One of the aspects of our behaviour that we now understand considerably more because of behavioural economics is that of our preferences: the values we assign to the various options available to us when making decisions. The view of preferences traditionally adopted by mainstream economists is that they are complete, stable, reflexive, transitive and immune from changes in ownership (see Chapter 1), but there now exists a plethora of behavioural findings demonstrating they are not in fact like this.

These findings are the focus of this chapter. Our preferences when faced with immediate choices – which may or may not be certain – are examined first, leaving our preferences when faced with choices across time to later in the chapter. The focus throughout is on the decisions we make that are not affected by, nor affect, the decisions of others: the focus is on our individual rather than strategic behaviour (see Chapter 5 for an examination of the latter).

Loss aversion

Jimmy Connors, the former world number one tennis player with eight major championship titles to his name, remarked that he hates to lose more than he likes to win. Such a sentiment is perhaps unsurprising from such a competitive individual, but behavioural economists have in fact shown it to be common to us all: a sentiment known as loss aversion.

The traditional assumption that our preferences are reflexive (see Chapter 1) implies the utility we gain from an item is exactly the same as the utility we lose from having the very same item taken away from us. Work on prospect theory (see Chapter 4), however, reveals this is not the case and that our preferences can in fact be represented by utility functions such as that in Figure 3.1. Gaining an item – a first glass of wine in this case – brings us a certain amount of utility, in this case an amount of satisfaction equivalent to £5. Gaining a second brings us additional utility, but less than the first because of diminishing marginal utility (see Chapter 2): £2 in this case.

Since the seminal works of Daniel Kahneman and Amos Tversky in the 1970s, behavioural economics has experienced astonishing growth in both its reach and influence. It is now firmly established as a field in its own right, encompassed within the wider discipline of economics (see Earl 2005):

• • Three Nobel Prizes have been awarded to academics for their work relating to behavioural economics: Herbert Simon in 1978 and Daniel Kahneman and Vernon Smith in 2002.

• • There now exists substantially more than 50,000 papers citing the two pioneering works of Kahneman and Tversky (Burnham 2013).

• • There are an ever-expanding number of dedicated academic societies (such as the Economics Science Association, the Society for the Advancement of Socio-Economics and the Society for the Advancement of Behavioural Economics) and journals (including the Journal of Economic Behavior and Organisation, the Review of Behavioural Economics, Experimental Economics and the Journal of the Economics Science Association).

• • Universities are now competing with one another to offer courses in the field and the subject is being taught as part of the curriculum for A level economics in the UK.

The relationship between those studying economics as a whole and those examining economic decision-making in particular has not always been straightforward, however, and has undergone a number of shifts over the past 180 years. There is an argument that this relationship remains one of tension and distrust rather than of mutual admiration and acceptance (see Chapter 7).

The classical era

No one can be criticised for asserting that economists have always been concerned with the study of how we – as individuals, families and groups such as businesses – actually make economic decisions. With economics being commonly defined as the “science which studies human behaviour as a relationship between given ends and scarce means which have alternative uses” (Robbins 1932: 15), such an assertion seems both innocuous and self-evident.

During the era of classical economics, this assertion was certainly true. This is most clearly demonstrated in the works of Adam Smith, who is now considered the father of modern economics. Born in Scotland, kidnapped by gypsies at the age of four, educated at the University of Oxford and prone to exceptionally eccentric behaviour, Smith was actually a classical philosopher who spent most of his academic life at the University of Glasgow.

Popular books on behavioural economics, many of which enliven a growing proportion of the economics shelf space in any good bookshop, tend to focus on the findings about our preferences explored in the previous chapter. However, behavioural economics is much broader than just this: it is also concerned with uncovering the actual processes we execute when making our decisions. This work does not contradict that of mainstream economists, who have largely been unconcerned with the means by which we make decisions, being solely concerned with the ends and their effects. In this sense, behavioural economics is a welcome extension of the economics discipline: welcome because an understanding of the processes involved in our decision-making is essential if the decisions we make across the differing settings in which we find ourselves are to be in any way predictable. The ends cannot be understood in isolation from the means.

