Conflict over arms accumulation in market and command economies

Abstract

This paper is concerned wth the classic "guns versus butter" dlemma.There are two countries engaged in an arms race.The first country is a decentralized market economy and the second country is a command economy.This asymmetry might capture the difference between West and East.The government of each country maximizea the life-time utility of the representative consumer, which depends upon conaumption, leisure and defence.Defence is a characteriatic, which depends positively upon the own weapon stock and negatively upon the foreign weapon stock.The government of the first country usea distortionary taxes on labour ncome to finance the provision of public goods, whereas the government of the second country simply commands its constituents.This paper contrasts coordinated and decentralized decision making.It is argued that coordinated policiea lead to lower levels of government spending and arms accumulation.As far as decentralized decision making is concerned, it is crucial to distinguish between openloop, general closed-loop and subgame-perfect Nash equilibria.The openloop Nash equilibrium relies upon pre-commitment to an announced path of ~This paper was presented to a Meeting of the European Public Choice Society, April 2-5, 1986, Noordwjkerhout, The Netherlands and to a Conference on International Economic Security organized by the Centre for Economic Policy Research, June 19R6, London.The authors are grateful to the participants of those meetings for their comments and to A. Markink for excellent computational assistance.government spending and is the solution concept moet frequently used in the literature.The problem with this concept is that it relies upon very restrictive i nformation sets and over-eatimates the inefficiencea generated by the arms race.The closed-loop Nash equilibrium allows each country to have knowledge of current and past weapon stocks.Within this framework it is possible to model threata, which can induce cooperative behaviour.The principle of subgame-perfection gves uniquenesa and credibility within the class of closed-loop Nash equilibria.This subgameperfect equilibrium coincides with the open-loop equilibrium when utility is separable in home and foreign weapon stocks.In general, this is not the case and subgame-perfect equilibria typically lead to less arms accwnulation than open-loop equilibria.This i llustrates that i n a gametheoretic context an increase in information can make both countries better off and countries should therefore be encouraged to monitor the weapon stocka of their rival.The results are illustrated wth a numerical example based upon CES utility functions and linear technologiea.This gives an opportunity to test a recently developed algorithm for the calculation of aubgameperfect equilibria i n dynamic gamea.