Courtesy Reuters

AMERICA'S ARMS TRADE MONOPOLY

For the first time in modern history, one country is on the verge of monopolizing the international arms trade. Rising costs and declining defense budgets are putting pressure on the world's inefficient defense producers, and most of them are collapsing under the strain. Soon the worldwide armaments industry will be nearly unrecognizable. By the early 21st century, the United States will be the sole producer of the world's most advanced conventional weaponry, as other countries discover, like the Soviets did, that the costs associated with financing new defense programs are too heavy to manage.

If exploited properly, this monopoly will benefit not only the United States but international security as well. The past proves that countries that rely on American arms are less likely to start wars with their neighbors. Ironically, a U.S. monopoly would also be good for the world economy. With inefficient defense firms put out of their costly misery, governments will be able to put scarce resources to more productive pursuits.

Accordingly, the United States should welcome the coming era. Owing to the benefits that will flow from its monopoly position, the United States need not encourage multilateral efforts to create a cartel of arms suppliers or encourage other great powers to remain in the weapons game. Indeed, past U.S. policies that transferred advanced weapon technology to allies should be stopped, and the United States henceforth should export only finished weapons.

But monopoly power has dangers as well. Monopolists who use their power coercively drive consumers to seek alternatives and, in the case of military technology, this will likely mean a scramble by many countries to develop weapons of mass destruction. Further, monopolists tend to grow lazy and invest little in innovation, leaving themselves vulnerable to new technologies that erode their positions. In sum, America's arms trade monopoly gives it tremendous opportunities to shape the international economic and security environments, but prudence will dictate restraint in the exercise of that power.

WATCHING THE DEFENSE BUDGETS

In order to understand the inexorable forces that are working on the world's defense industries, one must first examine their economic environment. The most important number for any firm is the defense budget of the nation in which it is based, since in most cases the government remains the single largest buyer of domestically produced weaponry. Throughout the Western alliance, defense budgets have been falling for several years, and the downward plunge will continue for several more. In the United States, defense spending fell by 13 percent between 1986 and 1991, and the projected defense budget in 1997 will be almost 40 percent smaller in real terms than it was in 1985. Similar if smaller cuts are underway in Britain and Germany. Among the Western allies, only France and Japan have been trying to maintain the size of their defense budgets in real terms.

Even after these cuts, the U.S. defense market will continue to be much bigger than the markets of all its allies combined. In fact, it would probably be bigger even if one were to include the markets of China and Russia. At present, the combined expenditures of all NATO allies are only one-half those of the United States; roughly the same ratio exists for procurement budgets.1

During the Cold War, the only other country that financed a defense budget equivalent to America's was the Soviet Union, which spent far more as a percentage of its gross national product. While reliable statistics on current Russian expenditures are hard to come by, every observer agrees that defense spending has fallen through the floor. It is now a small fraction of the American defense effort.

By some accounts, the Chinese are now increasing their investments in defense industries. The Chinese defense budget is perhaps ten percent of America's, but given its rapid economic growth Beijing could prove to be a long-term challenger in the arms market. At the same time, the Chinese leadership has apparently been seized by the Russian lesson that excessive defense spending does not provide increased security, only economic ruin. As a result, China may seek to purchase its security on the cheap by building weapons of mass destruction. A similar strategy might appeal to regional powers, but they face more daunting obstacles: a lack of cash, insufficient technological capacity and greater disincentives for contravening U.S. nonproliferation policies.

While budgets are falling in most countries, the costs associated with producing advanced weapon systems are rising; even the industrious Japanese have yet to produce high-tech weaponry cheaply. The aerospace industry provides a telling example of stubbornly rising costs. In 1970, U.S. firms shipped 3,500 military aircraft with a value of $4 billion to foreign and domestic customers. In 1975 the industry shipped 1,700 units with a value of $4 billion. In 1980 1,000 military aircraft were shipped at a value of $6 billion. In 1985 the number dropped to 919, but the value had trebled to $18 billion.

A similar story can be told for the European defense industry. Take the European Fighter Aircraft, a project by a consortium including Britain, Germany and Spain to produce of a multi-role jet for the next century. Only five years ago, the Europeans believed that the plane's development would cost them about $5 billion; today cost estimates are running as high as $47 billion, leading to ruptures between consortium members. The Germans pulled out of the EFA project in 1992, only to be coaxed back by assurances that the fighter would return to the drawing board, with a less expensive model produced in its place. (It should be noted that, when fielded ten years from now, the EFA will still be inferior to present-day American products, and it will not even possess stealth technology).

The EFA project also reveals the problems that countries face when they engage in international arms collaboration. Squabbling over designs, costs and control over production renders most of these programs a disaster. Collaboration may be nice in theory, but it is devilish in practice.

Modern weapons are expensive because of large up-front costs in research and development that can only be recouped through fairly long production runs; as production runs shorten, unit costs must increase. In 1990, for example, the United States government devoted almost $40 billion to defense-related research, development, training and evaluation. In addition, the large defense contractors made significant investments of their own.

