The Concise Encyclopedia of Economics


by Benjamin Zycher
About the Author
National defense is a public good. That means two things. First, consumption of the good by one person does not reduce the amount available for others to consume. Thus, all people in a nation must "consume" the same amount of national defense (the defense policy established by the government). Second, the benefits a person derives from a public good do not depend on how much that person contributes toward providing it. Everyone benefits, perhaps in differing amounts, from national defense, including those who do not pay taxes. Once the government organizes the resources for national defense, it necessarily defends all residents against foreign aggressors.

These two features of national defense cause an important "free-rider" problem. Because people benefit whether or not they contribute toward defense, each person has an incentive to wait for others to provide the public good and get a "free ride." Also, because a free-rider's consumption does not reduce the amount available for others to consume, even those who pay have little incentive to prevent free-riding by others.

As a result of free-riding, an individual acting alone to provide national defense would produce too little. Each person would provide defense until the incremental benefits to him equaled the incremental costs. But for society as a whole—that is, for all individuals—the incremental benefits exceed the incremental costs. That is because once an individual provides some of the public good, all people benefit from it and cannot be excluded. This free-rider behavior provides one of the important traditional arguments for government: by imposing taxes on all individuals and then providing public goods, government, in principle, eliminates free-rider behavior and can produce the "right" amount of national defense and other public goods.

How Can Government Be Induced to Provide the Optimal Amount of National Defense?

That traditional rationale for government taxation and spending on national defense is incomplete. It states that the government can eliminate free-rider behavior, but is silent on whether the government has the right incentives to do so. Just as economists have shown that individuals acting alone will provide too few public goods, public choice economists (see Public Choice Theory) have shown that democratic government, acting under a majority decision rule, also will provide too few public goods. The reason is that the political majority can impose taxes on all citizens and then reduce spending on such public goods as national defense while increasing spending on private (that is, nonpublic) goods that benefit the majority but not the minority. Transfer payments such as Social Security and other subsidies such as price supports for farmers are examples of government spending on private goods.

If, however, the public goods provided by government can be transformed into private ones—that is, if provision of the public goods yields ancillary benefits that some majority coalition of voters views as private—then the problem of government underprovision of public goods can be offset, at least partially. National defense does yield ancillary benefits to special interests. Defense contractors, defense-related workers, and communities with military bases all benefit privately from defense spending.

These interests are located in a majority of congressional districts and in a majority of states. Their presence, therefore, offsets the bias toward too little defense spending. Ironically, therefore, the proliferation of military bases, geographic dispersion of defense contracts, and other seemingly "wasteful" aspects of defense spending actually may make government spending more efficient.

Optimal Taxation When the Government Provides National Defense

The traditional theory of optimal taxation states that the kinds of taxes used and the rates levied should minimize distortions. That is, they should interfere as little as possible with the choices taxpayers make in the private marketplace (see Taxation, A Preface). But this traditional theory assumes implicitly that the size and composition of the government budget are independent of the kinds and magnitudes of the taxes imposed. That assumption is unrealistic. If government programs benefit one group of voters but are financed by another, the beneficiaries will demand larger programs than if they were required to bear the tax burden themselves. A striking modern-day illustration of this is Congress's speedy 1989 repeal of compulsory catastrophic health insurance for the elderly. Congress did so at the behest of old people within months after these people realized that their taxes alone would pay for the program. In the area of defense, political processes are more likely to achieve the optimal amount of spending if each person pays taxes in proportion to the value he or she derives from the defense services provided.

National defense benefits everyone, but in different degrees. National defense defends against the threat that foreign aggressors will confiscate or destroy domestic property and destroy lives. It defends individual liberty, political freedom, and the domestic political system. It provides a foundation for foreign policy, which, presumably, serves the interests of all, but in differing amounts. In addition, the U.S. defense budget is used to support many foreign policy objectives and so is dedicated in part to protecting foreign people and assets. The post-World War II commitment to NATO is the best example.

Nevertheless, the protection of domestic wealth from foreign confiscation or destruction is an obvious and large part of the service provided by national defense. Accordingly, a substantial part of the demand for national defense can reasonably be ascribed to those U.S. residents who own assets threatened by foreign aggression. Some kinds of assets are more vulnerable than others: American-owned assets located overseas may be more vulnerable than identical ones in the United States, and civilian aircraft that can be moved may be more vulnerable to confiscation but less vulnerable to destruction than office buildings. In any event, a rough surrogate for individual valuation of this defense service is individual wealth. Thus, an important component of a tax system designed to yield appropriate democratic choices on the size of the defense sector is a tax on wealth. Taxes on incomes or consumption may provide good approximations to such a tax. Similarly, individual preferences for political freedom, for protection of the political system, and for foreign policy maneuverings are likely to be correlated positively with individual wealth. Again, taxes on wealth, income, or consumption may, therefore, be appropriate.

