Economics of Conflict, War, and Peace Prof. Dr. Jurgen Brauer; Summer 2009 Chulalongkorn University; Bangkok, Thailand Session 4.2 Capital: Major conventional weapons

Major conventional weapons: trade (1) Brauer in Sandler/Hartley, 2007, p. 978. Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Major conventional weapons: trade (2) Brauer in Sandler/Hartley, 2007, p. 979. Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Major conventinal wepons: production Brauer in Sandler/Hartley, 2007, p. 986. Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Background (1) Two “stylized” facts First expansion, then decline of number of states that produce/export conventional arms (whole-units) from 1950s to 2000s Transnationalization of conventional arms production, esp. of component production; integration into transnationalized supply chains Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Background (2) Exporters (whole-units) 50s 60s 70s 80s 90s 00s High income states 20 25 27 30 32 [32] 26 [26] Non-high 9 23 38 37 [43] 21 [39] Exporters of major conventional weapons (from Brauer, 2007, in Sandler/Hartly Handbook of Defense Economics, vol. 2), based on Brauer (1991, 2000, and updates) Brauer in Sandler/Hartley, 2007, p. 985. Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 What is to be explained? Addition of states as arms producers/exporters (whole-units), esp. of non-high income states Drop-off of states as arms producers/exporters (whole-units), esp. of non-high income states Transnationalization of arms production, esp. of components Integration of non-high income and some high-income states into transnationalized arms production and component supply chain Integrate fall of post-Cold War demand and continuous unit-cost increase (Dunne/Surry: “structural disarmament”) into the model Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 A heuristic model (1) T – technical efficiency ΔT – difference between make or buy $ High cost differential => don’t make in-state but buy in out-of-state market (valuation) ΔT k (asset specificity) k* k** High agency cost differential => in-state agency cost < out-of-state agency cost (note: k > k*) High agency cost differential => in-state agency cost > out-of-state agency cost (note: k < k*) ΔC ΔA A – agency efficiency ΔA – difference between make or buy Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 A heuristic model (2) $ There is a value of k** above which in-state production is at an advantage relative to out-of-state procurement (valuation) ΔT k (asset specificity) k** k < k** k > k** ΔC ΔC > 0 ΔC < 0 ΔA There is a value of k** below which in-state production is at a disadvantage relative to out-of-state procurement Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 A heuristic model (3) ΔT is the difference in technical efficiency between in-state and out-of-state production; so, even if in-state production becomes 5% more efficient but out-of-state production becomes 10% more efficient, ΔT will still shift upward to ΔT’ … $ (valuation) ΔT’ ΔT k (asset specificity) k* k** ΔC’ ΔC ΔA Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 A heuristic model (4) ΔT is the difference in technical efficiency between in-state and out-of-state production; so, even if in-state production becomes 5% more efficient but out-of-state production becomes 10% more efficient, ΔT will still shift upward to ΔT’ … $ (valuation) ΔT’ D ΔT k (asset specificity) k* k** k*** ΔC’ ΔC ΔA Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Playing with the model If ΔT rises to ΔT’, k** shifts right to k*** more contracting out If ΔT falls, k** shifts left less contracting out If ΔA rises, k** shifts right if the difference in agency cost rises If ΔA falls, k** shifts left If both ΔT and ΔA change, the move of k** depends on the relative shifts (and directions) of ΔT and ΔA Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 An extreme case $ (valuation) ΔT k (asset specificity) k*** k* k** ΔC ΔA ΔC’ ΔA’ Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Some implications (1) Prior to the end of the Cold War (ΔA constant), ΔT shifted downward as states “developed” and k** shifted leftward, resulting in more in-state arms production Thus, high-income states producing/exporting whole-units went from n=20 to n=30 and non-high income states from n=9 to n=37 With the end of the Cold War, agency costs of contracting-out have fallen (ΔA shifts upward) and the cost of technical inefficiency (ΔT constant) has become more apparent, leading some states to drop out of whole-unit production (k** shifts rightward) Also, post-Cold War demand drop-off leads to smaller production runs (higher T and, probably, higher ΔT’s) Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Some implications (2) In addition, technical requirements push T upward and, probably, the ΔT’s, disadvantaging some states This might explain why post-Cold War we seem to see some states dropping out of whole-unit production and more states engaged in transnationalized component production There is capacity for efficient component production but not whole-unit production and there is willingness (ΔA) to transfer component technology but not whole-unit technology (battles over offsets-technologies) The model also suggest that states that refuse to integrate into the transnationalized component supply-chain and that insist on whole-unit production might find themselves carrying unusually high defense production/procurement burdens Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2

Economics of Conflict, War, and Peace Session 4.2 Conclusion Heuristically, the model makes some sense (to me at least) It suggests that for the industry as a whole, agency efficiency, technical efficiency, and asset specificity drive decisionmaking behavior The challenge now is to work up some real-world case studies and to apply/refine the model; convert from post-hoc to make predictions Prof. J. Brauer; Summer 2009 Chulalongkorn U., Bangkok Economics of Conflict, War, and Peace Session 4.2