The worldwide decline in both domestic defense spending and the length of production runs could presumably be offset by increased arms exports. But here too the picture has been relatively bleak. World arms exports peaked in 1984 at $64 billion. By 1989 they had fallen to $45 billion, and U.S. government analysts expect the market to stabilize at $40 billion per year or less for the remainder of the decade.2

In the past, this market was dominated by the Soviet Union and the United States, with European, Soviet-bloc and some Third World producers all obtaining relatively small shares. Today the market is America's to lose. Once the United States becomes the virtual monopoly supplier of advanced conventional weapons, the small sales that will remain available to other countries will hardly be sufficient to maintain increasingly costly domestic arms industries.

THE COMING AMERICAN MONOPOLY

It is an odd twist of fate that the greatest arms sale show on earth coincided with the end of the Cold War. During the six-week blitzkrieg of Iraq, the United States demonstrated the awesome capacity of its ships, missiles, planes and tanks. Every night on CNN viewers could peer through the electronic sights of an F-15 fighter or follow the deadly path of a Tomahawk missile. Since the war, sales of American military equipment have boomed, helped by some high-pressure lobbying from Washington.

The major marketplace for weapons since 1989 has been the Middle East. Seven of the top weapons buyers in the world are in that region, including the single largest buyer, Saudi Arabia. America is becoming the supplier of choice. In 1989 the United States supplied only $1.5 billion of arms to the Middle East, out of total deliveries to the region of $12.1 billion. The largest supplier was the Soviet Union ($3.1 billion), followed by the United Kingdom ($2.1 billion) and France ($1.7 billion).

By 1992, the regional picture had changed dramatically. Leaving aside Israel, total agreements to buy new arms in 1992 were about $7 billion, of which some $3 billion were ordered from the U.S. arms industry. In short, the United States had signed contracts to supply the region with nearly half its new weapons.

In East Asia, the other region where arms sales are booming, the United States has long been dominant. It is virtually the sole supplier of advanced weaponry to Japan and has a substantial share of the marketplace in South Korea and Taiwan. During fiscal year 1992, U.S. arms companies signed agreements worth $4.2 billion, again making it by far the region's single largest supplier. While Japan may have the technological capacity to make a bid for more of this market, such a move would increase regional tensions and strain its special relationship with the United States. Moreover, if counterbalancing China's military threat becomes more critical, Japan is likely to turn to development of nuclear weapons.

THE ECONOMICS OF ARMS

The trend toward American dominance of the arms trade should not be surprising. From a purely economic perspective, the United States obviously has an advantage in weapons production. It has a large domestic market for armaments, and its defense-related research, development and manufacturing cannot be matched.

Perhaps more questionable is the assertion that America's relative position in the weapons market is increasing. But the United States is standing on the verge of a revolution in military technology, as demonstrated by the Persian Gulf War. Its integration of new naval, ground and aerial systems places it years ahead of any would-be competitors. This revolution is the product of America's superior levels of investment in military research and development.

The pure economics of weapons production is only expressing itself now that the Cold War is over. Previously, inefficient industries were kept alive around the world for allegedly strategic reasons, although most of the time that was just a euphemism for protectionism. In Western Europe, the Third World and elsewhere, political forces stood in the way of economic forces for reasons of state. Those days are over, and with them the rationale for domestic production of weaponry, because U.S. allies lack the cash and technology to produce new weapons platforms. Nor can they look to the United States for help in that regard. Washington's rationale for engaging in international arms collaboration has disappeared.

One could argue that the numbers noted above do not indicate the presence of a monopoly or anything like it. After all, in neither region is the United States the sole supplier of arms, and one would expect buyers to seek some diversification among their suppliers. During the summer of 1992, for example, the government of Taiwan decided to purchase advanced jet fighters from both the United States and France.

But what counts over the long term is the ability to determine market outcomes. Economists and antitrust authorities generally believe that monopolies exists whenever a single firm controls more than one-third of a market. When firms obtain this market share, they are usually able to shape the market to their liking.

America is now in such a position. The threat of its entry into any arms market changes the nature of the game. If the United States were determined to enter a given marketplace it could do so by underpricing the competition or by offering better technology. Its ability to change the terms of competition, to tilt the playing field in its favor, gives the United States something close to monopoly power. The U.S. position in this regard will only strengthen over time.

The first problem of any country that is considering which weapons to buy is assessing the capabilities of its most likely opponents. If an opponent has American weaponry, which is increasingly the case, it would do well to have American weapons as well, a point driven home by the Persian Gulf War. Would a country really want to rely on French or Russian or Chinese systems when its adversary had purchased American arms?

In the past, countries were often constrained in their weapons purchases by Cold War commitments. Thus, many countries would buy from Russia or Europe because they could not acquire American arms. That is no longer the case, giving the United States a wider range of customers. In sum, the economics and politics of the arms trade point to an era of American dominance, and there is good reason to regard such a prospect favorably.

