The Restructuring of the International Arms Industry

J Paul Dunne, Maria Garcia Alonso, Paul Levine, and Ron Smith

UWE, Kent, Surrey and Birkbeck

http://carecon.org.uk/Armsproduction

Context

• Declining military spending and procurement

• Peaked in mid 1980s fell gradually and then rapidly

• Arms trade halved mid 1980s-90s

Context

• Production for military not homogeneous– Large and small etc

• Features:– Concentration of production– high fixed R&D costs– steep learning curves– mes large relative to size of market– problems when demand declines

Context

• Particular characteristics of major weapons system production have led to rather particular corporate structures

• Role of government: whether private or public• Difference from civil

– Performance rather than cost– Risk borne by govt– Elaborate rules and regulations– National ownership– Incumbents favoured– Considerable barriers to entry and exit– Need to get funds out of government rather than produce for

market

End of Cold War

• End of Cold War– quantitative change in demand: bottomed out– qualitative change in demand– hangover from previous designs– technology: spin off to spin in– national DIB infeasible: structural disarmament– changes in government policy to DIB– Revolution in Military Affairs

Government dilemma

• Introduce Competition– reduce prices– problem maintain competition– problem maintain innovation

• Tension between benefits of scale and competition

• Problem of security of supply?

Corporate Options

• Firm responses– convert– diversify– cooperate– concentrate– internationalise

Company Changes

• Systems integrators• Subcontracting• International supply chains• Cross ownership, joint ventures• Hollowing out: role of finance capital• Spin in rather than spin off: COTS• Intra network trade• Marketing and lobbying

Restructuring

• US Defence Mergers• Concentration evident• European restructuring different

– Ownership differences

– Still consolidation

– Requires cross country mergers• BAE systems

• EADS

• Thales: Racal

Restructuring

• Continuing concentration but not so much to reduce capacity as to gain new capabilities– Ended for majors– Still going on for smaller companies

• New companies joining club– IT, electronics

• Govt attitude changes:– US concerns home production– EU concern for industry

restructuring

Explanations of Concentration

• Structural models: SCP Paradigm

• Managerial/institutional:

• Statistical/dynamic: Gibrat explaining?

• Strategic interaction: game theoretic models sensitive to assumptions

• Particular nature of arms industry

Understanding concentration

• To investigate the concentration we have used three approaches:– Abstract structural model of global arms

market: See other papers– Bounds approach to market structure– Statistical approach

• Consider the last two here

Observations

• Decline in market means expect increase in concentration

• Proportionate decline in milex less than decline in number of equivalent firms.

• So decline in demand not full explanation for reduced no. firms

• Fall in R&D less than decline in milex so fixed costs have risen

Bounds Approach

• Sutton Bounds Approach:– game theory– statistical assumptions– sub markets– lower bound on concentration

Explanations of Concentration

• Sutton approach– degree of linkage with submarkets: defence low

because government controlled– elasticity of fixed and sunk costs to quality:

defence low because high R&D

Evolution of Concentration

• SIPRI company database

• Sample top 100 1990 on

• Expect increase in concentration but what we get is very large– Herfindahl index doubled for arms sales, bit

less for total– Lorenz curves concur

Evolution of Concentration

• Concentration– top5 22%-42% arms production 1990-2000– Sutton lower bound 20%– Others close to lower bound– Total sales more concentrated and increase less

33%-40%

Evolution of Concentration

• Expect increase in concentration following fall in demand but this rather large

• Suggests nature of market concentrated: – like pharmaceuticals civil aerospace

• National government’s policies have prevented inevitable concentration

Evolution of Concentration

• Expect to find that growth of firms:– showed no clear pattern that suggested

strategic success of companies– rather a general change across the whole size

distribution– adjustments to declining demand not leading to

unhealthy industrial profile

Evolution of Concentration

• Analysis of growth rates– fall in arms sales not reflected in total sales– suggests not leading to unhealthy market

• Transition matrices– most exit medium to small size groups

• Corporate strategy and success– most converters (declining arms sales and

increasing civil) with decreasing arms share

Growth and Size

• Law of proportionate effects

• Basic model: log Sit = + log S it-1

• Econometric problems

• Country effects

Results

• In both arms and total sales not significantly different to 1

• Total equation fits better

• Some significant country effects

• No specific US effect but further work…

Conclusions

• End of Cold war industry restructured

• Arms industry relatively unconcentrated– close to lower bound

• Reason: government national procurement

• Decline market and rise R&D intensity led to increase in concentration

• Still a way to go

Conclusions

• Preliminary econometric analysis did not reject hypothesis that rate of arms sales independent of initial level for companies

• Important difference between US and Europe need further investigation– US restructuring continues– EU restructuring some way to go

Conclusions

• Interesting new developments in the industry– RMA implications: increased COTS– New companies and corporate structures

• Implications for the control of international arms and technology transfer

• Further research needed