Israel: Defense boom seeks wiggle room

Originally formed to offset the insecurity of military procurements from foreign suppliers, the Israeli defense industry has outlived this initial purpose, emerging as a leading arms exporter and major player in high-tech weapons systems.

The industry incorporates major companies such as Israel Aerospace Industries (IAI), Elbit, Rafael and Israel Military Industries and a plethora of subsidiaries and smaller companies and laboratories supplying a range of military equipment and R&D services in conjunction with domestic and foreign partners.

Restructuring

The current rude health of the Israeli defense industry is in stark contrast to the crises of the 1990s when falling global and domestic demand and systemic industry dysfunction forced the closure of weapons system programs and mass redundancies. However, the context for the success of Israeli defense companies in foreign markets had begun to develop independently of the parlous state of major companies at the time.

Institute for National Security Studies Program Director Yiftah Shapir told ISN Security Watch, "In terms of military industry I think the Oslo Accords and the collapse of the Soviet Union opened many avenues for export that were not available before that."

Despite these openings, the by-then bloated and highly bureaucratic domestic defense industry continued to struggle until a fundamental restructuring, which saw organizational upheavals and a refocusing on niche markets. The Israeli taxpayer stumped up almost US$3 billion for the rehabilitation of the industry in the 1990s.

Significant privatizations also occurred. Referring to major companies, Shapir said, "On one hand you had a privatization of government-owned companies; the change that Rafael went [through] from being only a lab to a [combination] of national lab and a company which produces and sells."

"The second change," he said, "was the merging of smaller companies into huge conglomerates like [private company] Elbit, which swallowed many smaller industries."

Bonanza

Israeli Defense Ministry Director-General Pinchas Bucharis, external pageconfirmedcall_made last December that rising overseas sales, at US$4 billion for 2007, meant that Israel had leapfrogged the UK to become the world's fourth largest arms exporter.

Major players have returned strong results in recent years with IAI earning US$40 million in first quarter profits in 2008 on sales of US$1 billion as its backlog of orders grew by 11 percent to US$8 billion. Elbit announced 38 percent growth in revenues for 2007.

The director of the Galili Center for Strategy and National Security, Dr Reuven Pedatzur, told ISN Security Watch, "The reason for the growth is the developing international market; it is nothing particularly connected to the Israeli market." Last year, IAI reported that only 13 percent of its business was with domestic customers.

Significant areas of specialization have developed, such as UAV design and fabrication, electronic warfare systems, air-to-air and anti-missile rockets and targeting, radar and imaging systems, with Israel now one of a handful of countries to operate both communications and spy satellites.

To Shapir, one of the key advantages the Israeli defense industry enjoys is "a very close connection between the operators and the system developers […] Sometimes it is the same people who work in the industry, and once a year they do reserve service in a combat unit where they actually use [the technologies]," he said.

Asked what problems currently exist within the Israeli defense industry, Pedatzur said: "Too many duplications, because there are several companies that deal with the same areas. So there is a competition within Israel and outside Israel."

Israeli influence in the UAV market can be seen in the recent shooting down of an Israeli-made Hermes-450 drone over the breakaway Georgian republic of Abkhazia and the reported operation of Israeli UAVs over Kurdish Workers Party (PKK) positions in northern Iraq in recent months in support of Turkish troops.

Flagship projects

Major flagship projects have bolstered both export growth and technological sophistication. This is particularly true of the Lavi fighter program and the ongoing development of the Arrow anti-missile system, Shapir explained.

The indigenous Lavi fighter program was cancelled under significant US pressure in 1987 when it became clear that Washington was unwilling to provide funding for a rival to the F-16.

Referring to the Lavi, Shapir said: "On the one hand, it was a crazy idea because the project was too heavy for a state and economy the size of Israel. It is no wonder that the project eventually died."

However, "even though the Lavi did not materialize as a combat aircraft during those years, this was the lighthouse for the Israeli industry. This project drove the whole industry […] towards the cutting edge of technology," he said, adding, "We still sell sub-systems that were developed [specifically] for the Lavi."

According to some analysts, the growth in Israeli defense exports over the years and the industry's concurrent burgeoning technical prowess have been important factors in convincing the US to drop its objections to the sale to the Israeli military of sophisticated weapons systems and platforms - moves designed to stymie the Israeli production of competitive equivalents.

These sales may have backfired with the US provision of previously withheld advanced air-to-air missiles and electronic warfare kits appearing to encourage Israeli technological advances in these areas.

