscal debt inflicting their respective states and indicates the vulnerability of a country’s defence industry to national economic pressures.
Domestic demand
The US Department of Defence has enforced a number of changes that have considerably reduced domestic demand. First, it has implemented a policy of upgrading weaponry as opposed to frequent replacements. In addition, according to the Performance of the Defence Acquisition System 2014 Annual Report, the Pentagon is attempting to administer more sophisticated and individually tailored contracts, as the traditional format is known for encouraging overspending.
Furthermore, the withdrawal from Iraq and Afghanistan has also reduced the weaponry requirements of the US Government drastically. Public outrage and global pressures have influenced this radical change in foreign policy, thereby highlighting the susceptibility of the industry to the political paradigm. As demonstrated in this case, foreign policies can change suddenly and drastically; the direct impact on arms manufacturers is immediate. As such, US producers must now await another ‘peace-keeping excursion’ in order to significantly bolster their sales again.
Despite the general downturn in the global weapons market largely resulting from economic pressures, Russia’s gains are the result of an investment strategy that was administered in the 2000s. Funding was furthered when the State Armaments Programme was implemented in 2008 and instigated the radical renovation of the Russian Ministry of Defence. The transformation began with the reorganisation of the military’s structure from divisions to brigades, and was then followed by the armament of the newly-formed contingents.
Reflecting this change in policy is the state’s three most prolific firms that have had a combined revenue growth of 172 percent in 2013 from the previous year. What is striking about the recent success of Russian arms producers is the timescale required to turn investment into profit, a standard protocol for the industry. In order to advance revenue growth, heavy investment and a long-term strategy is required, both of which can be interrupted if domestic or global political circumstances interfere; making the nature of this industry more precarious and protracted than most.
Japan is another market in which domestic demand is on the rise as its defence policy – which has been notoriously subdued for decades – begins to change. Threats from ISIS insurgents, including the recent beheading of two Japanese citizens, has brought into focus the country’s legal obstruction of deploying troops abroad. In addition, verbal clashes with China regarding territorial waters and provocation by North Korea as it tests rockets near the Japanese border have given Prime Minister Abe a strong pretext to drastically shift this aspect of the country’s foreign policy.
As a result, Japan augmented its defence budget to a record JPY 4.98trn ($4.3bn) in January, according to Bloomberg – in spite of the economic challenges currently facing the state. Not only will increased power overseas bring Japan in closer alignment with the security strategy of other nations, it will also have a positive impact for the country’s arms industry.
Exporting weaponry
There are further hopes of bolstering the revenue of Japanese products through the overseas market. Since 1967, the state’s ban on the export of almost all weaponry had restricted its arms industry to domestic sales. In another bold move made by Abe, the once strict regulations were eased last year. Mitsubishi Heavy Industries was the first to be awarded with an arms export licence, and has signed agreements to sell its sensors for US missiles and propulsion technology for Australian submarines.
Opening up Japanese producers to foreign markets can allow economies of scale to be achieved, a significant factor when considering that for the past five decades the customer base has consisted of just one patron. Despite a great deal of anticipation from Japanese manufacturers, a significant increase of exports is doubtful due to the nature of the global arms industry. International competition is greater than ever, therefore the gap available in the market for expensive Japanese products may only be marginal.
There is also a group of newcomers to the industry that have begun to increase their respective sales and attract attention: India, Brazil and Turkey. South Korea is a notable case as a rising player on the international scene, with sales of fighter jets to the Philippines, Indonesia and Iraq.
Despite relative success of emerging producers in recent years, their profit growth is capped by the fierce level of competition for exports. In addition, achieving long-term projects is an extremely complex and costly business and so presents another limitation to emerging economies. Furthermore, Dr Fleurant argues that the success of these new suppliers has been overstated: “In truly quantitative terms, their place as arms producers is not that important, but they attract a lot of attention from traditional suppliers”.
There is another new challenge facing the saturated market: competition from the ever-growing and increasingly influential tech industry. As a by-product of greater investment and research capabilities, tech companies are currently exploring the field of innovative weaponry, such as robotics and exoskeletons. There has been considerable media attention about this overlap of the two spheres, most likely because it appears to be a logical convergence of the two industries.
Yet, the reality of this trend is yet to transpire as there are a series of inhibitive factors that prevent the tech industry from supplying weaponry. The extremely long lead times for development and commercialisation in the defence industry are a far cry from those in the tech sector. This is largely due to military standards and export controls, which are far more rigorous and demanding than those required for commercial products. The drastically different nature of the two markets raises further doubts; with the civilian consumer base being so much wider, varied and more profitable, the hurdles affiliated with the defence industry may make the much-talked-about endeavours of tech companies un-viable.
Unlike other industries, the arms market is impossible to forecast. As customers are governments, and defence budgets are determined both by a state’s economic success and the geopolitical climate – industry experts cannot predict how markets will evolve in the coming years. With that being said, it is likely that the fierce competition prevalent in the export market will continue. Global economic growth continues at a slow rate, thereby constricting defence spending in general. Furthermore, sales are tied into the long-standing relations between states that make it extremely difficult for a new supplier to make headway into an established buyer-seller relationship, particularly as politics are principally at play. For example, a number of countries prefer to purchase Russian or Chinese equipment over US counterparts, not only due to much lower prices, but also because of traditional alliances.
Sluggish GDP growth means that a state’s defence budget is a popular target for cuts, particularly in light of growing social and political pressures. Therefore, in consideration of such a restrictive client base and flagging domestic demand, it is increasingly necessary for arms manufacturers to evolve. Their strategy and product line are in much need of diversification in order to reverse the current trend of falling profits and vast job cuts.
Although some firms are reluctant to expand into the civilian sphere, the scope for modifying products exists, and has potential; examples include vehicle components and hi-tech systems. Of course, there are challenges inherent to this kind of adaptation for any industry, in addition to those attached specifically to weapon manufacturers, which include public disapproval and reluctance from potential business partners. Yet even for those who are against the industry as whole, this is a logical step, and one that should be encouraged both internally and externally.
