UPDATE 1-EU seeks to boost Europe's defence industry
* EU seeks more active role in promoting research
* Bloc tackles protectionism in EU defence markets
* EU may itself acquire some military equipment
BRUSSELS, July 24 (Reuters) - The European Commission proposed helping Europe's defence industry cope with pressure from falling military budgets by funding research and aiding the development of new technologies with military uses.
The European Union's executive body, which has traditionally left defence responsibilities to its 28 member states, also on Wednesday raised the possibility that the EU itself could buy and operate some equipment needed for military missions.
Europe's defence industry had sales of 96 billion euros ($126.9 billion) in 2012 and employed about 400,000 people.
But EU officials fear sharp cuts in defence spending by governments in response to the economic crisis are eroding the competitiveness of the sector, dominated by companies such as Britain's BAE Systems, Franco-German EADS and Italy's Finmeccanica.
In a sign of growing international competition, China replaced Britain in the top five arms-exporting countries in the 2008-2012 period, a respected Swedish thinktank said in March.
The United States and Russia were by far the biggest suppliers, followed by Germany and France, the Stockholm International Peace Research Institute said.
Experts say the European defence industry is fragmented, with firms developing many similar products, while the continent lags in key technologies such as drones, where the United States and Israel lead.
"Member states cannot afford an isolated approach to security and defence any more ... We need to spend wisely, avoiding duplication, by pooling more investment and sharing more assets," European Commission President Jose Manuel Barroso told reporters, presenting the 17-page Commission document.
The paper is part of a debate, set to culminate in a summit of European leaders in December, on how Europe can strengthen its arms industry and bolster a common defence policy.
EU governments like Britain jealously guard defence as a national issue off-limits to Brussels, and the EU proposals brought a strong riposte from Geoffrey Van Orden, British Conservative defence spokesman in the European Parliament.
"(The Commission's) driving motive is political. It is a step in the direction of European political integration," Van Orden said in a statement, adding that British defence companies needed to work with the United States as well as European firms.
The Commission says civilian research carried out under the EU's 80 billion euro Horizon 2020 research programme may have spin-offs for the defence industry.
The Commission, keen to encourage defence cooperation across Europe, said it would take a more hands-on approach in fostering technologies with both civilian and military applications.
It said it would help fund a scheme to acquire prototypes of some technologies.
The first candidates could be equipment to detect chemical, biological, radiological, nuclear and explosives threats, RPAS (remotely-piloted aircraft systems or drones), and radio communication equipment using software on personal computers.
The Commission said it would study what capabilities with both a military and a civilian use were needed for EU security policies. The EU has launched a number of overseas military or civilian missions, including training troops in Mali.
"It will come up with a proposal for which capability needs, if any, could best be fulfilled by assets directly purchased, owned and operated by the (European) Union," the paper said.
A Commission official suggested there might be a need for the EU to have communication, transport, weapons detection or surveillance equipment, such as drones.
The Commission urged EU governments to identify a joint project in the area of key defence capabilities.
The document said the EU was ready to support the creation of a European space surveillance and tracking service - used to monitor space debris that can damage satellites - built on a network of equipment already owned by EU member states.
The Commission promised a crackdown on discriminatory practices and distortions affecting the defence market in Europe, where governments often try to keep manufacturing and skills at home by favouring domestic companies.
The Commission said it would monitor the openness of member states' defence markets and make sure that new rules on procuring defence equipment were applied by EU governments.
European governments are exempt from the usual EU rules on giving state aid to their industries if they can prove that "essential security interests" are at stake. The Commision said it would keep a close eye on ensuring governments met the conditions when asking for exemptions from state aid rules.
The Commission wants to encourage European-wide standards and testing procedures for defence equipment. Drones and encryption technologies could be candidates for setting common European standards, it said.
Many EU officials see the failed $45 billion merger between EADS and BAE Systems last year, which collapsed in the face of political differences, as a missed opportunity to consolidate the European defence industry.