The benefits of defense industry privatization: Markets, technology and U.S. military supremacy since World War II

Abstract

Recently, China and Russia have taken unnoticed steps to partially privatize their defense industries to make them more innovative. If successful, these reforms could seriously alter the international balance of power at the expense of the United States. However, previous academic writings have usually been skeptical of the benefits of privatization in the defense industry. I argue that private markets constitute the best way to instill innovativeness in the defense industry. To demonstrate it, I compare the technological performance of the defense industry of two extreme and opposite cases, namely the United States and the USSR during the Cold War.

Disclosure statement

I have no conflict of interest to declare.

Notes

1 Zi Yang, “Privatizing China’s Defense Industry: China Hopes to Create Its Own Military-Industrial Complex, but It Won’t Be Easy,” The Diplomat, 2017, https://thediplomat.com/2017/06/privatizing-chinas-defense-industry/.

2 Yang.

3 Leo Lin, “China’s Answer to the US Military-Industrial Complex: The Central Commission for Integrated Military and Civilian Development Represents a New Trend in Civil-Military Relations,” The Diplomat, 2017, https://thediplomat.com/2017/04/chinas-answer-to-the-us-military-industrial-complex/.

4 Andrew E. Kramer, “Kalashnikov, AK-47 Maker, Goes Private as Russian Government Sheds Stake,” The New York Times, 2017, https://www.nytimes.com/2017/11/13/business/dealbook/kalashnikov-ak47-sale.html.

5 Rostec, “Development Strategy: New Strategy of the Corporation Is the Way to Leadership,” accessed December 18, 2019, https://rostec.ru/en/about/strategy/.

6 Michel Cabirol, “Les Fusils d’assaut Kalachnikov Se Tirent Dans Le Privé,” La Tribune, accessed December 18, 2019, https://www.latribune.fr/entreprises-finance/industrie/aeronautique-defense/les-fusils-d-assaut-kalachnikov-se-tirent-dans-le-prive-636650.html.

7 Eugene Gholz and Harvey M. Sapolsky, “Restructuring the U.S. Defense Industry,” International Security 24, no. 3 (2000): 19.

8 J. Paul Dunne, “The Defense Industrial Base,” in Handbook of Defense Economics, edited by Keith Hartley and Todd Sandler, vol. 1 (Elsevier, 1995), 423.

9 R.P. Smith, “Military Expenditure and Capitalism,” Cambridge Journal of Economics 1, no. 1 (1977): 65–66.

10 Dunne, “The Defense Industrial Base,” 401; M. Kidron, Western Capitalism since the War (Harmondsworth: Penguin, 1970), 49, 55–61.

11 Smith, “Military Expenditure and Capitalism,” 64.

12 Dunne, “The Defense Industrial Base,” 423.

13 Yaacov Lifshitz, The Economics of Producing Defense: Illustrated By The Israeli Case (New York: Springer Science + Business Media, 2003), 146.

14 Lifshitz, 146.

15 See John K. Galbraith, “The Big Defense Firms Are Really Public Firms and Should Be Nationalized,” New York Times Magazine, November 16, 1979.

16 N. Gregory Mankiw, Principles of Microeconomics, 7th ed. (Cengage Learning, 2014), 151.

17 F. A. Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1996), 95; see also Mankiw, Principles of Microeconomics, 66–67.

18 Jacques S. Gansler, The Defense Industry (Cambridge: MIT Press, 1980), 30–31.

19 Carlos Martí Sempere, “A Review of Market Failures in the Defence Industry,” Defence and Peace Economics, 2019, 1–17.

20 Martí Sempere, 2.

21 Martí Sempere, 8–9.

22 Martí Sempere, 2 and 8.

23 R. H. Coase, “The Nature of the Firm,” Economica 4 (1937): 392.

24 J. Eric Fredland and Adrian Kendry, “The Privatisation of Military Force: Economic Virtues, Vices and Government Responsibility,” Cambridge Review of International Affairs 13, no. 1 (1999): 152.

25 Gansler, The Defense Industry, 238.

26 Martí Sempere, “A Review of Market Failures in the Defence Industry,” 14; Fredland and Kendry, “The Privatisation of Military Force: Economic Virtues, Vices and Government Responsibility,” 152.

