By David Brunnstrom

BRUSSELS (Reuters) - NATO nations meet in Brussels on Wednesday under mounting pressure to expand cooperation in defense projects given big cuts looming in the U.S. defense budget.

The two-day meeting of NATO defense ministers comes as the 28-member alliance is close to concluding an air-and-sea campaign in Libya that saw Muammar Gaddafi overthrown without a single NATO casualty.

However, NATO remains bogged down in a hugely expensive war in Afghanistan, where 10 years of Western fighting has failed to subdue a Taliban insurgency, and officials say the extra effort in Libya has exposed limitations that must be addressed.

In the lead-up to a NATO summit in Chicago in May, alliance Secretary-General Anders Fogh Rasmussen wants members to identify projects in which they can cooperate to make best use of resources at a time of severe economic austerity in which defense budgets have been particularly badly hit.

"Improving our capabilities is not only necessary -- it is vital," he told a briefing on Monday, adding that Libya and Afghanistan had shown shortcomings among non-U.S. allies in key areas such as unmanned surveillance drones, intelligence gathering and air-to-air refuelling.

"We must spend on priorities and spend together, by financing shared projects that make us all safer."

Rasmussen champions "Smart Defense," saying this does not mean spending more, "but spending more effectively." However, the bid to cut duplication and waste faces foot-dragging by governments anxious to project domestic defense industries.

PRESSURE GROWING

Pressure is growing now that the United States, which spends far more on defense than its NATO allies combined, faces the prospect of having to cut its spending by as much as $1 trillion over 10 years.

So far, U.S. President Barack Obama and Congress have approved $350 billion in cuts to national security spending. If a Congressional "super committee" fails to reach a deficit deal by the year-end, automatic across-the-board cuts could take another $600 billion from that budget.

This has raised questions about the future of expensive cooperative projects, such as a U.S.-led missile defense initiative, and some in the U.S. Congress have argued for further cuts in the 79,000 U.S. military personnel in Europe.

U.S. Defense Secretary Leon Panetta, on his first trip to Europe since taking over the position this year, will explain some of the consequences in a 0800 GMT speech on Wednesday before meeting his NATO counterparts.

"What you will hear from Panetta is the reality that the United States will have to start cutting its defense budget and will cut its defense budget," a senior NATO diplomat said.

"That means that the time in which Europe could rely on the United States to do everything; that era, if it ever existed, now is clearly coming to a close.

"That is why it's so important that we begin a serious discussion about how we can meet our core requirements and field the capabilities we need by working more together. The United States is not going to be filling the gaps forever."

In June, Panetta's predecessor Robert Gates fired a sharp parting shot at European allies saying future U.S. leaders might not consider U.S. investment in NATO worthwhile unless the decline in European defense capabilities was reversed.

"That is truer today that when Gates was here in June," the NATO diplomat said.

Among the joint NATO projects the United States is particularly keen to see progress this week is Allied Ground Surveillance, a system that will employ drones to provide a picture of ground conditions from high altitude.

The project, to which 13 countries have committed, would be based around the Global Hawk RQ-4B drone produced by U.S. firm Northrop Grumman. However it has been under discussion for a decade and NATO states have yet to agree how to jointly fund its operation, maintenance and support.

(Reporting by David Brunnstrom; Editing by Myra MacDonald)