The government is preparing a law whose aims include improving the resilience of the Dutch defence industry to strengthen the armed forces and national strategic autonomy. Our working group is of the opinion that the envisaged goal will not be achieved with the market regulation part of the law.

The Politics and Defence Engineering Working Group of the Royal Institute of Engineers (KIVI) has submitted the following reaction to the proposal for a "Defence Industry Resilience Act" which went into internet consultation on 1 July 2024. It has been prepared based on publicly available documents and defence technology knowledge and experience. The comments and questions concern only technological or related aspects.
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On 1 July, the Minister of Economic Affairs offered draft Defence Industry Resilience Act for internet consultation. This act consists of three parts: Market Regulation, Security Test and Suitability Declaration.

Our working group believes that with the market regulation component, the government will market regulation of this law, it will not achieve the intended goal of strengthening the armed forces, the defence industry and national strategic autonomy.

Market regulation

If passed, this part of the law is a fundamental violation of the democratic market economy of the Netherlands. It affects our open society, which is precisely what we want to fight for.
With the instrument of designation in this law, the government can and will gain absolute power within companies it selects without consultation or possibility of objection.

This will make it even harder for companies to attract external funding, worsen international competitiveness and make technology and system development by companies more difficult. See the explanation below.
This applies not only to companies that receive a designation, but also to companies for which this is then legally possible, but not (yet) done.
The explanatory memorandum tries to nuance these consequences, but the legal text is very clear.

There is great awareness among companies of the increased instability in the world. International security is vital for our economy. Plenty of companies in our country want to actively engage in Defence. Provided on reasonable terms. Some have been asking for this for years.
The assumptions about unwillingness and very high compensations in civilian contracts in the Policy Compass form therefore seem to our working group to be a goal reasoning, which evokes resistance.
To achieve the desired goal, open consultation about possibilities and limitations is necessary. This should include an understanding that not everything is possible. However, there are always alternatives.

As is also evident from the Ministry of Defence's Production Security Task Force report of 7 June 2024, a better solution direction than this bill is threefold:
(1) Place guaranteed orders for a longer period of time, longer than the review period of the strategic supply plan mentioned in the bill,
(2) Modify procurement procedures in such a way as to make it easier to reach a contract, and
(3) Pay executed orders on time.
This may also require a law, but a different one than the one currently proposed.

Even in a war economy, instructions and coercion are not the primary, let alone the right, means of making national defence and the economy function optimally. Coercion should only be used as a last resort and carefully controlled. However, there is no threshold built into this bill, such as a "state of crisis" proposed by the European Commission.

Finally, this is a purely Dutch-focused law. However, military resources rarely, if ever, come from our country alone anymore. A national approach to the proposed market organisation will, with high probability, be counterproductive. After all, the Dutch defence market is small and companies will prefer to relocate or expand to an environment abroad with greater revenue potential and in which there is less or no coercion on their activities.

Some form of market organisation of the defence industry is really only possible and viable if it is done on a European scale. To this end, we sent the proposal Clustering the EDTIB to the European Commission on 29 May 2024 in the Eurodefense and EDTA context.

Comment

The law gives the government discretion over all companies it chooses to issue directions to carry out or refrain from carrying out activities. This starts 6 months after enactment of the law and does not depend on the international security situation.
The "general economic interest" criterion used can go far beyond the Defence sector. This may also be important for the implementation of the law, as there are many civilian companies, which need to supply crucial dual-use components for defence applications. A limitation to the Policy Compass form mentioned of "15 companies" is not reflected in the bill.

The proposed law will make it even more difficult for companies in the defence sector to attract external funding than it already is under the adopted European 'Environmental and Social Governance' regulation . This is because the impact of a designation on the company's asset position and profitability cannot be foreseen. As a result, investing becomes a risk. Even for companies producing dual-use technology that could receive a designation. Even the chance of passing this law has a negative effect on investor interest.

Furthermore, the bill harms the international competitiveness of all Dutch companies in the sector. After all, a designation to keep goods ordered by a foreign customer in the Netherlands is a risk that a foreign now always has to take into account. Even if that designation only takes place while a long-term supply contract has started well before.

For technology and system development, the effect is also significant. If the government is given the power to transfer technological knowledge to a competitor without consultation or consent, few entrepreneurs will take the risk of using their business and knowledge for technology development. Presumably not even paid development assignments, because "proprietary" knowledge will always be used for that. Since the directions in the draft law are directly binding, the TRIPS treaty's exceptions to intellectual property and patent law, among others, are difficult to enforce.

Finally, the idea that a Dutch company can be ordered to carry out maintenance and modernisation of equipment purchased abroad is unrealistic and a form of wishful thinking. Especially if Defence - as indicated - did not replace or modernise in time. Maintenance and renewal of systems phased out by the original manufacturer is almost never technically possible.
Complex parts are (also) no longer available, software source code is not made available and modern technology can almost never be replicated by reverse engineering.

Many Dutch companies are happy to contribute to Defence, either as OEMs or as suppliers. However, the business-necessary planning horizon for investments in product development and production facilities is well over four years for most defence companies. Therefore, the four-year strategic supply plan review period mentioned in the bill provides risk rather than certainty.
On the other hand, the strategic supply plan review period is far too long. After all, the war in Ukraine started only 2½ years ago. Regular adjustment by mutual agreement is therefore necessary.

Other aspects

No international security criteria have been established under which the law will take effect. Six months after enactment of the law, companies in the EDTIB can expect a designation.
In a "state of crisis", elements of this law might be reasonable. This could be built into the law, as the European Commission has done in the EDIP, but not now.

A designation takes place without consultation possible or possibility of objection. Once a company is designated, the board and shareholders effectively lose their powers. A minister and a silent administrator determine the activities. There is a strong possibility that this will lead to resistance and opposition that is difficult to overcome.
Also, selection of the companies concerned, the activities assigned and any compensation for the assigned activities are within the discretionary power of the minister. As currently proposed, this is an unacceptable risk to a company's operations, profitability and asset position.

The statement in the explanatory memorandum that a designation is only in the nature of an obligation of effort is not evident from the draft bill. The powers of the minister and administrator are absolute. Without the participation of management and shareholders.

The defence and economic ministers have split power in the draft law, which will make it unclear in implementation where decisions are actually taken. On some issues, the draft does not yet identify which ministry is responsible, but mentions PM.

The law's goal of gaining strategic autonomy as the Netherlands is no longer feasible anyway in the intertwined international economy. Virtually no military product can be realised exclusively by Dutch companies. Subsystems or components or raw materials always come from all over Europe or far beyond.

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The Hague, 30 August 2024
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Disclaimer: The facts and opinions given are based on open sources and on the knowledge and experience of working group members.
This is not an official position of KIVI. The association accepts no liability for anything put forward by the working group or its members.

Photo: Ministry of Defence