27 Israek M. Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics (London: Routledge, 1992), 38.

28 Steven Horwitz, Microfoundations and Macroeconomics: An Austrian Perspective (Routledge, 2000), 4.

29 Thomas DiLorenzo, “A Note on the Canard of ‘Asymmetric Information’ as a Source of Market Failure,” The Quarterly Journal of Austrian Economics 14, no. 2 (2011): 250.

30 Sanford Ikeda, “How Compatible Are Public Choice and Austrian Political Economy?,” The Review of Austrian Economics 16, no. 1 (2003): 67.

31 DiLorenzo, “A Note on the Canard of ‘Asymmetric Information’ as a Source of Market Failure,” 250.

32 Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, 50.

33 Kirzner, 50.

34 David A. Harper, Entrepreneurship and the Market Process: An Enquiry Into the Growth of Knowledge (Routledge, 1996), 3.

35 Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, 47.

36 Israel M. Kirzner, The Driving Force of the Market: Essays in Austrian Economics (Routledge, 2000), 9.

37 Kirzner, 9.

38 R.G. Lipsey, “Economic Policy with and without Maximizing Rules,” Pacific Economic Review 22, no. 2 (2017): 205; see also Harper, Entrepreneurship and the Market Process: An Enquiry Into the Growth of Knowledge, 3.

39 Don Lavoie, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (Cambridge University Press, 1985), 22.

40 See also Frederic Sautet, “The Competitive Market Is a Process of Entrepreneurial Discovery,” in Handbook on Contemporary Austrian Economics, edited by Peter J. Boettke (Edward Elgar Publishing, 2010), 102.

41 Gansler, The Defense Industry, 148–51.

42 Sautet, “The Competitive Market Is a Process of Entrepreneurial Discovery,” 102.

43 Donald J. Boudreaux, “Antitrust and Competition from a Market-Process Perspective,” in Research Handbook on Austrian Law and Economics, edited by Todd J. Zywicki and Peter J. Boettke (Edward Elgar Publishing, 2017), 286.

44 Boudreaux, 286.

45 Coase, “The Nature of the Firm,” 404.

46 F. A. Hayek, “The Use of Knowledge in Society,” The American Economic Review 35, no. 4 (1945): 519–20.

47 Hayek, 521–22.

48 Andrea Gilli and Mauro Gilli, “Why China Has Not Caught Up Yet: Military-Technological Superiority and the Limits of Imitation, Reverse Engineering, and Cyber Espionage,” International Security 43, no. 3 (2019): 141–89.

49 This is especially true in the “information age” where complex economic activities require a complex “division of labour,” that is a complex “division of knowledge.” See DiLorenzo, “A Note on the Canard of ‘Asymmetric Information’ as a Source of Market Failure,” 250–53.

50 Geoffrey M. Hodgson, Economics & Utopia: Why the Learning Economy Is Not the End of History (Routledge, 1999), 41.

51 Gilli and Gilli, “Why China Has Not Caught Up Yet: Military-Technological Superiority and the Limits of Imitation, Reverse Engineering, and Cyber Espionage,” 164.

52 Gilli and Gilli, 165–67.

53 Hayek, “The Use of Knowledge in Society.”

54 Peer Zumbansen and Gralf-Peter Calliess, Law, Economics and Evolutionary Theory (Edward Elgar Publishing, 2011), 208–9.

55 Hayek, “The Use of Knowledge in Society,” 527.

56 Hayek, 524–26.

57 Coase, “The Nature of the Firm,” 389.

58 Murray N. Rothbard, “The Politics of Political Economists: Comment,” The Quarterly Journal of Economics 74, no. 4 (1960): 659.

59 Rothbard, 659.

60 Hayek, “The Use of Knowledge in Society,” 524.

61 Hayek, 521–22.

62 Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, 160.

63 Kirzner, 159–61; see also Esteban F. Thomsen, Prices & Knowledge: A Market-Process Perspective (Routledge, 1992), 44–47.

64 Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, 158.

65 Kirzner, 158.

66 Alexander L. George and Andrew Bennett, Case Studies and Theory Development in the Social Sciences (Cambridge: MIT Press, 2005), 181.

