Economic Interdependence and Stability in an Anarchy System

Abstract

This paper analyzes links between economic interdependence and the existence and stability of optimal resource allocations under anarchy. The main findings and testable hypotheses are as follows: (1) When economic goods from two states are substitutable for each other, any changes in endowments or technologies from both states affect the resource allocation between the military sector and the economic sector. Moreover, the existence of comparative advantage of production technologies is an essential factor of equilibrium stability. Without any comparative advantage in production technologies, each state has a unique stable equilibrium at which both states build the same military level regardless of their size. With a comparative advantage by each state either in the military sector or in the economic sector, there may exist multiple equilibria containing at least one unstable equilibrium. (2) On the other hand, when economic goods from two states are complementary to each other, the essential factor that affects a state's resource allocation is its own maximum military level of production out of its resource endowment. In this case, there exists a unique stable equilibrium. (3) When both states have the same resource endowments and production technologies, the optimal allocations in the case of substitutes are the same as those in the case of complements, and they are unique and stable. But if the system is not in equilibrium, then during the transition to equilibrium, a state's optimal military level given a rival's military level, tends to be smaller when two states produce complementary goods than when they produce substitutes -- that is, the system fluctuates less in the presence of economic interdependence between states that in the absence of it.