Economic arsenals: the Middle East’s rise as a global defense industry hub

June 2023 Al-Monitor PRO Trend Report 

3796 words

Introduction

As Turkey’s momentous and contentious presidential election entered its final stages, it was hard to ignore the prominent role that drones, howitzers and a shiny new amphibious assault ship played in the campaign. That is, key to Turkish President Recep Tayyip Erdogan’s stump was highlighting homegrown defense products — both as a projection of Turkish power and industrial prowess. The sector enjoyed record exports worth $4.4 billion in 2022, a bright spot amid Turkey’s otherwise gloomy economic situation. 

That tactic helped Erdogan secure reelection and underlined Turkey’s emergence as a weapons-manufacturing powerhouse. That industry rise began almost 50 years ago, according to David DesRoches, a professor at the National Defense University in Washington DC, when Turkey — in the name of national sovereignty — embarked on an economically inefficient program to attain self-reliance in areas including weapons production. That’s now paying off for Ankara, but more importantly it’s also serving as a template for regional neighbors to emulate and improve upon. “Gulf states have an opportunity to partially replicate this, mostly because the nature of weapons design has shifted from large factories bending metal towards software, which can be developed as a national competency relatively quickly,” DesRoches tells Al-Monitor.

Alongside ongoing defense industry development in Turkey and Israel — the region’s leading players — several countries in the Middle East are busy developing sector capabilities. That’s especially pronounced in the Gulf, where oil money and big ambitions are propelling the rise of new defense industry hubs. Simultaneously, Middle East countries are also increasingly diversifying relationships with foreign arms suppliers. That’s generating moves that buck convention, such as the UAE cancelling a $879 million military helicopter deal with Airbus in May 2023, with the “failure to achieve in-country value goals” cited as a key reason for the termination by an Emirati government official. Ultimately, this is all coalescing to threaten the influence that US and European defense companies have long enjoyed in the Middle East, a trend magnified by China’s growing regional clout and the West’s competing priorities in Ukraine. As that plays out, billions of dollars in contracts are at stake, with significant ramifications for local economies and global defense industry companies alike.

1. State of play: Autarky and sovereignty

The Middle East is a tantalizing market for global defense contractors — look no further than Abu Dhabi’s biennial international defense exhibition, known as IDEX, which attracted around 130,000 visitors in February 2023. That included a strong international presence (not to mention US players bumping shoulders with Chinese and Russian rivals). Yet, dealmaking had a distinctly local flavor: the UAE signed over 50 agreements worth a combined $6.3 billion during IDEX, with at least $5.9 billion of that devoted to local firms. That included Abu Dhabi defense giant EDGE scoring a $1.3 billion contract for its subsidiary Halcon to supply advanced precision-guided glide munitions to the UAE’s armed forces.

Following IDEX’s 2021 edition, when the UAE spent $5.7 billion, this offered up another unmistakable glimpse of the larger storylines dominating the region’s defense industry landscape. “The overall trend across the Middle East region is autarky and self-sufficiency,” Andreas Krieg, a senior lecturer at the School of Security Studies at King's College London, told Al-Monitor. Middle East states are increasingly focusing on becoming more self-sufficient and less reliant on overseas defense contractors — a trend being amplified by fraying ties with traditional Western security partners. 

The UAE and Saudi Arabia were taken aback when some weapons suppliers discussed or implemented halts in weapons shipments because of their conduct in the Yemen war, notes DesRoches. "They realized that political concerns in other countries could stifle their access to weapons at a point when they need them most, and thus have been trying to find ways to secure reliable and uninterruptable sources of weapons for them to pursue their security interests as they see them, not as the Bundestag sees them,” said DesRoches. 

Gulf states also view themselves as advanced countries that should be seen as peers of some NATO members, yet they chafe under security and technical restrictions on weapon transfers, regarding them as infringements on their sovereignty. A prime example: US restrictions on Chinese infrastructure as a security condition for the sale of F-35 fighters to the UAE. “By developing a domestic industry, the reason goes, Gulf states will have full command of a sovereign defense line of supply,” said DesRoches.