67 George and Bennett, 181.

68 George and Bennett, 185.

69 Stephen Van Evera, Guide to Methods for Student of Political Science (Ithaca: Cornell University Press, 1997), 80.

70 Van Evera, 80.

71 Combined Chinese and Russian military spending was only half of the US military budget in 2018. See Nan Tian et al., “Trends in World Military Expenditure, 2018” (SIPRI, 2019), 2.

72 Gilli and Gilli, “Why China Has Not Caught Up Yet: Military-Technological Superiority and the Limits of Imitation, Reverse Engineering, and Cyber Espionage,” 158.

73 Gilli and Gilli, 163–67.

74 Gilli and Gilli, “Why China Has Not Caught Up Yet: Military-Technological Superiority and the Limits of Imitation, Reverse Engineering, and Cyber Espionage.”

75 Thomas C. Lassman, Sources of Weapon Systems Innovation in the Department of Defense : The Role of Research and Development, 1945–2000 (Washington, DC: Center of Military History, 2008), 2.

76 Elliott V. Converse III, “Into the Cold War: An Overview of Acquisition in the Department of Defense, 1945–1958,” in Providing the Means of War Historical Perspectives on Defense Acquisition, 1945–2000, edited by Shannon A. Brown (U.S. Army Center of Military History, 2005), 39–40.

77 Converse III, 39.

78 Lassman, Sources of Weapon Systems Innovation in the Department of Defense : The Role of Research and Development, 1945–2000, 2.

79 The Department of Defense, “The University Role in Defense Research and Development: For the Committees on Appropriations United States Congress,” 1987, 7.

80 Office of Technology Assessment, “The Defense Technology Base: Introduction and Overview,” 1988, 56.

81 Office of Technology Assessment, 56.

82 Office of Technology Assessment, 8.

83 Henry E. Brady, David Collier, and Jason Seawright, ‘Sources of Leverage in Causal Inference: Toward an Alternative View of Methodology’, in Rethinking Social Inquiry: Diverse Tools, Shared Standards, edited by Henry E. Brady and David Collier, 2nd ed. (Rowman & Littlefield, 2010), 252.

84 Noel E. Firth and James A. Noren, Soviet Defense Spending: A History of CIA Estimates, 1950–1990 (Texas A&M University Press, 1998).

85 Office of the Undersecretary of Defense for Research and Engineering, “The FY 1987 Department of Defense Program for Research and Development” (Department of Defense, 1986), II–5.

86 Firth and Noren, Soviet Defense Spending: A History of CIA Estimates, 1950–1990, 113 and 116.

87 Firth and Noren, 194.

88 Investments by “missions” do not include R&D resources which are classified as “Other.” The reason is that the CIA was never able to determine with certainty where the Soviet R&D efforts were really going. All the agency could do was to estimate the overall R&D effort of the USSR during the Cold war. Consequently, I use the investments by “missions” mainly as a proxy to make rough assumptions concerning Soviet priorities in terms of R&D investment.

89 Estimates made in 1982 rubles (often considered as more reliable than estimates made in dollars) for the period of 1951–1990 tend to confirm the lower priority given by the USSR to tactical air as well as the sustained interest of Soviet leaders for strategic forces, land forces and navy. See Firth and Noren, 111.

90 1986 figures are very similar to those of 1984 with the USSR lagging in 16 major deployed systems, on par in 9 and ahead in only 4. However, data concerning strategic defence is no longer available except for anti-satellite weapons. See Office of the Undersecretary of Defense for Research and Engineering, “The FY 1987 Department of Defense Program for Research and Development” (Department of Defense, 1986), II–12.

91 Christoph Bluth, “The Soviet Union and the Cold War: Assessing the Technological Dimension,” Journal of Slavic Military Studies 23 (2010): 305.

92 Bluth, 300.

93 Quoted in Rebecca V. Strode, “Soviet Design Policy and Its Implications for U.S. Combat Aircraft Procurement,” Air University Review 35, no. 2 (1984): 54.

94 William T. Lee and Richard F. Staar, Soviet Military Policy Since World War II (Hoover Press, 1986), 174.

95 Peter Almquist, Red Forge: Soviet Military Industry Since 1965 (New York: Columbia University Press, 1990), 118.

96 “Science Indicators: The 1985 Report” (Washington, DC: National Science Board, 1985), 186.

