23CHAPTER

National Defense

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-2

National DefenseNational Defense In 1960, comprised half of federal In 1960, comprised half of federal

government spendinggovernment spending In 1999, just over 16%In 1999, just over 16% Defense spending can be adjusted on Defense spending can be adjusted on

the marginthe margin Especially expenditures to defend U.S. Especially expenditures to defend U.S.

interests internationallyinterests internationally

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-3

The Level of Military The Level of Military ExpendituresExpenditures

Year Percent of GDP1945 41.0%1950 4.8%1955 10.5%1960 9.4%1965 7.2%1970 8.1%1975 5.5%1980 5.0%1985 6.3%1990 5.4%1995 3.7%2000 3.0%2003 3.7%

Source: Calculated from data in the Statistical Abstract of the United States , various

Table 23.1 Expenditures on National Defense as a Percentage of GDP

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-4

The Marginal Benefits of The Marginal Benefits of Additional ExpendituresAdditional Expenditures

Marginal Costs of Military = Marginal Marginal Costs of Military = Marginal BenefitsBenefits

MB decline as dollars are spent on MB decline as dollars are spent on less vital itemsless vital items

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-5

The Marginal Benefits of The Marginal Benefits of Additional ExpendituresAdditional Expenditures

The Optimal Level of Military Expenditures

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-6

The Arms Race and the The Arms Race and the War on TerrorWar on Terror

What if reaction of other nations to What if reaction of other nations to military spending is negative?military spending is negative? Arms raceArms race

Potential prisoner’s dilemmaPotential prisoner’s dilemma Incentive to heavily armIncentive to heavily arm End up worse off as resultEnd up worse off as result

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-7

The Arms Race and the The Arms Race and the War on TerrorWar on Terror

An Arms Race as a Prisoners’

Dilemma Game

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-8

Military AlliancesMilitary Alliances Optimal sharing group may be larger Optimal sharing group may be larger

than one nationthan one nation Economic rational for alliancesEconomic rational for alliances Example:Example: NATO NATO

Increased security also increases Increased security also increases propensity for warpropensity for war

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-9

Economic WarfareEconomic Warfare Arms races can cause major Arms races can cause major

economic problemseconomic problems Example:Example: Soviet Union during Cold War Soviet Union during Cold War

Economic warfare can be used to Economic warfare can be used to bankrupt an adversarybankrupt an adversary

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-10

Do Democracies Spend Do Democracies Spend Enough?Enough?

Military spending reduces current Military spending reduces current consumptionconsumption

Might be investment towards future Might be investment towards future consumptionconsumption Example:Example: 1991 war with Iraq 1991 war with Iraq

Democratic governments might be Democratic governments might be biased towards short-term spendingbiased towards short-term spending Leads to inadequate military investmentLeads to inadequate military investment

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-11

Military Procurement Military Procurement ContractsContracts

How can contracts be written to How can contracts be written to purchase uncertain items?purchase uncertain items?

Fixed feeFixed fee Often infeasibleOften infeasible

Cost plus fixed feeCost plus fixed fee Little incentive to control costsLittle incentive to control costs

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-12

Military Procurement Military Procurement ContractsContracts

Cost plus percentage feeCost plus percentage fee Incentive to overspendIncentive to overspend

Cost plus incentive feeCost plus incentive fee Limited applicabilityLimited applicability

The perfect contractThe perfect contract Does not existDoes not exist

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-13

Procurement Versus Life-Procurement Versus Life-Cycle CostsCycle Costs

True cost is cost over life-cycleTrue cost is cost over life-cycle Two aspects relevant to military Two aspects relevant to military

expendituresexpenditures Cost of maintenanceCost of maintenance Cost of finishing a started programCost of finishing a started program

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-14

Conscription Versus Conscription Versus VolunteersVolunteers

Advantages of conscriptionAdvantages of conscription Lower personnel costsLower personnel costs Constant costsConstant costs

Disadvantages of conscriptionDisadvantages of conscription Heavy tax on conscriptedHeavy tax on conscripted Misallocates labor resourcesMisallocates labor resources

PUBLIC SECTOR ECONOMICS: The Role of Government in the American EconomyRandall Holcombe 23-15

Conscription Versus Conscription Versus VolunteersVolunteers