International Defense Alliances

Nations facing a common threat often pool their defense efforts in such alliances as NATO. While NATO is a formal alliance, nations can cooperate in informal alliances as well, sharing defense responsibilities and burdens without the trappings of an international organization. In principle, little communication between such informal partners is necessary: each nation can undertake given defense activities knowing that the other(s) will pursue complementary activities in response. Whatever the nature of the alliance, the defense (or other) efforts aimed at common goals are, again, a public good. Thus, nations, just like individuals, face the free-rider problem and the resulting underprovision of defense. Because larger nations like the United States are likely to value the collective defense effort more highly than smaller ones like Belgium, small nations may attempt to exploit larger ones by free-riding on the larger countries' defense efforts. Thus, members of alliances often bargain over "burden sharing," or the specific efforts to be made by each.

One problem with achieving an equitable and efficient sharing of burdens is knowing what the appropriate burdens are. Even if countries agree that they should contribute "proportionally," the question remains "proportional to what?" Population, GNP, per capita GNP, and physical proximity to the perceived threat all seem like plausible candidates. Furthermore, even if nations agree on what the effort should be proportional to, there are different measures of effort. One measure is military spending. But another reasonable measure is contribution of physical defense assets. Contributions of physical assets and manpower may not be proportional to spending because of differences in valuation or pricing, differences in efficiency, and a host of other factors. For example, U.S. defense spending in the mid-1980s was roughly 60 percent of the NATO total, while the United States provided about 46 percent of the main battle tanks and about 40 percent of the division-equivalent firepower. The German Federal Republic provided about 8 percent of NATO spending, but about 17 percent of the main battle tanks and 13 percent of division-equivalent firepower. Such indices are crude, but illustrate the difficulty of measuring relative contributions.

No definition of fairness in burden sharing is obviously correct, and this ambiguity inexorably creates tension within alliances. Furthermore, citizens of one nation may value the collective defensive effort less or more than citizens of another nation, and also may have different perceptions of how serious the threat is. That was the case in NATO for many years, as the United States and West Germany perceived a substantially greater threat than did Greece.

Dependence versus "Vulnerability" in Foreign Defense Procurement

Modern military forces combine many kinds of manpower and physical materiel. Inevitably, some of these inputs, such as rare metals and electronic components, are purchased from foreigners because doing so is necessary or at least cheaper than buying them at home. Many people worry that foreign procurement makes the United States vulnerable to a cutoff in items supplied by foreigners. They fear that cuts in foreign supplies may exceed, in both number and variety, potential cuts in supplies from domestic firms.

That view is misguided. Suppose that some defense good is purchased from foreign suppliers and that this arrangement is subject to easy but unpredictable cutoffs. Suppose, also, that such interruptions are easy to insure against (with stockpiles, alternative suppliers in other parts of the world, or excess production capacity in the United States). If so, then foreign dependence does not cause true vulnerability. The key question, therefore, is not the source of the defense goods, but rather the ease with which interruptions in supply—either foreign or domestic—can be insured against. If domestic dependence is more difficult to insure against than foreign dependence, then ironically, domestic dependence causes greater vulnerability.

What could make insurance more difficult for domestic purchases than for foreign ones? One possibility is the expectation of price controls. Producers of defense-related goods know that the prices of such goods can rise dramatically when a government at war or preparing for war increases its purchases of those goods. These price increases serve an important function: they reward domestic producers for stockpiling goods, maintaining excess production capacity, and increasing production quickly. But domestic producers also know that governments, wanting goods on the cheap, often impose price controls on just such goods. The imposition of price controls on petroleum products during past wars is but one example. Taking anticipated price controls into account, domestic producers do not stockpile as much or maintain as much excess capacity. Nor do they increase production as much when price controls are actually imposed. But governments cannot impose price controls on foreign producers. Therefore, foreign producers have stronger incentives to stockpile and to maintain excess capacity.

Also, such government practices as cost-plus contracting may affect domestic suppliers of defense-related goods disproportionately. If cost-plus contracting is based upon historical or accounting cost instead of market value at the time of purchase, future prices paid by the government may not cover the market value (or opportunity cost) of many kinds of assets, thus causing a loss for suppliers. In short, the "vulnerability" issue is far more complex than the common foreign/domestic dependence view suggests.

Efficient Delivery of Defense Services

Now that the Soviet economic system is likely to be gradually replaced with free markets, the U.S. Department of Defense (DOD) may be the largest centrally planned economy in the world. And there is little reason to believe that central planning works better in the United States than elsewhere.

