CHAPTER

23
National Defense

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

National Defense
In

1960, comprised half of federal

government spending
In 1999, just over 16%
Defense spending can be adjusted on the
margin
Especially

expenditures to defend U.S.

interests internationally

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-2

The Level of Military

Expenditures

Table 23.1 Expenditures o n

Natio nal Defense as a
Percentage o f GDP

Year
Percent o f GDP
1945
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%
So urce: Calculated fro m data
in the Statistical Abstract of
the United States , vario us

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-3

The Marginal Benefits of

Additional Expenditures
Marginal

Costs of Military = Marginal

Benefits
MB decline as dollars are spent on less
vital items

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-4

The Marginal Benefits of

Additional Expenditures

The Optimal Level of

Military Expenditures
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe

23-5

The Arms Race and the War on

Terror
What

if reaction of other nations to

military spending is negative?
Arms

race

Potential

prisoners dilemma

Incentive

to heavily arm
End up worse off as result

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-6

The Arms Race and the War on

Terror

An Arms Race as a
Prisoners Dilemma
Game
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe

23-7

Military Alliances
Optimal

sharing group may be larger than

one nation
Economic

rational for alliances

Example: NATO
Increased

security also increases

propensity for war

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-8

Economic Warfare
Arms

races can cause major economic

problems
Example:

Soviet Union during Cold War

Economic

warfare can be used to

bankrupt an adversary

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-9

Do Democracies Spend
Enough?
Military

spending reduces current

consumption
Might be investment towards future
consumption
Example:

1991 war with Iraq

Democratic

governments might be biased

towards short-term spending
Leads

to inadequate military investment

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-10

Military Procurement
Contracts
How

can contracts be written to purchase

uncertain items?
Fixed fee
Often

Cost

infeasible

plus fixed fee

Little

incentive to control costs

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-11

Military Procurement
Contracts
Cost

plus percentage fee

Incentive

Cost

plus incentive fee

Limited

The

to overspend

applicability

perfect contract

Does

not exist

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-12

Procurement Versus LifeCycle Costs

True

cost is cost over life-cycle

Two aspects relevant to military
expenditures
Cost

of maintenance
Cost of finishing a started program

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-13

Conscription Versus
Volunteers
Advantages

of conscription

Lower

personnel costs
Constant costs
Disadvantages

of conscription

Heavy

tax on conscripted
Misallocates labor resources

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-14

Conscription Versus
Volunteers

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

23-15