97 Vladimir Kontorovich, “The Long-Run Decline in Soviet R&D Productivity,” in The Impoverished Superpower: Perestroika and the Soviet Military Burden, edited by Henry S. Rowen and Charles Wolf, Jr. (ICS Press, 1990), 265.

98 CIA, “The Sovient Defense Industry: Coping with the Military-Technological Challenge,” 1987, iii.

99 Firth and Noren, Soviet Defense Spending: A History of CIA Estimates, 1950–1990, 107.

100 Firth and Noren, 106.

101 Robert L. Paarlberg, “Knowledge as Power: Science, Military Dominance, and U.S. Security,” International Security 29, no. 1 (2004): 124.

102 Bluth, “The Soviet Union and the Cold War: Assessing the Technological Dimension.”

103 Marshall I. Goldman, USSR in Crisis: The Failure of an Economic System (W. W. Norton & Company, 1983), 30–45.

104 Alec Nove, The Soviet Economy: An Introduction (Praeger, 1961), 155–67.

105 Nove, 157.

106 Recall that prices expressed in rubles were arbitrarily fixed by central planners and not by markets, and thus did not reflect people’s “tacit knowledge.” Consequently, “prices were in many cases completely irrational.” See Pekka Sutela, Economic Thought and Economic Reform in the Soviet Union (Cambridge: Cambridge University Press, 1991), 51.

107 Quoted in Almquist, Red Forge: Soviet Military Industry Since 1965, 82–83.

108 Almquist, note 87, p. 187.

109 Sutela, Economic Thought and Economic Reform in the Soviet Union, 50.

110 Nove, The Soviet Economy: An Introduction, 158.

111 Sutela, Economic Thought and Economic Reform in the Soviet Union, 50.

112 Christopher Davis, “Country Survey XVI the Defence Sector in the Economy of a Declining Superpower: Soviet Union and Russia, 1965–2001,” Defence and Peace Economics 13, no. 3 (2002): 152.

113 Matthew Evangelista, Innovation and the Arms Race: How the United States and the Soviet Union Develop New Military Technologies (Ithaca: Cornell University Press, 1988), 47.

114 David Holloway, “Innovation in the Defence Sector,” ed. Ronald Amann and Julian Cooper (Yale University Press, 1982), 342–43.

115 Strode, “Soviet Design Policy and Its Implications for U.S. Combat Aircraft Procurement,” 53.

116 Arthur J. Alexander, “R&D in Soviet Aviation” (Rand Corporation, 1970), 36.

117 Jacques S. Gansler, The Defense Industry (Cambridge: MIT Press, 1980), 251.

118 Alexander, “R&D in Soviet Aviation,” 29–31 and 34.

119 Holloway, The Soviet Union and the Arms Race, 142.

120 Israek M. Kirzner, The Meaning of Market Process: Essays in the Development of Modern Austrian Economics (London: Routledge, 1992), 158.

121 Mark Harrison and Andrei Markevich, “The Soviet Market for Weapons,” in Guns and Rubles: The Defense Industry in the Stalinist State, edited by Mark Harrison (New Haven: Yale University Press, 2008), 157–58.

122 Harrison and Markevich, 161.

123 Harrison and Markevich, 159–65.

124 William P. Rogerson, “Economic Incentives and the Defense Procurement Process,” The Journal of Economic Perspectives 8, no. 4 (1994): 65–90.

125 Harrison and Markevich, “The Soviet Market for Weapons,” 165.

126 Almquist, Red Forge: Soviet Military Industry Since 1965, 57.

127 Julian Cooper, “Appendix 9C. Developments in the Russian Arms Industry,” in SIPRI, 2006. SIPRI Yearbook: Armaments, Disarmament and International Security, 2006, 432.

128 Defense Contract Management Agency, “About the Agency,” accessed February 11, 2020, https://www.dcma.mil/About-Us/.

129 Holloway, “Innovation in the Defence Sector,” 343.

130 Holloway, 343.

131 See for instance Gansler, The Defense Industry, 29.

132 This is called “bi-lateral monopoly” by economists. See Timothy Coffey, “‘Chance Favors Only the Prepared Mind’ The Proper Role for U.S. Department of Defense Science and Engineering Workforce” (Washington, DC: Center for Technology and National Security Policy, 2013), 18–19.