Bounded rationality and satisficing

Since the beginning of the twentieth century, mainstream economists have at least implicitly assumed that we make our decisions optimally (see Chapters 1 and 2). The polymath psychologist, computer scientist and Noble Prize winning economist Herbert Simon saw things very differently, arguably being the first to focus on the actual procedures involved in our decision-making. He suggested we are characterized by bounded rationality: that in all but the very basic and most straightforward of settings we are simply unable to make optimal decisions.

Consider the relatively unimpressive decision involved in purchasing a bottle of whisky as a gift, for example. Depending on our budget and the degree of refinement of the recipient’s taste, we can with relative ease narrow down our choice to that between single malts or between blends; but then we have to consider the desired intensities of peat and smoke that can be tasted, the age of the spirit, whether we opt for normal or cask strength, the prestige of the distillery, the appearance of the bottle and the price. To make this decision optimally requires us to look at every bottle available to us – which could be in a whole array of different shops in our local town as well as on an increasing number of websites online – comparing them all according to each of these characteristics.

Why this book? I was attracted by the idea of a relatively short book on the economics of the arms industry. Economics has a contribution to make to the understanding of an industry that is often the subject of criticism and condemnation. It is an industry in which economics, morality and ethics cannot be avoided. Such a combination provides massive opportunities for economists to contribute to the debate by identifying myths, emotion and special pleading, and subjecting these to economic scrutiny and critical evaluation. This book brings together my research interests in arms industries; it presents an economic analysis and evaluation of the industry; and it attempts to inform readers about this controversial industry, which is so important for the future of civilization. Effectively, the book tells you all you need to know, and more, about the economics of the arms industry.

This book reflects a lifetime of interest in arms industries. I was born in Leeds on 14 July 1940 in the early stages of the Battle of Britain (officially the battle started on 10 July 1940) and my date of birth coincided with the anniversary of the French Revolution and the storming of the Bastille (14 July 1789). My parents worked in the clothing industry and my father also served in the Royal Air Force (RAF). My early life was dominated by the exploits of Spitfires, Hurricanes, Lancasters, Halifaxes and Mosquitos. The first jet fighter aircraft entered RAF service in 1944 and the jet engine revolutionized air warfare and civilian air travel. I followed these developments by attending annual Battle of Britain air displays at nearby RAF Church Fenton (now East Leeds Airport) and RAF Finningley (now Robin Hood Airport). I often cycled to the local RAF bases, as well as visiting disused former bomber bases. My interest in military history and former RAF bases has continued to this day, and I recently discovered a Mosquito base in Norfolk with the delightful name of Little Snoring, the exploits of which are recorded in the local church.

The economics came later. I started studying economics by accident: my sixth-form subject preferences could not be fitted into the school timetable so I had to choose a third A level.

Introduction: the issues

What are the facts about the world’s arms industries? What is known, what is not known and what do we need to know for making sensible policy choices about arms industries? We need to know which countries are the world’s major arms spenders and which are the major arms companies and industries, we need to know their size measured by annual sales and employment, and we need to know where they are located. Information is also needed on arms R & D spending, arms exports and the trade in small arms.

What is known?

There is only a limited literature on the economics of the world’s arms industries, much of it dated. A classic pioneering book dealt with The Economics of Defense in the Nuclear Age (Hitch & McKean 1960) and this was followed by The Weapons Acquisition Process: An Economic Analysis (Peck & Scherer 1962). Subsequent publications have included NATO Arms Co-operation (Hartley 1983) and The Political Economy of Aerospace Industries (Hartley 2014).

Statistical data provides an alternative method for dealing with what is known about the world’s arms industries. For a sector dominated by security concerns, there is a surprising variety of published sources. Examples include the Stockholm International Peace Research Institute, with its yearbooks and databases (SIPRI 2016a,b,c) providing data on military expenditure, arms transfers and the world’s top 100 arms companies. Reports from the World Military Expenditures and Arms Transfers provide data on military expenditure, armed forces personnel and arms transfers (WMEAT 2016). Further sources include the Small Arms Survey (SAS 2015), the annual volumes called The Military Balance that are produced by the International Institute for Strategic Studies (IISS 2016), and various reports from the US Congressional Research Service (CRS: Washington, DC) and the Rand Corporation (Santa Monica, CA). Other data sources include national defence ministries, company annual reports and industry trade associations.

