Can defense save Europe’s ailing car industry?

The European automobile industry is in a structural crisis. Slowing demand for electric vehicles, loss of market share from Chinese competitors and high borrowing costs have created a perfect storm for the industry over the past five years, as sales volumes continue to fall well below pre-pandemic levels.

European automakers have a long history of producing defense equipment and weapons when needed in wartime. Some companies now think that returning to these roots could provide a lifeline.

Analysts at Citi called this shift the “everything but autos” trade.

On Monday, Renault announced that it has developed a land-based drone for military and civilian use. This comes after it announced in January that it would partner with advocacy group Turgis Gaillard to produce drones in France.

Meanwhile, the German automaker volkswagen It is reported to be in talks with Israeli defense firm Rafael to produce parts for missile defense systems.

According to FT’s news dated March 24, the two are in talks to convert VW’s factory in Osnabrück, Germany, into facilities where components of the Israeli Iron Dome missile defense system produced by Rafael will be produced.

European automakers struggle to compete directly with Chinese rivals such as BYD. While new car sales in the EU fell through January, according to ACEA data, BYD stunned the market with a 175% year-on-year increase in deliveries to 13,982 units.

The decline in the sector is also felt in the share prices of automobile manufacturers. While the Stoxx 600 Automobile index has fallen 30% in the last five years as of April 2, VW has lost over 60% of its value since then. StellantisOwner of brands including Fiat and Peugeot.

In contrast, the European defense industry is developing rapidly. The urgent need to rearm following Russia’s invasion of Ukraine in 2022 and the apparent breakdown in relations within NATO means Europe must become more self-sufficient in defense production.

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

“The defense industry has huge growth potential, supported by government budgets and NATO requirements,” Rico Luman, senior industry economist for transportation and logistics at Dutch bank ING, told CNBC via email.

“For the defense industry, the issue is how to expand production. Reorienting production capacity is an opportunity for the automotive industry.”

But other analysts question whether pursuing defense will be enough to save the struggling auto industry, citing several concerns about automakers’ ability to grow in that area.

The relationship between automakers and weapons production has always been symbiotic. During World War II, automotive companies around the world shut down civilian production to focus on their countries’ war efforts (production of military vehicles, aircraft engines, as well as weapons and ammunition).

According to experts, the transition from wheels to guns and back to guns can be achieved in part because many of the basic skills are highly transferrable.

“There is a significant overlap in capabilities as both sectors rely on advanced manufacturing, complex supply chains and engineering,” Zuzana Pelakova, director of economics and business at Slovakian think tank Globsec, told CNBC via email.

“There is also historical precedent. Countries such as Slovakia and the Czech Republic, which today are among the world leaders in car production per capita, have based much of their automotive power on workforces that once worked in the defense industry before the end of socialism.”

VW is in a particularly difficult situation, facing worsening profitability and aiming to cut headcount by 35,000 (or roughly 5% of its workforce) before 2030.

If talks with Rafael or other defense suitors bear fruit, the potential to repurpose VW’s former Osnabrück plant, which it will close in 2027, could save up to 2,300 jobs.

However, Germany’s largest union said that transferring large numbers of workers from other industrial sectors to defense industry companies was “unrealistic” and “not a solution” to the sector’s structural problems.

“This will not be enough to offset the upcoming job losses in the automotive industry, among suppliers and in other major sectors of the metal and electrical industries,” IG Metall told CNBC in an emailed statement.

“Sectors work very differently for this. For example, unlike the high-volume automotive industry, the defense sector is dominated by small series production. Even if production volumes are increased here, production will not resemble the automotive industry.”