A FORCE FOR PEACE

If exercised with appropriate caution, the American arms trade monopoly will be good for the United States, international security and the world economy. Every company in the world would love to monopolize its marketplace; a monopoly position translates into leverage, power and control. For countries in which dominating arms companies are based, the dependence of arms buyers can be exploited to advance political and economic interests. For the United States, it will ensure that only friends and allies obtain advanced conventional weaponry and that adversaries will be denied arms of equal quality. The number and variety of buyers will enable American defense firms to maintain production runs during periods when procurement budgets are falling. Moreover, it will provide the possibility of exercising leverage in other issue areas through diplomatic linkage.

More problematic is the issue of whether the American monopoly is good for international security. Since monopoly power is considered by economists to be bad for consumer interests, students of international relations might deem it bad for the state system. Balances are better, one might argue, since they place a check on the behavior of any single state. But there is strong evidence that countries relying on American weaponry have not started wars with their neighbors.3 Contrast that record with the one compiled by countries that have purchased their weapons from Russia, Western Europe or Third World suppliers. To cite the most egregious example, Iraq, which attacked Iran in 1980 before turning on Kuwait a decade later, had purchased its weapons primarily from Russia and France.

Why American arms should be used primarily for defensive purposes is an interesting question. The most likely reason is that countries reliant on the United States fear being cut off and forced to look elsewhere if they misbehave. These incentives will become all the more powerful as America exercises monopoly power.

As countries give up their inefficient armaments industries, they will free resources for more productive purposes. Today many countries engage in the development and production of defense hardware in which they have no comparative advantage. The result is a deadweight loss for the national economies in question and world trade.

The case of the Brazilian defense industry is telling. During the 1970s and early 1980s, Brazil tried to build a world-class armaments industry, and soon it was selling hardware to Iraq, Libya and other aggressor nations. As it tried to build more sophisticated weaponry, however, the financial burdens associated with research and development became excessive. Further, buyers of big-ticket weapons usually obtain help with financing from the seller, and Brazil, cut off by its debt crisis from access to hard currency, was unable to offer its customers attractive financial deals. Today the industry lies in bankruptcy, and Brazilian companies are still owed money by many erstwhile clients. Even worse, Brazilians poured money down this defense rat hole at a time of growing economic crisis, widespread poverty and crime.

HUSBANDING POWER

There are lessons to be learned from the Brazilian example, not just by other Third World nations but by industrial nations as well. Inefficient industries are kept alive at the expense of more potentially dynamic activities. Even when protected under the guise of national security, they are often maintained due to special interest pleading. The United States should not encourage the maintenance of such industries.

Ironically, the United States has done more than its share in the past to prop up these arms producers, especially in the NATO countries. U.S. technology sharing agreements and arms collaboration programs have helped develop industries in countries that long ago should have given up defense production. The General Dynamics F-16, for example, is assembled in Western Europe and Turkey, and a variant, the FSX will be built in Japan. The McDonnell-Douglas F-18 may be assembled in both Europe and Korea. Clearly, it would be cheaper and more efficient for these weapons to be produced in the United States and then exported. These collaborative deals of the Cold War era no longer belong in U.S. arms trade policy.

The coming American domination of the arms trade will provide policymakers in Washington with tremendous opportunities to shape the international economic and security environment, but there are dangers as well. Monopolists always walk a tightrope between demanding too much or too little for their services. If they demand too much, alternative suppliers or resources will ultimately develop. In the case of monopoly power in the arms trade, high prices could spur a search for unconventional weapons or weapons of mass destruction. Perhaps North Korea is providing an advance warning of the world to come.

But if the United States demands too little in return for access to its weapons, it faces a tremendous moral hazard. In recent years the United States has tied arms sales to improvement of human rights, nonaggression, controls on technology transfer and other long-term goals. Some of these links will have to be maintained, but they cannot be applied so firmly that countries will be tempted to develop weapons of their own or to encourage weapons production by others.

Monopoly power, therefore, should not be confused with absolute power. It must be exploited with skill, or it will soon be lost. Washington may be tempted to use its newfound position coercively, but coercion will only undermine the political foundations of its world leadership. Thus, the era of monopoly power will also present the United States with the greatest tests of its policymaking ability.

FOOTNOTES

1 World Military Expenditures and Arms Transfers: 1990, U.S. Arms Control and Disarmament Agency, Washington: Government Printing Office, 1991, p. 89; author interviews with U.S. officials, September 1992 and October 1993.

2 For a fuller explanation of these economic issues, see my chapter in the forthcoming book edited by Andrew Pierre, Cascade of Arms: Conventional Arms Proliferation in the 1990s, Washington: The Brookings Institution for the World Peace Foundation.

3 Some readers will argue that the Israeli preemptive strike of 1967 on Egypt and the invasion of Lebanon in 1982 are exceptions to this rule. Most scholars, however, consider the former action to have been purely defensive, while the latter was aimed not at a state, but at a terrorist organization that had constantly launched attacks on Israeli civilians.

  • Ethan B. Kapstein is Co-Director of the Economics and National Security Program at Harvard University's John M. Olin Institute for Strategic Studies.
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