A nation’s total military spending is a starting point in identifying the major arms spending nations. Total military spending comprises more than arms spending: it includes spending on military personnel, bases and facilities.

Introduction

Critics of arms spending focus on the economic benefits of disarmament and the prospects of a peace dividend. There are, of course, other non-economic benefits of disarmament, namely, peace itself and the creation of a safer world. Defence and peace have a common feature in that both are public goods. My consumption of peace is not at the expense of your consumption of peace, and once provided, peace is available to everyone (known as non-rivalry and non-excludability).

A recent experience of major disarmament occurred with the end of the Cold War in 1991. The US and the former Soviet Union, and their associated military alliances (NATO, the Warsaw Pact), ended their Cold War arms race and made major reductions in their arms spending. The result was a new security environment with prospects of a peace dividend from reduced arms spending. Was such a peace dividend achieved? How large was it? And what were the problems in realizing a peace dividend (Gleditsch 1996)?

The economics of conflict: the case for disarmament and peace

The costs and consequences of conflict provide the mirror image of the case for disarmament and peace. Peace allows the successful development of capitalist market economies and other types of economy. A starting point for analysis requires consideration of the impact of wars on market economies. In peace time, these rely on the price mechanism to allocate scarce resources to promote beneficial trade and exchange both within and between nations. Voluntary trading is beneficial to both buyers and sellers, with markets promoting creative power reflected in the growth of output (i.e. more goods and services).

Wars use military force to reallocate resources from losers to winners (cf. theft). Wars arise where a nation uses military force to acquire resources owned by another nation (e.g., land, water, oil, minerals), or they might arise from national pride, or from prejudice, a desire for revenge or from mistakes. Conflict destroys markets, leading to chaos and disequilibrium with a focus on destructive power and society becoming worse off. Wars result in the death of and injuries to military and civilian personnel on both sides, as well as the destruction of military and civilian infrastructure and housing (roads, bridges, hospitals and schools) and the loss of freedoms for the defeated nation.

Introduction

This chapter explains the economics of arms industries and their distinguishing economic features. All industries have economic features and the question we address here is, what are the distinctive economic features of arms producers and industries? The chapter starts by defining arms markets, some of the key facts about such markets and their distinctive economic features. These include their dependence on government and their distinctive supply-side features.

Arms markets

Industries form the supply side of a market that includes buyers. The competitiveness of a market is determined by the numbers of buyers and sellers. Large numbers of buyers and sellers form a competitive market, and this market provides a benchmark for assessing all markets and their industries. The opposite extreme arises where there is a single buyer or a monopsony buyer and a single seller or monopoly supplier.

Some markets are competitive, with large numbers of private buyers and private sellers. Examples of private competitive markets include agriculture, construction, household services (e.g., plumbing, window cleaning), motor vehicle repair and maintenance and some financial services. Within military markets, defence departments buy products and services such as accommodation, furniture, computers, telephones, motor vehicles and transport services that are also bought by large numbers of private consumers. Typically, most markets are characterized by large numbers of relatively small buyers, so they are competitive on the buying side of the market. Examples include large numbers of buyers of motor cars, televisions, fridges, washing machines, computers and mobile phones.

Arms markets are different on the buying side. Governments are the major, or only, buyer of arms (they are a single buyer, or monopsony). Only governments buy major lethal equipment (combat aircraft, missiles, tanks, warships). Potential buyers include the national government and any foreign governments that receive arms exports. But some arms might only be bought by the national government, which then becomes a monopsony buyer (e.g., nuclear-powered submarines in France, the UK and the US). As a result, the buying side of arms markets forms one of their distinctive economic features (see Chapter 4).