133 Eugene Gholz and Harvey M. Sapolsky, “Restructuring the U.S. Defense Industry,” International Security 24, no. 3 (2000): 17.

134 Harvey M. Sapolsky, Eugene Gholz, and Caitlin Talmadge, US Defense Politics: The Origins of Security Policy, 2nd ed. (Routledge, 2014), 129.

135 Gholz and Sapolsky, “Restructuring the U.S. Defense Industry,” 19–20.

136 Jerrold T. Lundquist, “Shrinking Fast and Smart in the Defense Industry,” Harvard Business Review, no. November–December (1992), https://hbr.org/1992/11/shrinking-fast-and-smart-in-the-defense-industry.

137 David R. King and John D. Driessnack, “Analysis of Competition in the Defense Industrial Base: An F-22 Case Study,” Contemporary Economic Policy 25, no. 1 (2007): 59.

138 Gansler, The Defense Industry, 129.

139 Gansler, 152.

140 Jacques S. Gansler, Defense Conversion (Cambridge: MIT Press, 1995), 119.

141 Aaron L. Friedberg, In the Shadow of the Garrison State (Princeton University Press, 2000), 280–92.

142 Mark Lorell, “The U.S. Combat Aircraft Industry 1909–2000: Structure, Competition, Innovation” (RAND, 2003).

143 See also Lorell, 140.

144 Lorell, 75.

145 Lorell, 87.

146 Lorell, 99.

147 Lorell, 99–100.

148 Lorell, 140.

149 Mark Lorell and Hugh Levaux, “The Cutting Edge: A Half Century of U.S. Fighter Aircraft R&D” (RAND, 1998), 134.

150 Ben R. Rich and Leo Janos, Skunk Works: A Personal Memoir of My Years at Lockheed (Little Brown & Company, 1994), 22–25.

151 Lorell and Levaux, “The Cutting Edge: A Half Century of U.S. Fighter Aircraft R&D,” 135.

152 Lorell and Levaux, 135.

153 Lorell, “The U.S. Combat Aircraft Industry 1909–2000: Structure, Competition, Innovation,” 38.

154 Lorell, 99.

155 Lorell, 69.

156 Lorell, 72.

157 See for instance Lorell, 51, 74, 96, 97, and 110.

158 Lorell, 120.

159 Lorell, 120–21.

160 Lorell, 87–88.

161 Lorell, 29.

162 Lorell, 60.

163 Lorell, 67.

164 J. Paul Dunne, “The Defense Industrial Base,” in Handbook of Defense Economics, edited by Keith Hartley and Todd Sandler, vol. 1 (Elsevier, 1995), 423.

165 Yaacov Lifshitz, The Economics of Producing Defense: Illustrated By The Israeli Case (New York: Springer Science + Business Media, 2003), 146.

166 Linda Weiss, America Inc. ? Innovation and Enterprise in the National Security State (Ithaca: Cornell University Press, 2014).

167 Zi Yang, “Privatizing China’s Defense Industry: China Hopes to Create Its Own Military-Industrial Complex, but It Won’t Be Easy,” The Diplomat, 2017, https://thediplomat.com/2017/06/privatizing-chinas-defense-industry/.

168 Yang.

169 Rostec, “Interview with S.B. Abramov, Industrial Director of the Cluster of Conventional Weapons, Ammunition and Special Chemistry,” accessed December 19, 2019, https://rostec.ru/en/news/interview-with-s-b-abramov-industrial-director-of-the-cluster-of-conventional-weapons-ammunition-and/.

170 Andrew E. Kramer, “Kalashnikov, AK-47 Maker, Goes Private as Russian Government Sheds Stake,” The New York Times, 2017, https://www.nytimes.com/2017/11/13/business/dealbook/kalashnikov-ak47-sale.html.

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Valentin Lara

Valentin Lara is a PhD candidate in Political Science at the Université de Montréal. He holds a LL.M. in international law and LL.B. in Canadian law. His research interests focus on privatization in military affairs. This article was written while the author was a PhD fellow at the Montreal Center for International Studies (CÉRIUM).