The Evaluation of Efficiency in the Arms Industry

Abstract

Economic theory establishes a general presumption that arms industries and weapons markets are both allocatively and technically (or x-) inefficient. They operate in markets where national governments are monopsonists, determining the form and extent of competition. Governments can determine technical progress, the size of the domestic arms industry, its structure and entry conditions, as well as prices and profitability. The result is a set of State-regulated imperfect markets, characterised by one or a few relatively large suppliers either privately- or publicly-owned, competing through technical ideas rather than price, with firms protected from the entry of new domestic and foreign rivals. Such markets are likely to be characterised by allocative inefficiency and resource misallocation. Market conditions are also conducive to x-inefficiency. Weapons firms are supported by cost-based contracts which ensure that producers can recover their actual outlays almost regardless of their level! The potential for x-inefficiency is reinforced by government regulation of defence profits so that firms have inducements to pursue non-profit objectives, usually at the taxpayer’s expense. Thus the absence of rivalry, together with cost-based contracts and state profit controls, provide the conditions for x-inefficiency amongst suppliers.