Introduction

Critics focus on arms producers being inefficient and operating in state-protected markets earning excessive profits at the expense of taxpayers. They point to a failure to manage major weapons projects, reflected in cost overruns, delays and weapons that are costly and often fail to perform to their operational requirements. Further, it is claimed that any export successes are achieved either through large government subsidy payments or through the payments of bribes to foreign buyers, or both. Religious, moralist, ethical and peace groups also condemn arms industries for supplying products that kill and injure people.

Supporters of arms industries point to their military benefits in the form of supplying weapons that contribute to maintaining peace, protection and security for a nation’s citizens, their property and their way of life. Contrary to the opponents of arms industries, some groups argue that arms producers save lives and protect a nation’s citizens’ independence and freedoms. There are additional wider economic benefits in the form of employment, technology, spin-offs, exports and import-savings benefits.

Are arms industries worthwhile industries?

How can these conflicting views be assessed? Economists need to assess the various arguments critically and consider the criteria for determining whether the arms industry is a worthwhile industry and one which should be retained. The economic criterion for a socially desirable change is demanding: namely, that change is desirable if one person can be made better off without making someone else worse off. In reality, this criterion is likely to be replaced by the less demanding criterion of cost–benefit analysis: do the benefits of change exceed the costs? But the fact that the issue of whether the arms industry is a worthwhile industry is being raised at all needs to be considered.

Typically, a competitive industry is regarded as worthwhile if consumers are willing to pay its economic price and the returns to the industry cover all its costs, earning at least normal profits. Here, profits are regarded as normal if they are sufficient to induce investors to remain in the industry, providing continued funding for the business.

Introduction

Buying arms appears to be a simple process: the armed forces decide on their requirements and buy from arms producers who meet their requirements at the lowest price. Reality is different, and buying arms is a much more complex process. It is not like buying a car, television or mobile phone, all of which exist and can be sampled before buying. Armed forces often require weapons that do not yet exist and have to be “tailor made” for the military. Also, governments usually interfere with armed forces procurement choices as they pursue military–strategic interests and wider economic benefits by buying arms from national suppliers. These claimed military and wider economic benefits need to be assessed critically and costed. For example, buying from national arms producers can be costly and risky compared with purchasing existing arms “off the shelf” from overseas suppliers. This chapter assesses the arguments.

Buying arms is a complex process

Arms buying involves choices about what to buy, who to buy from, how to buy and when to buy.

What to buy?

The armed forces and governments have to decide the type of equipment needed. This requires an assessment of future threats and the available budget, where both threats and budgets are characterized by uncertainty. Moreover, uncertainty is increased where the arms required do not yet exist and have to be developed and produced for a specific national requirement. Here, the armed forces have to specify the operational performance of the weapons they need (e.g., speed and range of combat aircraft, firepower of tanks), which might involve major technical advances, further increasing uncertainty. Technical change might render current arms obsolescent. Examples include the development of ballistic rockets replacing long-range strategic bombers, nuclear weapons replacing large-scale conventional forces, jet engines replacing propeller aircraft, and UAVs replacing manned aircraft. Further complications arise where governments interfere with arms procurement choices for military–strategic interests and wider economic benefits.

Who to buy from: choice of contractor?

Once a requirement has been formulated, a contractor has to be selected, either using competition or direct negotiation with a preferred supplier.

Introduction: is the government to blame?

In addressing controversial problems, society and the media often seek to blame some individual, group or organization. For controversies associated with arms producers, governments are an obvious target for criticism. In response to the question of whose fault it is, the reply is often that the government is to blame! This chapter explores the role of government in arms industries. It assesses the importance of government and the validity of claims that “it is all the government’s fault”.

The role of government

Governments are central to understanding the arms market and arms industries. Their importance arises from their buying power, with government as either a monopsony or major buyer of arms, particularly of lethal equipment (including the supply of parts and components for such equipment). Examples include aircraft carriers, warships, nuclear-powered submarines, combat aircraft, missiles, tanks, armoured fighting vehicles and artillery, where national governments are often the only buyers of such equipment. As a single buyer, they are monopsony buyers. Exceptions arise where arms are exported, so there are also foreign buyers but the national government remains a major buyer of the equipment. In such cases the national government is not only a major buyer: it is also the original buyer that initiated and funded the project.