Central planning in DOD creates the same two problems that central planning always creates. First, DOD decision makers who design weaponry or who specify characteristics and performance features of equipment designed by contractors respond poorly to consumer preferences. The "consumers" of the weapons and equipment are the soldiers in the foxholes, the airmen facing dogfights and antiaircraft fire, and so on. A good proxy for these ultimate users may be the theater commanders charged with winning battles. But few institutions at DOD induce decision makers to conform their preferences to those of even the theater commanders. The absence of a profit motive weakens the incentive for DOD to adapt their decisions to the perceived preferences of users. The absence of competition in defense diminishes it even more.

As a result the DOD often has promoted weapons designs with dubious combat features and effectiveness. The air force's A-10 "Warthog" aircraft is a good example. The Warthog performed brilliantly in the 1991 Gulf War in support of army and marine ground operations. It was designed for that specific purpose. Yet the air force tried for years to eliminate funding for the A-10 precisely because it supports the other services and thus yields few bureaucratic benefits for the air force. The air force wanted to use F-16s and other more glamorous aircraft for ground support despite the fact that their great speed makes them much less suitable for such missions. One way to get weapons and other equipment that conform more to user demands is to give the users a larger voice or a direct veto in design decisions.

The absence of a profit motive, and of an individual or group with a claim to the economic benefits from reductions in costs, weakens the DOD's incentive to minimize the cost of achieving given objectives. Contracts for design and production of weaponry are often written on a cost-plus basis, under which the contractor receives a payment from the government equal to costs plus some predetermined "profit." Therefore, the contractors have little incentive to minimize costs. If, on the other hand, the contractor simply receives a fixed price for the output of defense goods, he has a strong incentive to minimize costs, but the contractor must bear the risk of increases in the prices of inputs and of other outcomes that cannot be predicted perfectly.

DOD itself has only a weak incentive to operate efficiently. Because the military services have sharply defined tasks with little overlap, each service is, in effect, a monopolist in its defined missions. The army, for example, is prevented from flying fixedwing aircraft, thus giving the air force a near monopoly in providing close air support for ground operations. Because each service is likely to have better information than does Congress about the cost of providing given defense services, the efforts of the services to maximize their budgets can lead them to provide defense at a higher cost than necessary.

The services can be aided in this quest by such important interest groups as defense contractors in various congressional districts. This lobbying by private defense interests weakens the incentive for Congress to minimize the cost of obtaining a given package of defense output. An important way to reduce this inefficiency would be to have the services compete. The army and the Marine Corps could be required to compete on a much broader scale in "producing" ground combat operations. The army and the air force could compete in providing close air support for ground combat. The navy could be forced to compete on a much broader scale with the Coast Guard. Such competition, like competition in the private sector, would decrease the cost of defense.

The Defense Establishment and the Threat to the Polity

The existence of an armed defense establishment always threatens civilian governments and the rights and liberties enjoyed by individuals. The Founding Fathers recognized this threat. In August 1789, when Congress was considering the Bill of Rights, Congressman Elbridge Gerry wrote, "What, sir, is the use of militia? It is to prevent the establishment of a standing army, the bane of liberty." Therefore, they made two institutional arrangements. First, because the threat is posed mainly by ground forces, the ground forces are split into the army, the marines, and the states' national guards. That way, any service whose officers want a military coup must take into account the potential opposition posed by the other ground combat services.

Second, the Founding Fathers recognized from their own experience that an armed citizenry is more immune to the efforts of governments—of centralized military establishments—to impose dictatorship. Thus, they specified the "right of the people to keep and bear arms" in the Second Amendment to the Constitution. Unlike the First Amendment, which placed constraints only upon Congress, the Second Amendment decreed that the right to keep and bear arms "shall not be infringed."


National defense, while not a separate field of study within economics, raises a vast range of economic issues. Defense, like other areas of public policy, is suitable for the prescriptions yielded by economic analysis.

About the Author

Benjamin Zycher is a senior economist at the Rand Corporation in Santa Monica and a visiting professor of economics at UCLA.

Further Reading

Cooper, Charles A., and Benjamin Zycher. "Perceptions of NATO Burden-Sharing." Rand Corporation paper no. R-3750-FF/RC, June 1989.

Enthoven, Alain C., and Wayne K. Smith. How Much Is Enough? Shaping the Defense Program, 1961-1969. 1971.

Halbrook, Stephen P. That Every Man Be Armed: The Evolution of a Constitutional Right. 1984.

Hitch, Charles J., and Roland N. McKean. The Economics of Defense in the Nuclear Age. 1970.

Thompson, Earl A. "Taxation and National Defense." Journal of Political Economy 82, no. 4 (1974): 755-82.

Zycher, Benjamin, Kenneth A. Solomon, and Loren Yager. "An 'Adequate Insurance' Approach to Critical Dependencies of the Department of Defense." Rand Corporation paper no. R-3880-DARPA, 1991.

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