In our inaugural comment, we noted that since the 1990s, we’ve been hearing about the need for rationalization and integration in the defense industry. The reason, whether supported by hard analysis or just common narrative, is that all those companies in Europe and North America simply have too much capacity chasing too few programs. That capacity costs money, and ultimately customers pay for it one way or the other. And we doubt that we have heard the last clarion call for consolidation from the European Defence Agency or denizen investment bankers, offering yet another (or just the same) set of sound microeconomic reasons for strengthening a smaller industrial base in Europe or across the alliance. But in preemptive defense, we offer at least two four reasons for tempering those hopes.

The first is itself microeconomic. On this point, we particularly like the opinion of John Dowdy from McKinsey & Company in Jane’s Defence Weekly last October: “many segments in the upper tiers, such as engines, avionics, and aircraft systems, are already highly concentrated.” To be sure, there are exceptions, and Dowdy mentions aerostructures as a standout. But generally, the long-term opportunity cost to the customers of reducing an industry from three to two suppliers is much greater than in reducing it from, say, six to five. Much of the benefit depends on the specific cost curve of the industry, and where the minimum efficient scale of production is high, two may be all that is possible. But there is still a cost: not every duopoly is vigorously rivalrous, and perhaps fewer still wildly innovative. And sometimes, those duopolies become hardly distinguishable from monopolies. Consider here the example of the industrial co-dominion in the Virginia-class submarine program in the United States. Huntington Ingalls Newport News and General Dynamics Electric Boat each has an incentive to keep its cost curve ahead of its partner’s, but which has an incentive to propose something wholly different? The current arrangement is almost a sinecure.

That gets to our second point, which is more managerial. We find very interesting the forthcoming paper in the Journal of Financial Economics by Jie He of the University of Georgia and Xuan Tian of Indiana University, “The Dark Side of Analyst Coverage: The Case of Innovation“. Analysis of defense industry stocks from Wall Street or the City, they find, incentivizes management to de-emphasize riskier, longer-term projects. If their thesis holds, public scrutiny of public companies may keep them on the rails, but the tracks won’t lead in unexpected directions. Now, if the customers want to pay for that technical risk, the financial risk to the suppliers may be minimal. Here, the Joint Strike Fighter (JSF) program comes to mind. But we believe that customers should realize that they don’t have all the answers a priori, and might benefit from hearing those crazier ideas that smaller, privately-owned firms might dream up.

The third issue is political. Some national governments are relatively content with a laissez-faire approach to domestic supplier management; Sweden under the Moderates in the past few years immediately comes to mind. Others seek a degree of autarky to support political goals in the absence of overt allies; Sweden under the Social Democrats in the Cold War is the example there, and from that policy flowed a long series of innovative aircraft from Saab, warships from Kockums, guns from Bofors, and vehicles from Hägglunds. Yet others view domestic arms industries as political assets within the alliance structure; good examples today are found in all the major European powers—Britain, France, Italy, Germany, Poland. So in this last context, any further cross-border European consolidation will run up against the constraints of not just economics, but policy.

And the fourth, frankly, is military. Big suppliers can be all too happy to beget big programs for big systems, which may become too big to fail politically (the JSF again?), but too concentrated as well, both technologically and on the field. It’s hard to know in advance which weapons will work better or worse in battle; time was, many expected that the high-speed, missile-equipped F-105 Thunderchief and F-4 Phantom II would be adequate fighter aircraft. As Marshal Michel recounted in his book Clashes: Air Combat over North Vietnam, it’s remarkable how well the Navy’s older F-8 Crusader performed with shorter-ranged weapons (and admittedly much better pilots). Today, with half the alliance geared to buy the same airplane, there’s something to be said for diversity in supplier selection. Sameness and size can bring fragility into a force structure.

All these arguments militate against a military devotion to scale. Is this culturally ingrained today in a transatlantic military or defense-industrial mindset? It’s so prevalent, we wonder sometimes. As we wrote extensively a few years back in a book on (literally) Arms & Innovation, depending on a range of factors specific to individual markets and technologies, there can be real advantage to organizational smallness in developing new weapons. Thus, our tone today remains cautionary, for we continue to find that bigger is just not always better. The right industrial structure for military security is more complicated than simple pursuit of the returns to scale.

James Hasik is a senior fellow with the Brent Scowcroft Center on International Security.

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