Can defense forces save Europe’s ailing auto industry?

The European automobile industry is in a structural crisis. The past five years have been a perfect storm for the electric vehicle industry, as slowing demand for electric vehicles, loss of market share to Chinese competitors and rising borrowing costs have kept sales well below pre-pandemic levels.

European automakers have a long history of manufacturing defense equipment and weapons in response to wartime demands. Some companies now believe that returning to these roots could be a lifeline.

Citi analysts are calling this shift a “non-auto” deal.

on monday, renault The company announced that it is developing ground-based drones for military and civilian use. This follows the company’s announcement in January that it would partner with defense group Tourgis Gaillard to produce aviation drones in France.

On the other hand, German car manufacturers volkswagen It is reportedly in talks with Israeli defense company Rafael to produce parts for missile defense systems.

The FT reported on March 24 that the two men are in talks to convert a VW factory in Osnabrück, Germany, into a facility that would manufacture parts for Israel’s Iron Dome missile defense system, which Rafael manufactures.

European automakers have struggled to compete directly with Chinese rivals such as BYD. According to ACEA data, new car sales in the EU were down until January, but BYD surprised the market by posting 13,982 deliveries, a 175% year-on-year increase.

The industry’s decline is also reflected in automakers’ stock prices. The Stoxx600 auto stock index had fallen 30% in the past five years as of April 2, and VW has fallen more than 60% since then. StellantisThe company, which owns brands such as Fiat and Peugeot, fell 58% in the same period.

In contrast, Europe’s defense industry is booming. With the urgent need for rearmament in the wake of Russia’s 2022 invasion of Ukraine, and the apparent breakdown in ties within NATO, Europe needs to become even more self-sufficient in defense production.

Last year, EU President Ursula von der Leyen said Europe was in an “era of rearmament” and could mobilize 800 billion euros in defense investment through loans and other programmes.

“There are strong growth prospects for the defense industry on the back of government budgets and NATO mandates,” Rico Luman, senior sector economist for transportation and logistics at Dutch bank ING, told CNBC in an email.

“For the defense industry, the question is not whether to expand production, but how. Redirecting production capacity is an opportunity for the auto industry.”

But other analysts question whether riding on the defense sector’s tailwind alone can save the ailing auto industry, raising some concerns about automakers’ ability to grow in the sector.

The relationship between automakers and weapons manufacturers has always been symbiotic. During World War II, automobile companies around the world suspended civilian production to focus on their own war efforts, producing military vehicles, aircraft engines, guns and ammunition.

Experts say the transition from wheels to weapons and back again is achievable in part because many of the underlying skills are highly transferable.

“Both industries rely on advanced manufacturing, complex supply chains and engineering, so there is considerable overlap in capabilities,” Zuzana Perakova, director of economics and business at Slovak think tank Globsec, told CNBC in an email.

“There are also historical precedents. Countries like Slovakia and the Czech Republic are today world leaders in per capita car production, but much of the strength of the auto industry is built on a workforce that once worked in the defense industry before the end of socialism.”

Volkswagen is in particular trouble, facing declining profitability and considering cutting 35,000 jobs, or about 5% of its workforce, by 2030.

If negotiations with Rafael and other defense candidates come to fruition, Volkswagen could reuse its aging Osnabrück factory, which is scheduled to close in 2027, potentially saving up to 2,300 jobs.

But Germany’s largest trade union said transferring large numbers of workers from other industrial sectors to defense companies is “unrealistic” and “not a solution” to the industry’s structural problems.

“This is not enough to compensate for impending job losses in the automotive industry, suppliers, and other key sectors of the metals and electrical industries,” IG Metall told CNBC in an email.

“The sectors operate too differently for that to happen. For example, unlike the auto industry, which produces in large quantities, the defense sector is dominated by low-volume production. Even if production increases here, manufacturing will never resemble that of the auto industry.”

Partnerships between automakers and defense companies can also raise ethical concerns if workers are given the choice between producing weapons or facing layoffs.

Citi warned of political risks, citing how public opinion over Elon Musk’s involvement in President Donald Trump’s administration coincides with the collapse of Tesla sales in Europe.

“It is unclear at this point what kind of political reaction VW’s relationship with an Israeli defense company will provoke in Europe,” the analysts added.

“If companies give workers the opportunity to keep their jobs, the vast majority of workers will continue to fulfill their contractual obligations and continue producing for defense manufacturers,” said Matthias Schmidt, founder of Schmidt Automotive Research.

“When you have a family to support, your morality has its limits.”

Despite a spate of partnerships between automakers and defense companies, analysts are skeptical about a full-scale shift to weapons manufacturing.

“We don’t expect big automakers to become big defense manufacturers,” Perakova added. “What we’re likely to see is a selective and opportunistic move into defense.”

IG Metall said that at scale, defense cannot provide a solution to the industry’s woes.

“We place all our hopes in the defense industry and caution against neglecting other sectors,” they told CNBC via email.