Governments can use their buying power to determine the size, structure, conduct, performance and ownership of both arms producers and arms industries. Buying power takes the form of arms contracts. National governments awarding arms contracts to their domestic arms producers and industries can determine the size of the arms industry: more contracts mean a larger domestic industry. For example, arms industries expand during wars and conflicts such as the First and Second World Wars, the Cold War, and the Korean, Vietnam, Afghanistan and Iraq conflicts.

Government can also use its buying power to determine the structure of its national arms industry through affecting the size of firms as well as the conditions of entry and exit from the industry. For example, major contract awards might be conditional on arms producers merging to create larger firms.

Introduction: the policy issues

Arms producers and arms industries are controversial: they are often criticized and condemned. But such criticisms need to be addressed and carefully considered. Arms firms and whole arms industries cannot be dismissed and proscribed without more detailed and careful analysis and evaluation of their apparent “wrongdoings”.

This chapter sets the scene and outlines the policy issues to be explored in the book. Are arms industries important: if so, why, and which other industries are viewed as important? Do they provide “good value for money”, or are they inefficient, corrupt and immoral; should they be condemned as “merchants of death”; and do they exploit their market power at the expense of taxpayers? What can and should governments do about them: should privately owned arms firms be subject to tighter government regulation or should they be taken into state ownership, and will state ownership solve the “problem”? These and other questions will be addressed in this book, at the end of which the reader will be able to reach a more informed judgement about the economic aspects of the arms industry. In this chapter, the arguments surrounding the arms industry will be presented and assessed. A legal approach would ask what is the case for the prosecution and what are the arguments for the defence? A starting point requires an explanation of why economists disagree about arms industries and other policy issues, followed by a definition of the arms industry.

Why economists disagree

The typical view of economists is that where there are ten economists there will be ten views and only one will be correct, but no one knows who will be correct!

Economists have good reason to disagree. Their disagreements might focus on differences of view about the relevance of a specific theory (e.g., Keynesians versus monetarists), on whether theories should be accepted or rejected on the basis of their explanatory power and predictive accuracy, or on the realism of their assumptions. Disagreements continue over the accuracy and reliability of evidence and on the appropriateness of particular policy solutions in relation to each economist’s value judgements and their views about the best solutions.

Introduction: do they have a future?

Arms producers and industries will survive so long as nation states face threats to their existence. Threats can be internal through civil wars, rebellions and terrorism or external through other nations or external groups threatening the existence of a nation state. As one expert has stated: “War has always been with us as a violent method of resolving disputes… The history of the world is primarily the history of war” (David 2009: 8).

Over time, wars have been fought between tribal groups, cities, regions and nation states. Conflicts have been of varying durations, ranging from days to years. There have been different causes, including conflict over resources, with wars to change the allocation of resources between different owners: examples include wars over land, mineral resources and water resources. Conflicts have also arisen over national borders, from longstanding grievances and for reasons related to race and religion, including ethnic cleansing. Personal factors can intervene in the form of a desire to remove dictators, protect the weak and a desire for revenge and conquest, and there is also the possibility of war due to mistakes and miscalculations. Political systems are relevant, with democracies dependent on voter preferences for conflict while totalitarian systems and dictatorships can ignore such preferences. Interestingly, the end of the Cold War has not meant the end of wars. Since 1991 there have been conflicts in Afghanistan, Iraq, Georgia, Chechnya, Yugoslavia, Kosovo, Crimea, Ukraine, Yemen and Syria. Also, by 2017, there were signs of the re-emergence of the Cold War nuclear arms race between Russia and the US.

There is also the concept of the just war originally associated with Thomas Aquinas, which specifies the criteria under which war is morally justifiable, namely, where it is morally right to use armed force, and how the war should be fought. For example, the Allies in the Second World War believed that they were fighting a just war against Hitler and Nazi Germany. The just war concept has been extended to deal with the end of wars and the prosecution of war criminals.