That’s seeing a wave of industry activity, with the UAE, Saudi Arabia and Qatar investing heavily into their defense sectors. For instance, Riyadh — which aims to localize 50% of military procurement by 2030 — announced in 2021 that it would invest over $20 billion into its domestic military industry over the next decade. Localized defense expenditure in the kingdom reached 11.7% of the total outlay in 2021, up from 2% in 2018. There’s also Saudi Arabia’s headquarters initiative to consider, which requires multinationals to relocate Middle East head offices to the kingdom in order to secure government contracts, which also applies to defense firms. 

Meanwhile, the UAE’s rate of arms imports fell nearly 40% between 2018-2022 when compared to the prior four-year period, according to the Stockholm International Peace Research Institute, or SIPRI. Emirati companies have also become export players, with Egypt, Jordan and Algeria its largest customers, while EDGE inked a $1.1 billion deal at IDEX to build ships for Angola’s navy. Alongside diversifying suppliers, the UAE is eying investments into foreign companies. For example, EDGE bought a majority stake in Estonia’s Milrem Robotics in February 2023.   

Still, Gulf efforts remain nascent compared to the wider region's traditional defense industry heavyweights. Israel, long the regional leader in defense R&D, registered three firms in the top 100 industry companies list published by Defense News in 2022: Elbit Systems at 31, Israel Aerospace Industries at 37, and Rafael Advanced Defense Systems at 41. Israeli players have also benefitted from the Abraham Accords, like Rafael, which announced the opening of a new office in Abu Dhabi in early 2023. Out of the record-high $12.5 billion in Israeli defense exports in 2022, almost $3 billion were export deals with Arab countries. 

Yet, Turkey has gained on Israel in recent years, rising to become a potent weapons supplier in the region and beyond. It currently ranks as the 12th largest arms exporter globally, while Israel stands at 10th, according to SIPRI. Its defense sector has excelled at producing drones and continues churning out new developments, such as its domestically produced 5th generation fighter jet, dubbed KAAN, which is set to take flight in 2023. Ankara is targeting $6 billion in export revenues this year, up from a record-breaking total of $4.4 billion in 2022. Plus, Erdogan has boasted that Turkey’s local industry now meets 80% of military requirements, compared to only 20% when he came to power 20 years ago. Three Turkish firms featured in the top 100 defense companies list in 2022: Aselsan at 49, Turkish Aerospace Industries at 67, and Roketsan at 86. The only other regional firm ranked was Saudi Arabian Military Industries, or SAMI, a firm wholly owned by the Public Investment Fund, which debuted on the list at 98th.

Alongside strategic autonomy, domestic arms production is being championed as a means of economic diversification. It’s also an opportunity to reduce large cash outflows in a decarbonizing world. After all, weapons are expensive and they’re purchased by governmental fiat, meaning they’re ripe targets for either cuts or substitution by domestic production, notes DesRoches. Yet, Middle East government defense budgets remain dynamic. Heading into 2022, Saudi Arabia’s government budgeted $46 billion for military spending; instead, Riyadh splashed out an estimated $75 billion, a 16% increase year-on-year, according to SIPRI. That marked its first spending hike since 2018 and made it the world’s fifth largest military spender. Meanwhile, Qatar’s military expenditure surged by 27% in 2022, reaching $15.4 billion, but other regional counterparts cut their military spending, including Turkey’s 26% reduction and Israel’s 4.2% drop.

Despite aspirations to attain self-sufficiency, Middle East countries remain heavily reliant on defense imports and technology transfers. For example, Saudi Arabia still ranks as the world’s second largest arms importer and the UAE is 11th, with the United States the dominant supplier, again according to SIPRI. Even Turkey remains notably reliant on foreign tech, including elements of its KAAN fighter jet. Ultimately, joint ventures with external partners have loomed large: Krieg points to Saudi Arabia having long used this tactic to produce arms and ammunition domestically that would otherwise be sanctioned by European suppliers, while the UAE’s EDGE and Qatar's Barzan Holdings have used their capital endowments to enter partnerships with overseas companies to create subsidiaries or joint ventures that can produce and develop domestically.

