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PCONOMIZING DEFENSE: ECONOMICS OF THE MILITARY-INDUSTRIAL COMPLEX by Thomas K. Duncan A Dissertation Submitted to the Graduate Faculty of George Mason University in Partial Fulfillment of The Requirements for the Degree of Doctor of Philosophy Economics Department Chairperson Program Director Dean, College of Humanities and Social Sciences Spring Semester 2013 George Mason University Fairfax. VA Economizing Defense: Economics of the Military-Industrial Complex A Dissertation submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy at George Mason University By Thomas K. Duncan Master of Arts San Jose State University, 2008 Bachelor of Arts Hampden-Sydney College, 2005 Director: Christopher J. Coyne, Professor Department of Economics Spring Semester 2013 George Mason University Fairfax, VA Copyright: 2013 Thomas K. Duncan All Rights Reserved ii DEDICATION This dissertation is dedicated to my mother, Linda E. Duncan, for all the support she has given me in pursuit of my education, and to my father, Robert N. Duncan, who has motivated me to succeed throughout my life. iii ACKNOWLEDGEMENTS I am deeply grateful to the members of my dissertation committee. Christopher Coyne, thank you for going above and beyond in your role as my dissertation chair. You have been a constant source of guidance and support, and never once complained about the number of questions I had for you at any given time. Peter Boettke, thank you for all your words of wisdom, the knowledge you have imparted, and showing me what it means to be a master teacher. Peter Leeson, thank you for being a constant source of ideas and a continuous sounding board. I still credit you with my first publication. I would also like to thank Peter Lipsey. Thank you for your effort at every turn and for always being there when it was most needed. I would also like to thank Eric Celler for keeping my letters in order and being a fantastic officemate and Mary Jackson for keeping us all on track. Virgil Storr and Lane Conaway also deserve special thanks for their work in organizing the Graduate Student Programs. I would also like to thank the Atlas Economic Research Foundation and the Mercatus Center for their support throughout graduate school. Atlas gave me a chance early on, and I owe a great debt to Alex Chafuen and Leonard Liggio, not just for what they have done for me, but also for what they have done and continue to do for the world. I also owe my gratitude to the members of the Graduate Student Paper Workshop, and my fellow graduate students at George Mason University, past and present, for their feedback on all my various projects leading to this dissertation. I would like to give a special thanks to Daniel Smith, Thomas Hogan, Trey Carson, Liya Palagashvili, Solomon Stein, Jayme Lehmke, Abby Hall, William Luther, Alexander Fink, David Skarbek, Nicholas Snow, Adam Martin, and Geoffrey Lea. From those who came before George Mason, but who have influenced me greatly along the way, I would also like to thank Benjamin Powell, Edward Stringham, Edward Lopez, and Jeffrey Hummel who helped guide me through San Jose State University, and Tony Carilli who gave me my first economics lecture at Hampden-Sydney College. I would also like to thank Dallas Lewis and Dennis Cooper at Amelia Academy for their help in starting my educational journey. I would also like to give a special thanks to my brother, Christopher Duncan, for his support throughout graduate school and for keeping everything in hand at home while I iv am away. Lastly yet certainly not of least importance, I would like to thank my mother, Linda Duncan, for always being a source of inspiration and for listening every time, even when I was talking about economics. I realize that I may have missed people who were important to my development along the way. For that I apologize, but you always have my love and respect. Thank you all. v TABLE OF CONTENTS Page List of Tables .................................................................................................................... vii List of Figures .................................................................................................................. viii Abstract .............................................................................................................................. ix Chapter 1: Introduction ........................................................................................................1 Chapter 2: Dividing Conquer ...............................................................................................5 Chapter 3: The Overlooked Costs of the Permanent War Economy .................................28 Chapter 4: The Origins of the Permanent War Economy ..................................................59 Chapter 5: Conclusion........................................................................................................96 List of References ..............................................................................................................98 vi LIST OF TABLES Table Page Defense Spending 2001-2011 .................................................................................……38 vii LIST OF FIGURES Figure Page Global Military Spending ...........................................................................................…35 U.S. Defense Spending 1948-2010 .................................................................................36 viii ABSTRACT ECONOMIZING DEFENSE: ECONOMICS OF THE MILITARY-INDUSTRIAL COMPLEX Thomas K. Duncan, Ph.D. George Mason University, 2013 Dissertation Director: Dr. Christopher J. Coyne The military-industrial complex has long been an economic and political factor in the U.S. economy. The amount of resources fed into this war machine is staggering. Since World War II, the U.S. has continuously spent vast sums on the military, creating what has been termed a permanent war economy. Even in times of peace, the armed forces are kept in a state of readiness under the auspices of foreign threats or the need to protect the industrial base. This continued preparedness begs two central questions: 1) what is the proper size and scope of the military and 2) what is the institutional arrangement under which we can be assured of achieving that proper size and scope? This dissertation addresses these questions, extending the literature on defense optimality and the institutional arrangements of national defense in the U.S. The first essay considers the concept of national defense as a public good, which is the common reasoning for state provision of defense, and suggests that the optimal level of defense can be provided by the market. The second essay explores the institutional arrangement that has arisen in the United States, namely the military- industrial complex and its permanent war economy, and the costs that result from the top- down approach to defense contracting. The third essay examines the way that institutional arrangement originated from the central planning of the New Deal and World War II and argues that today’s permanent war economy is a function of the vested interests that arose via state management of those crises. CHAPTER 1: Introduction “[W]e have been compelled to create a permanent armaments industry of vast proportions. Added to this, three and a half million men and women are directly engaged in the defense establishment. We annually spend on military security more than the net income of all United States corporations. This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.” - Dwight D. Eisenhower (1961) Eisenhower’s (1961) Presidential farewell address stressed that “we have been compelled to create a permanent armaments industry of vast proportions”, admonishing future generations to “guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex.” His warning came as a response to the shifting nature of the national defense strategy since World War II, but it has not held off the advances of that influence. Rather than approaching the defense of the nation an exercise in responsiveness to threat, by the end of the war, the strategy had become one of constant preparation. The military and industry combined their efforts in an attempt to keep the U.S. forever in a state of readiness. Since the period of World War II, the great 1 military mobilizations of the economy have lead to continuous military spending, even in times of peace. Higgs (1987, 2004, 2005a, 2006, 2012) has argued the case for the ratchet effects of crises, played out through time as the complex captures greater influence in fits and starts as it reacts to a given moment of crisis. His argument has not been wrong. The economics profession has not entirely ignored Eisenhower’s admonition. There have been studies on the effects of free enterprise in response to entanglement with the defense industry (Raymond 1964). The creeping political influence of the military- industrial complex has been analyzed (Melman 1970, 1971, 1985; Higgs 1987, 2005a, 2012). Methods of financing American foreign policy