In America's military slipstream: Europe's defence firms are falling to adapt to life after the Cold War, warns John Appleby

THIS week's Farnborough Air Show seeks to convey the traditional glossy image of the world's aerospace industry. Yet the sector is entering a period of radical change.

The planned merger between the American defence manufacturers Lockheed and Martin Marietta, announced last week, demonstrates just how far this process has advanced in the US. The new company, Lockheed Martin, with sales of about dollars 23bn ( pounds 15bn) and an equipment inventory that includes many of America's most sophisticated aerospace systems, will be the country's biggest defence contractor and second only to Boeing among all aerospace firms. European governments should take note.

American military suppliers have always enjoyed an unquestionable advantage over their European rivals: in a trade still heavily influenced by national considerations, they can readily tap into a dollars 310bn US defence budget - double that of the European Union member states. The US government has also been far more active than the Europeans in aiding its defence industrial base. As a result, US military manufacturers are much further down the road in adapting to life in the post-Cold War military environment. And they are helped by economies of scale the Europeans do not enjoy.

Last September, the US administration launched a review of its military commitments. Seeking to outline US defence requirements, the review also established a strategy for government procurement decisions, and wide- ranging reforms to the Pentagon's acquisition procedures and management structure. This reappraisal gave defence firms crucial early indications of likely future military requirements.

In recent weeks, the US Defense Secretary William Perry has initiated policies specifically geared to promoting defence rationalisation and competition within the industry. The US approach is three-pronged. Washington is offering to reimburse defence companies generously for some industrial merger costs, especially when staff have to be retrained and moved.

At the same time, the administration is trying to make greater use of commercial buying practices. By providing greater access to government information, so allowing a wider range of civilian producers to compete for military contracts, the Pentagon estimates a saving of dollars 700m on one project alone over the next two years.

And, finally, there has been a great push to sell weapons. When Communism collapsed, arms sales from West European and American manufacturers were broadly equal. Last year, however, the US captured half of the international weapons market.

To be sure, all major European governments have sought to protect their military industries. Indeed, British and French companies, which dominate the market in Europe, have been in the forefront of the restructuring. The number of British producers, for example, has shrunk to two - one for aircraft and one for helicopters. The Germans have also shaken up their industry, which is now under the umbrella of Deutsche Aerospace.

Yet the Europeans continue to believe that the process can be undertaken on a national basis. Even defence manufacturers in those countries that pride themselves on open competition remain reluctant to abandon their close ties to the state. As a result, there have been numerous collaborative projects and cross-shareholding arrangements, but few full-blown cross-frontier mergers.

Free trade provisions within the European market are not much help, either. According to article 223 of the EC's founding Treaty of Rome, defence industries are exempted from the workings of the Single Market. Member states can therefore take whatever steps they consider necessary for the protection of their essential interests in matters of national security. This, in effect, gives Europe's governments the option of subsidising inefficient producers and distorting competition.

Europe's collaborative projects, such as the European Fighter Aircraft, are based on the policy of juste retour: each partner gets allocated work in proportion to the number of weapon systems eventually required by each participating government. The tactic appeases national sensibilities, by ensuring the survival of national producers, but it fails to rationalise research, development and production costs.

More important, it results in disputes and constantly changing specifications: the European Fighter Aircraft project has slipped in its production date almost as rapidly as its costs have risen, and there is no guarantee this high-profile programme will go into production in the form originally envisaged.

Nevertheless, European governments have clearly not learnt the lessons of the past. Seven nations - if the British government decides to participate - are preparing a collaborative venture to build the next-generation Future Large Aircraft. In the light of past experiences, it is perhaps not surprising that the UK government is examining the American alternative, Lockheed's upgraded Hercules C130.

This duel for the RAF next-generation transport aircraft is a microcosm of the transatlantic aerospace contest. The Europeans are squabbling at a political and industrial level over specifications, while America offers an established project with tried and tested technology and at a cheaper price. Despite this, there is intense political pressure on the UK to participate in the European venture.

The only way Europe's military manufacturers will be able to compete with the US is by pressing their governments to abolish the Treaty of Rome provisions exempting them from the operation of the free market. Next, the EU member states should outline a coherent strategy for the restructuring of the defence industry based on a constructive partnership between industry, governments and markets. Finally, more effort must be put into using the civil sector for some military contracts. Judicious pressure on producers to merge across frontiers should be coupled with greater competition in government contracts.

If, however, European governments continue with the illusion that they can maintain independent defence industries while competing with the US, they are in for a shock. Defence companies need to be set free from the shackles that bind them.

The author is a researcher at the Royal United Services Institute in London.

(Photograph omitted)