Economics of Alliances: the Lessons for Collective Action
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Journal of Economic Literature Vol. XXXIX (September 2001), pp. 869–896 Sandler and Hartley:Journal of Economic Economics Literature, Vol. XXXIX of Alliances(September 2001) Economics of Alliances: The Lessons for Collective Action TODD SANDLER and KEITH HARTLEY1 1. Introduction whose increased prevalence arises from growing populations, the fragmentation N MARCH 1999, the North Atlantic of nations, enhanced monitoring abilities, ITreaty Organization (NATO) admitted and cumulative industrial pressures on three new members—the Czech Repub- the ecosphere. Transnational externalities lic, Hungary, and Poland—thus expand- involve an action in one country that ing the membership to nineteen allies.2 creates a benefit or cost in another, and Although NATO has taken in members there is no market compensation. in the past, this largest and latest en- Some 35 years ago, Mancur Olson largement, coming just prior to NATO’s and Richard Zeckhauser (1966) wrote a fiftieth anniversary, has implications for seminal paper on the economics of alli- defense burden sharing, allocative effi- ances that spawned a large literature. ciency, and alliance design and stability. Perhaps, the greatest insights of their An understanding of these implications paper and its forerunner by Olson can also enlighten us about scheduled en- (1965) is the recognition that economic largements of the European Union (EU), principles of military alliances (hence- the World Trade Organization (WTO), forth, alliances) apply to a wide range of and other international organizations. We transnational issues and institutions inhabit a rapidly changing world where (see, e.g., Bruce Russett and John Sulli- collective action, as directed by a grow- van 1971). Olson and Zeckhauser (1966) ing number of transnational institutions, focused on burden sharing in an alli- is becoming more relevant owing to a host ance, dependent on a pure public good of transnational externalities and public of deterrence in which the large, rich goods (Inge Kaul, Isabelle Grunberg, and ally shoulders the defense burden of Marc Stern 1999; Sandler 1997, 1998), the small, poor allies by providing the latter with a relatively free ride. This 1 Sandler: Dockson Professor, University of Southern California. Hartley: University of York, proposition became known as the “ex- U.K. We have benefited from comments provided ploitation hypothesis.” In 1970, for by three anonymous reviewers and John McMillan example, the United States accounted on earlier drafts. Full responsibility for the arti- cle’s content rests with the authors. for just under 75 percent of NATO’s 2 On NATO expansion, see Ronald Asmus, Rich- defense spending, while the next larg- ard Kugler, and F. Stephen Larrabee (1995, est allies—Germany, France, and the 1996), David Gompert and Larrabee (1997), NATO (1995), and Sandler and Hartley (1999, United Kingdom—each assumed less ch. 2). than 6 percent of NATO’s defense 869 870 Journal of Economic Literature, Vol. XXXIX (September 2001) burden. Because the United States Insights garnered from the study of received only 35 percent of NATO’s alliances can be applied to a broad set defense benefits by one measure, an of collectives concerned with curbing exploitation appears obvious. Other environmental degradation, controlling findings stemming from their and sub- terrorism, promoting world health, sequent work on alliances addressed the eliminating trade barriers, furthering optimal size of such collectives, the scientific research, and assisting foreign suboptimality of resource allocation, development. This essay on alliances the strategic interactions among mem- has much to offer for understanding a bers, the nature of the collective link- wide range of international organi- age, and the form of the collective’s zations such as arms-control regimes, demand for the public good. As the the EU, the United Nations (UN), Olson-Zeckhauser model’s predictions WTO, and pollution pacts. Although went wide of their mark over time for much of our specific reference will be NATO and other alliances, new models to NATO, the economic theory of alli- stressed impurely public good aspects ances has been applied to other current of the shared defense good. and historical alliances. Perhaps, the In recent years, the interest in alli- main reason why the public good theory ances and similar transnational collec- and its offshoots have been first applied tives has grown in importance. Rather to alliances and only later to other inter- than the tranquility and security antici- national organizations is the relatively pated by the end to the Cold War, the easy identification and measurement of superpower confrontation has given way costs and benefits