2. A Chinese offensive

Among big ticket deals at IDEX 2023, a comparatively small one proved particularly consequential: a UAE agreement to acquire a dozen Hongdu L-15 jet trainers from China. The deal’s value wasn’t disclosed, but China reportedly sells L-15s for $10–15 million each, placing the order in the $120-$180 million range. Price tag aside, the deal was widely seen as a pointed message to Washington after the UAE walked away from acquiring F-35s in 2021 after the Biden administration paused transferring the jets and pressured Abu Dhabi to drop contracts with Huawei for 5G networks.

The timing is no accident: amid a perceived decreasing US commitment to regional security, China’s growing diplomatic clout and economic inroads in the Middle East are looming larger. US concerns about China’s weapons sales in the Middle East aren’t new and Beijing likely has little interest in attempting to replace the United States as the top security provider in the Middle East anytime soon, but Chinese defense companies have rising opportunities to quickly expand their regional footprint — and signs increasingly point to the potential for major new deals. 

Alongside the L-15 transaction, Chinese firms turned out in force at IDEX in 2023. That comes after Saudi Arabia’s defense ministry inked an ammunition deal worth roughly $115 million with China-based Norinco in 2022 and Riyadh’s ACES Co. struck a joint venture with China’s third-largest state-run electronics firm to locally develop Saudi UAVs. Although reports were never substantiated, Chinese media claimed that following the Zhuhai Air Show in November 2022, Riyadh had agreed to purchase $4 billion worth of armed drones, hypersonic anti-ship ballistic missiles and a counter-drone platform from Beijing. Plus, a leaked US intelligence document from December 2022 warned that Saudi Arabia plans to expand its “transactional relationship” with China by procuring drones, ballistic missiles, cruise missiles and mass surveillance systems.

Meanwhile, the policy of forging partnerships with foreign players to boost development suffers from the inability and unwillingness of Western companies to sign their crown jewels away, notes Krieg, which is where competitors can make an impact. “The UAE and Saudi Arabia have been quite successful in attracting partnerships and JVs with Chinese companies, especially in the tech and AI field, but also in the missile field,” said Krieg. “China appears to be ready to share more easily because they need Gulf investments.”

There’s plenty at stake for American defense players. For instance, Saudi Arabia imports nearly 80% of its arms from the United States, according to SIPRI. The kingdom serves as America’s largest foreign military sales customer, with over $100 billion in active contracts. That said, defense deals between Saudi Arabia and China were also starkly absent from President Xi Jinping's landmark visit to the kingdom in December 2022, which saw the two countries expand economic, energy and tech cooperation. A joint Saudi-Chinese statement from the summit stopped short of new defense announcements, but emphasized “determination to strengthen cooperation and coordination in various fields of defense.”

The summit came only weeks after the United States openly warned that certain deals between Arab states and China would force Washington to curtail cooperation with Gulf partners. Meanwhile, the Biden administration's halt to offensive arms sales in the Gulf over conduct in the war in Yemen has contributed to a significant request backlog from regional governments, further straining ties and raising concerns China could capitalize as a result. Yet, the White House has still sought to advance military cooperation with Gulf states and continues providing defensive weapons. The United States also did approve a potential $1 billion sale of an anti-drone system to Qatar in late 2022.

3. Outlook

• The coming period is likely to see plenty of defense industry activity in the Middle East, powered by Gulf countries. Expect further localization of procurement in key areas and new partnerships with foreign players that further alter the status quo, with key implications for Western suppliers. Additional strategic investments into foreign firms to help secure defense supply lines are also likely. 

• Saudi Arabia is poised to be quite active: Riyadh is set to host its second World Defense Show in February 2024, which will likely be bigger and busier than its inaugural edition in 2022. The kingdom sees the expo as a major platform to showcase investment and trade opportunities for foreign companies and it will also be keen to demonstrate the progress of domestic capabilities. That should produce a number of deals boosting local companies as well as see the kingdom begin developing an export footprint.

