Introduction

The economics of defence or defence economics is a subfield of economics, an application of the economic theory to the issues of military defence.

It is a relatively new field. An early specialised work in the field is the RAND Corporation report The Economics of Defence in the Nuclear Age by Charles J. Hitch and Roland McKean (1960, also published as a book). It is an economic field that studies the management of government budget and its expenditure during mainly war times, but also during peace times, and its consequences on economic growth. It thus uses macroeconomic and microeconomic tools such as game theory, comparative statistics, growth theory and econometrics. It has strong ties to other subfields of economics such as public finance, economics of industrial organisation, international economics, labour economics and growth economics.

Brief History

The roots of the science can be tracked back to the 1920s when The Political Economy of War by Arthur Cecil Pigou was originally published. A major step forward can be then accredited to Charles J. Hitch and Roland McKean and their work The Economics of Defence in the Nuclear Age from 1960. A great contribution to the subject came in 1975 when the British economist G. Kennedy published his book The Economics of Defence. However, importance of the field grew especially in the late 1980s and early 1990s due to political instability caused by the breakup of the Soviet Union and liberation of Eastern Europe. This resulted in the publication of a complex overview of the current state of the field in 1995 from Todd Sandler and Keith Hartley called The Handbook of Defence Economics.

While the science as such started developing in the 20th century, many of its topics can be found long before then. For example, the first written set of laws called the Code of Hammurabi from the 18th century BC can be considered one of the earliest works dealing with problems and questions of the economics of defence. Similarly, economic aspects of war and military operations are broken down in a great detail in Sun Tzu’s The Art of War from the 5th century BC. During the Middle Ages, political institutions emerged and a great step forward was made in military with the invention of devices using gunpowder.

Generally, developments in defence economics reflect current affairs. During the Cold War, the main topics included superpower arms races, establishment of strong and lasting alliances and nuclear weapon research. Afterwards, the focus shifted to conversion opportunities, disarmament and the peace dividend availability. And at the beginning of the new millennium, the research shifted its attention to an increasing number of regional and ethnic conflicts (Africa, Bosnia, Kosovo, Afghanistan, Iraq), international terrorist threats (terrorist attacks on the US) and weapons of mass destruction. Besides that, much work was dedicated to NATO, the European Union and other alliances that accepted new members and continued with developing new missions, rules and international organisations, an example being the European Security and Defence Policy, which involved the introduction of the European Defence Equipment Market and the European Defence Technological and Industrial Base.

Principles

The field revolves around finding the optimal resource allocation among defence and other functions of the government. While the primal goal is to find the optimal size of the defence budget with respect to sizes of other budgets managed by the public body, the field also studies the optimisation of allocation among specific missions and outputs such as arms control, disarmament, civil defence, sealift, arms conversion, mobilisation bases, or weaponry composition. At the same time, different ways these goals can be achieved are analysed on lower levels. These consist of finding the optimal choice between alternative logistic arrangements, rifles, specialised equipment, contract provisions, base locations and so on. Since the defence management of a country consists of choosing between many substitutes, an analysis of costs and benefits of various options is vital.

Economizing in the economics of defence represents the principle of reallocating available scarce resources such that an output of the greatest possible value is produced. This can be achieved in two ways:

• Improvement of the economic calculus; and
• Improvement of the institutional arrangements that shape defence choices.

These two are closely intertwined since finding an optimal choice is worthless if institutions lead decision-makers to different choices, just as functioning institutions do not provide much help if an optimal choice is not found. An absence of a widely accepted tool to calculate the change in value when choosing among various options represents a major difficulty in the economics of defence because it makes the identification of the optimal allocation practically impossible. Differences of opinions on security and threat protection topics are common between people, which causes improbability of such a tool being ever developed.

Although the economics of defence mainly studies microeconomic topics, which involve allocation optimization and optimal choice identification, it also looks into several macroeconomic topics, which focus on the impact of defence expenditures on various macroeconomic variables such as economic growth, gross domestic product and employment.

In terms of economics, a distinctive feature of the defence is that it is public goods, and as such it is both non-excludable and non-rivalrous. As such, it may suffer the so-called “free rider problem”.

General Economic Theories of Military Spending

The Neoclassical Theory

In the Neoclassical theory, military spending can be considered as a public good. The government acts as a rational agent, trying to maximise the welfare of society by taking into account the security benefits, the opportunity costs and the trade-off between military and civil spending. This theory is often criticised because of its unrealistic assumptions, for example (its assumption) about the rational agent (theory).

The best known neoclassical model is the one of Feder-Ram, developed by Biswas and Ram in 1986, and adapted by Feder a few years later. It mainly focuses on the effects of military spending on economic growth of developing countries through the export effect, thanks to a cross-country study. This model is criticised because military spending represents one single explanatory variable in a simple linear regression.

The Keynesian Theory

In the Keynesian theory, in case of ineffective aggregate demand, military spending increases the output of a country (see also Military keynesianism). According to Faini et al (1984), military spending can increase growth, through an increase of capacity utilisation, investment and profits. This theory is criticised because it is mainly focussed on the demand side and not enough on the supply and production side.

The Marxist Theory

The Marxist theory considers military spending as necessary for the development of the Military-industrial complex in class struggle and capitalism. According to Baran and Paul Sweezy (1966), this type of government spending enable to control wages and profits in case of underconsumption.

United States

Typically, the United States uses a combination of hard power (military force), soft power (diplomacy and foreign assistance) and domestic counterterrorism (homeland security). During the early 2000s, the United States’ national defence budget rose to about $800 billion per year. In recent years, it has dropped to $600 billion annually, which is still a large figure relative to Cold War averages and other countries’ budgets.