afforded by specialist to small, vicious wars driven by territo- military alliances. Similarly, the readily rial disputes, internal power struggles, available data on spending in NATO resource claims, and ethnic conflicts. In have made it the focus of attention in 1999, 27 wars raged throughout the globe contrast to other alliances where data in 26 locations (Stockholm International for so many years are not available.4 Peace Research Institute 1999, p. 9). This essay has a number of purposes. During the post-Cold War era, defense First, it provides an up-to-date sum- collectives have increasingly turned to mary of the findings of the literature on peacekeeping and peace enforcement in the economics of alliances. Second, the the world’s trouble spots.3 The creation of essay emphasizes how the study of mili- highly mobile forces, drawn from multi- tary alliances offers vital insights for a ple allies, requires a degree of integra- large number of transnational collec- tion and cooperation heretofore never tives. Third, the essay establishes that experienced in NATO (Palin 1995). the manner in which alliances address Dramatic declines in defense budgets in the post-Cold War era have augmented 4 By far, NATO is the most studied alliance theimportanceofallocativeefficiencyin using public good theory. Studies include Francis Beer (1972), Laurna Hansen, James Murdoch, and the defense sector, as countries must main- Sandler (1990), Hartley and Sandler (1990, 1999), tain security with diminished resources Gavin Kennedy (1979, 1983), Jyoti Khanna and assigned to defense. Sandler (1996, 1997), Klaus Knorr (1985), Martin McGuire (1990), Murdoch and Sandler (1984, 1991), Olson and Zeckhauser (1966, 1967), John 3 NATO’s new strategic doctrine of peacekeep- Oneal (1990a, 1990b, 1992), Glenn Palmer ing is presented and discussed by Erika Bruce (1990a,b, 1991), Sandler (1975, 1987), Sandler and (1995), Robert Jordan (1995), Roger Palin (1995), John Forbes (1980), Sandler and Murdoch (1990), Steve Rearden (1995), and Sandler and Hartley Stephen Sloan (1993), and Jacques van Ypersele (1999). de Strihou (1967). Sandler and Hartley: Economics of Alliances 871 burden sharing and allocative issues is that is a pure public good with nonrival related to strategic doctrines, weapon and nonexcludable benefits. Defense technology, the perceived threat, and benefits are nonrival when one ally’s membership composition. Fourth, the consumption of a unit of defense does essay indicates bounds to what the eco- not detract, in the least, from the con- nomics of alliances can and cannot do, sumption opportunities still available to and why. Fifth, areas needing further the other allies from that same unit. If development are identified. Through- defense benefits cannot be withheld at out this essay, the reader is invited to an affordable costs by the provider, replace NATO with the alliance or then these benefits are nonexcludable. transnational institution of his or her The true origins of this theory of alli- choosing. This replacement will affect ances is Olson’s (1965, p. 36) The Logic the impurity properties of the shared of Collective Action where he used alli- activity with predictable consequences ances, and NATO in particular, as an to the theoretic predictions. example of the kinds of international The remainder of this essay contains organizations which face allocative effi- nine primary sections. Section 2 reviews ciency problems from sharing a pure the origins of the economics of alli- public good. A formal model followed ances. In section 3, the pure public, in Olson and Zeckhauser (1966) where deterrence model of alliances is pre- defense was characterized as deter- sented. The more general and encom- rence or inhibiting an enemy’s attack passing joint product model of alliances on any ally through the threat of an is then reviewed in section 4. The im- annihilating retaliation.5 plications of these models on the allies’ Although these authors clearly recog- demand for defense are examined in nized possible extensions, their model section 5. Alternative empirical tests of rested on a number of key assumptions: burden sharing are reviewed in section (i) allies share a single purely public de- 6, where the applicability of these fense output, (ii) a unitary actor decides empirical methods to the study of defense spending in each ally, (iii) de- other collective action issues is also fense costs per unit are identical in addressed. The implication of the each ally, (iv) all decisions are made economics of alliances on peacekeeping simultaneously, and (v) allied defense activities is the subject of section 7. In efforts are perfectly substitutable. Olson section 8, other aspects of the study of and Zeckhauser (1966) stressed the dis- alliances are considered including dy- proportionate