• That said, the global market for weapons is competitive and there are generally more providers than buyers. “For the foreseeable future, Gulf weapons sales will not be profitable,” notes DesRoches. “Sales in the short term should be viewed as loss-leaders.” That means Gulf states will find their market is either with extremely cost-sensitive purchasers or with buyers who want technology that isn’t sold by traditional weapons suppliers because of sanctions, technology transfer concerns or other policy reasons. “It will be some time and there will be considerable expense before the Gulf states become major exporters of weapons along the lines of Turkey,” said DesRoches.

• So far, China’s defense industry sales remain low in the Middle East, but it’s nearly inevitable that Bejing will score more wins here. Saudi Arabia in particular looks ready to do more business on this front. The key question: will these be more warning shots or will Riyadh cross a line with Washington?

• Chinese defense firms should also become more prominent in the Saudi capital by answering the kingdom’s call to establish regional headquarters in Riyadh by 2024. Meanwhile, major US and European defense companies have yet to comply, a notable development considering the magnitude of government contracts at stake. It’s likely some will ultimately make the move. 

• Another area to watch: new high-profile weapons deals between regional players. Domestic defense industries offer a convenient platform to forge stronger local economic partnerships, mend ties and amass influence alongside reducing reliance on global suppliers. That’s already happening with Turkish drones, opening the door for Ankara to expand sales (and political ties) with key regional counterparts. Israel is also well-placed to benefit here.

• Turkey’s 2023 presidential election saw the defense industry serve as a key talking point for Erdogan and challenger Kemal Kilicdaroglu, but radical sector changes were never expected regardless of the outcome. “I do not expect any major shifts in Turkey's defense industry trajectory,” said Sitki Egeli, a military and security studies analyst teaching at Izmir University of Economics.

• However, Turkey’s defense industry does face headwinds, such as question marks around how to fund serial production of new weaponry, a national brain drain and continued reliance on foreign technology. Plus, the emphasis on local procurement means that market saturation will be a factor. However, continued export growth can help offset some of that.  

•The next wave of Turkish export success could come from smart munitions, or long-range precision guided weapons, opines Egeli. “A lot of them are upcoming right now,” said Egeli. “There's big demand for them internationally, even more so after the war in Ukraine.”

• However, Turkey’s relationship with Western partners remains frosty after the United States booted it from its F-35 fighter jet program and imposed sanctions in 2020 over its purchase of Russian S-400 missile systems. Although the United States in 2023 has been weighing the sale of F-16 fighters to Turkey, it’s unlikely Ankara will regain entry to the F-35 program.

• Elsewhere, Israeli defense firms have benefitted from the Abraham Accords, but regional inroads may prove fleeting if Prime Minister Benjamin Netanyahu's hardline government undercuts hard-won progress with neighbors and fails to see normalization with Saudi Arabia. 

4. Case study: Baykar

As Russia’s invasion of Ukraine unfolded in early 2022, an unlikely hero emerged on the battlefield — or more aptly, above it. The Bayraktar TB2, an armed drone manufactured by Turkish defense firm Baykar, played a decisive role in helping Ukraine repel Russia’s initial offensive. Along the way it became a symbol of Kyiv’s resistance and garnered global exposure.

That fame spotlights how Turkey’s drone market offerings are emerging as challengers to existing global players. It’s also a key sign of Turkey’s growing impact as a weapons manufacturing powerhouse, with Baykar proving an apt posterchild for this rise. Founded in 1986 by the family of Erdogan's son-in-law, Baykar has risen to become a key Turkish defense industry exporter. Although a private company, Baykar’s direct linkage to Turkey’s president underlines his government’s strong focus on the defense industry. 

The battlefield success of the Bayraktar TB2, which reportedly sells for about $5 million and first entered service in 2014, isn’t limited to Ukraine; it has proven a huge export success, with its appeal driven by relative affordability and Turkey’s willingness to sell weaponry to customers without strings attached.

Gulf countries have lined up too, starting with Qatar which signed an agreement to acquire six Baykar drones in 2018. More recently those deals have gotten more consequential: in January 2023, Kuwait’s defense ministry signed a $370 million agreement to acquire Bayraktars, a contract Baykar won despite competition from significant global firms in America, Europe and China. That comes after Reuters reported that Baykar delivered 20 Bayraktars to the UAE in 2022. Meanwhile, Saudi Arabia has also reportedly expressed interest in Baykar drones.