Shapir explained that the ongoing development of the Arrow gave a second major boost to the Israeli defense industry, arguing that "in conjunction with the Arrow, you had radars, you had sensors, you had battle management systems."

The Arrow also exemplifies a growing trend whereby Israeli companies seek US funding, often via partnership agreements, for weapons systems otherwise beyond the financial capacity of the Israeli state and military.

Lost contracts

The reorganization of the Israeli defense industry was also responsive to the progressive loss of Israeli military contracts to US competitors. In "all the areas that the Israeli defense industry deals with, there is a competition with the States," Pedatzur said.

The Israeli military won a new-found freedom to purchase its military systems overseas from the 1980s, increasing reliance on US suppliers through its preference for channeling defense funding towards established systems rather than uncertain indigenous R&D projects.

"The [Israeli defense] industry had to market its goods overseas because IDF acquisitions diminished considerably in the past decade, Shapir said.

While this is partly due to "diminishing budgets and the crisis of weapons systems, another issue is the grant that we get from the US," he said, adding, "Sometimes it is cheaper for the military to buy American than to buy Israeli."

The rapid depreciation of the US dollar against the shekel may act to encourage further purchases, while the US decision last year to increase its annual military aid commitment from US$2.4 billion to US$3 billion per annum for 10 years will also likely lead to the strengthening of Israeli reliance on US weapons systems and military technologies.

Tilted playing field?

While sharply tilted in favor of US imports, the bilateral defense relationship is reciprocal, with the majority of Israeli arms exports reportedly going to US buyers.

The US-Israel Reciprocal Defense Procurement Memorandum of Understanding (MOU), extended in 1997, envisages a situation in which Israeli and US contractors compete on an almost equal footing in each others' domestic markets.

However, a recent US government external pagetrade reportcall_made notes that US companies express concern that the MOU has not resulted in a sufficiently open market for U.S. suppliers interested in competing for MOD [Israeli Defense Ministry] procurements funded by Israel."

In Israel, the broad defense industry-military-government convergence on budgetary issues has remained intact throughout the ructions of recent years, and despite sometimes competing interests, has led to bolstered defense spending during a period of savage cuts to other government ministry budgets.

"We have a lot of generals who leave the army and go to the industry. And they have very good connections inside the political echelon," Pedatzur said.

Critics charge that a significant lack of oversight has developed in Israeli military purchases that favors local defense companies at the expense of rival foreign systems and suppliers.

The resultant lack of opacity in the Israeli military procurement system is perhaps best exemplified in the current spat over the Defense Ministry's support of Rafael's Iron Dome anti-missile system. This choice has been marred by subsequent revelations that the interceptor will not protect communities close to the Gaza border and media charges of serious malpractice and conflicts of interest in the selection process.

Exercising influence

Despite such charges of protectionism, the growing Israeli reliance on US military aid, systems and partnership agreements has won the US increased leverage over successive Israeli governments.

Israel has viewed recurrent US objections to weapons system sales to China (Phalcon, Harpy UAV upgrade) and India (Arrow sale plans) as unwarranted interventions in support of US competitors and as a major threat to the Israeli industry.

According to contested reports, the US has in the past demanded details of planned Israeli sales to China and a memorandum of understanding concerning future deals, while intimating a willingness to consider retaliatory aid grant cuts. Though this was denied, the US is understood to be behind the ouster of Defense Ministry Director General Amos Yaron in 2005 over the Harpy upgrade deal.

In its quest for foreign sales, the Israeli defense industry and Defense Ministry have maintained a liberal export strategy, including past sales to some states that have refused open bilateral ties, including Indonesia.

In an apparent response to US pressure, the Israeli government instituted a new law governing arms exports in December, designed to provide the country's first unified legal standard on which companies and relevant ministerial oversight authorities were to base export decisions.

The US fears that the new legal standards may in fact lead to a strengthening of the official bulwarks preventing open competition for domestic Israeli contracts through the influence of major Israeli defense industry players.

Asked if internal Defense Ministry oversight structures were sufficient, Pedatzur said: "There are controls, because if you are in Israeli industry you have to have approval from the [Defense] Ministry in order to export, but how efficient these controls are I don't know."

With the stakes high, the periodic clouding of bilateral US-Israeli relations, and Israeli defense industry efforts to find wiggle room and competitive advantage both at home and abroad, look set to continue.

Referring to the prospects for recurrent crises in US-Israeli defense relations, Shapir said these "might happen […] From time to time someone has to remind us that it is the dog that wags its tail and not the other way around," he said.