The Economics of Smart Defense

Abstract

Introduction: Difficult ChoicesNATO's proposal claims to be a new way of thinking about generating defense capabilities. It encourages allies to cooperate in developing, acquiring, and maintaining military capabilities. It means pooling and sharing capabilities, setting priorities, and coordinating efforts better. It involves member states not spending more but spending better; it is about specializing in what we do best and seeking multinational solutions to common problems.1Smart Defense has economic dimensions that need to be clarified and assessed critically. We do not live in a world of magic wand economics, where declarations of intent miraculously lead to efficiency improvements in defense markets. Smart Defense cannot ignore the incentives and constraints that operate in defense markets at both the national and Alliance levels.The financial and economic crisis of the past five years has meant cuts in national defense budgets, which have meant that nations cannot avoid the need for more and continuing difficult defense choices. Inefficiencies within member states' defense markets and within NATO have to be addressed. For each member state, budget pressures and rising input costs mean that, yet again, something has to go. The question is, What are the options and what goes?Furthermore, defense budgets that have been cut in real terms still have to finance defense equipment, which is both costly and becoming costlier. For example, intergenerational cost growth on U.K. main battle tanks and combat aircraft was almost 6 percent. The unit cost of the Hunter fighter aircraft was £4.6 million in 1955, compared with today's replacement, the Typhoon, at a unit cost of £72 million (2012 prices). Of course, the Typhoon is superior to the Hunter in terms of speed, weight, complexity, and capability.2 Such rising unit costs, which affect all nations, have led some commentators to forecast a future single-ship British Navy, a single-tank British Army, and a 'Starship Enterprise' for the Royal Air Force!The defense economics problem is clear. Defense budgets-which are constant or falling in real terms, and subject to costly and rising equipment costs-mean that difficult defense choices cannot be avoided. National defense policies will have to consider a range of choices affecting equipment and personnel. While these choices will include numbers of personnel and equipment, there are also substitution possibilities within equipment and personnel and between equipment and personnel.Some of these choice problems can be avoided where there are inefficiencies in defense spending. The defense economics problem identifies the need to increase the efficiency of defense spending, and this applies to all member states and NATO. Of course, efficiency improvements also involve winners and losers: some of the interest groups that currently benefit from consuming inefficiency will lose from efficiency improvements. Examples of inefficiencies in defense markets include non-competitive procurement policies, preferential purchasing (e.g., buy-national policies), a failure to assess the efficiency of military units, and the duplication of armed forces and defense industries in NATO.Inefficiencies in NATO Defense MarketsNATO is an inefficient organization for providing both armed forces and defense equipment. Inefficiency embraces opportunities for choosing an ideal or socially-desirable level of defense output and/or achieving the same defense output at a lower cost. Here, major problems arise, since defense markets are different. Compared with commercial markets, where there are large numbers of buyers and sellers, defense markets are dominated by governments as major or monopsony buyers, usually facing a national monopoly or oligopoly supplier of defense equipment. As major or only buyers, governments can determine the size of their national defense industry, its ownership, structure, and performance. …