However, Baykar’s success in Ukraine has been both a boon for Turkey and a problem for Ankara. On one hand, the drone’s success strongly promotes its prized defense industry, but it also complicates its relationship with Russia, a major trading partner. Erdogan has also touted his “special relationship” with Russian President Vladimir Putin.

Notably, the publication Daily Sabah quoted Turkey’s former Deputy Foreign Minister Yavuz Selim Kiran in 2022 as saying that Kyiv’s drone purchases were directly from Baykar and not a form of aid from Ankara. Still, there’s little doubt the government heavily monitors defense exports and the Russians have reportedly expressed their frustration to Turkey regarding drone sales to Ukraine. 

Regardless, Baykar has emerged as a key industry player to watch in the region. The firm reported $1.4 billion in revenue for 2022, with 99.3% of that from exports. At least 28 countries have struck deals to acquire Bayraktar TB2s, including four NATO members. Looking ahead, the company is currently developing an unmanned fighter aircraft dubbed Kızılelma and plans to start serial production in 2024. Baykar also recently unveiled a new cruise missile for use on its combat drones.

5. Key takeaways:

➡ Fueled by investments decades in the making alongside rising ambitions from upstart players in the Gulf, the Mideast's defense market is evolving, motivated by a desire to secure greater self-sufficiency and national sovereignty. That’s creating opportunities and challenges alike for global weapons suppliers targeting regional business. 

➡ Turkey and Israel remain home to the region's most powerful defense industries, but Gulf upstarts have the ambition and financial firepower to become more impactful players in the region and beyond. However, they have plenty of ground to make up. 

➡ It will take time for Gulf states to develop advanced manufacturing capabilities able to compete with Turkey, Israel and global players, but there’s also potential to expedite growth by focusing on innovative software-based defense solutions that require less industrial infrastructure and related technological capacity.

➡ Although economic diversification is championed as a key factor underpinning the development of domestic defense industries, homegrown sectors in the Gulf are still a long way from contributing greatly to national growth. Most regional exports remain relatively low-tech and have yet to make an impact in advanced markets. “To the extent that Gulf states export weapons, it’s to offset the costs of developing their own weapons production, which will probably never be cost-efficient in strictly financial terms,” said DesRoches.

➡ Amid efforts to localize spending, Middle East countries are still largely reliant on foreign technology and expertise to help develop industries capabilities. Joint ventures with external companies remain key to accessing R&D and edgy tech. “This approach has certainly led to billions of dollars being spent [but] it has still not cut the reliance on foreign defense contractors whose know-how and R&D is basically still imported indirectly,” said Krieg. “The challenge will be to attract talent who can do R&D domestically completely independently from overseas input.”

➡ Even Turkey’s robust domestic arms industry is a recipient of foreign equipment and technologies and remains very much integrated with the US and especially European industries. That calls into question the broader ability of Middle East countries to fully localize supply chains and achieve true national sovereignty. 

➡ Still, the Turkish template to industry development has proven potent: the affordability of Turkish arms and the flexibility of its export policy has given Turkey significant advantages over competitors. “The growth has been phenomenal,” notes Egeli. “It's the outcome of a very long-term investment going back to 1980s.”

➡ Global defense firms eying business in the region must prepare for increasing local competition as homegrown giants like EDGE and SAMI evolve and Israeli players expand their footprints. That should only amplify the importance of partnerships and technology transfer as a means to secure lucrative contracts. Local firms and subsidiaries of players like EDGE will likely be favored by their respective governments unless foreign companies demonstrate openness to help develop local intellectual property.

➡ More broadly, the perceived US disengagement and its strained ties with long-time allies is poised to have billion-dollar consequences for the Middle East's defense industry landscape. The door is open for China to play a more impactful role. US armaments will remain critical and coveted for the foreseeable future, but regional governments won’t fail to use this moment to seek more leverage and autonomy.