تهدید نظامی خارجی پیش بینی شده، انباشت سلاح، و حساب جاری در یک اقتصاد کوچک باز

This paper examines the effects of an anticipated foreign military threat on consumption, the home weapons stock, and net foreign asset position in a small open economy. If the utility function is separable between butter and guns, the economy decreases both butter and guns when the news arrives, accumulates foreign assets prior to the foreign threat realization, and increases guns as the foreign threat realizes. If the utility function is nonseparable between butter and guns, the economy may have two dynamic responses. The first is similar to the separable case, except that consumption exhibits a discrete jump when the foreign threat realizes. The second is that the economy increases both butter and guns on impact, decumulates foreign assets prior to the foreign threat implementation, but either increases or decreases guns as the foreign threat realizes.

This paper examines both the long-run and short-run responses of consumption, the home weapons stock, and net foreign asset position to an anticipated foreign military threat in an intertemporal optimization model of a small open economy. The study of this issue is well justified for two reasons. First, the literature of competitive arms accumulation based on a dynamic optimization model has in recent years received considerable attention. For example, some models highlight the strategic aspects of arms accumulation in a dynamic game (Brito, 1972, Simaan and Cruz, 1975, Deger and Sen, 1984, Van der Ploeg and de Zeeuw, 1989 and Van der Ploeg and de Zeeuw, 1990, while others examine the economic effect of consumption, military spending, and arms accumulation in the presence of a foreign threat (Deger and Sen, 1983, Deger and Sen, 1984, Zou, 1995 and Chang et al., 1996). However, these studies are restricted to the closed economy. With the increasing integration of the international economy, domestic macroeconomic performance has become more sensitive to foreign shocks, yet we still lack a well-grounded theoretical analysis of the small open economy. This paper thus, attempts to analyze the economic response of a small open economy to competitive arms accumulation. Second, in the real world a country often faces its enemy with a potential military confrontation rather than with an immediate invasion. For example, as India and Pakistan, respectively insist on developing their nuclear weapons, the general public in both the countries anticipate that military tension will increase in future. The peace talks between Israel and the Arabs have been held repeatedly and a peace agreement has been signed step by step in recent years. This makes people in that region anticipate that a military conflict threat in the Middle East may be lessened in future. However, existing studies on arms accumulation do not reflect these facts, whereby they have not explicitly analyzed the effects of an anticipated foreign military threat. To our knowledge, the issue of an anticipated foreign military threat has been the subject of recent studies by Zou (1995) and Chang et al. (1996). However, in these studies none of the authors have made use of the simple representative-agent infinite-horizon dynamic framework of a small open economy, as is done in this paper. As the analysis of an anticipated foreign threat on economic performance has its practical need in the real world and theoretical interest, this paper makes a first attempt to examine the impact of an anticipated foreign threat in the context of an open economy. This paper extends the standard framework of Deger and Sen, 1983 and Deger and Sen, 1984 and Van der Ploeg and de Zeeuw (1990) to the setting of a small open economy with a perfect world capital market. The assumption of a perfect world capital market not only is in accordance with the literature of international macroeconomics such as Obstfeld, 1983, Djajić, 1989, Sen and Turnovsky, 1989, Turnovsky and Sen, 1991 and Brock, 1996, but also imparts some realism to the present approach, since it describes the greater degree of integration, that prevails in international asset markets. Such an integrated world capital market plays an important role in facilitating the financing need of a small open economy from abroad. This paper specifically intends to construct an open-economy intertemporal optimization model embodying arms accumulation and perfect capital mobility, and use it to examine the effects of a foreign military threat on domestic consumption, military spending, and the current account. Although the model we develop is a non-monetary one in nature along the lines of Obstfeld, 1983, Djajić, 1989 and Fisher, 1995, and Zou (1997), it provides a useful first step to highlight the linkage between the current account and intertemporal allocations of foreign assets in response to a shock of foreign military threat. Moreover, this framework can serve as a benchmark for extending to a monetary model of the small open economy with arms accumulation, which enables us to understand the current-account implications and exchange-rate fluctuations as a result of an anticipated foreign military threat.1 Within this amended model, the small open country derives positive utility from the consumption and security provided by domestic military services, but disutility from the foreign military threat. When the foreign country announces, that it will increase its arms stock in the future to raise the military tension, how should the home economy respond? Intuitively, the answer depends on the extent of home country’s attitude towards resisting the foreign military threat. If this small open economy decides to provide more resistance to the foreign military threat, its weapons stock must increase to a greater extent at the instant of foreign threat realization. To meet this end, the economy in advance decreases butter and guns on impact to accumulate foreign assets prior to the enforcement of the foreign threat, so that it in turn increases more guns by selling foreign assets at the time of foreign threat realization. Alternatively, if the economy does not offer much resistance to the foreign military threat, its weapons stock need not increase very much at the instant of foreign threat realization. Thus, the economy in advance increases both butter and guns on impact to decumulate foreign assets prior to the enforcement of the foreign threat. The remainder of the paper is organized as follows. The theoretical structure of the model is outlined in Section 2. Section 3 investigates the evolution of consumption, the domestic weapons stock, and net foreign asset position in response to an anticipated shock from a foreign military threat. Finally, the main findings of our analysis are presented in Section 4.

This paper has made a new attempt to investigate the dynamic effects of an anticipated foreign military shock on domestic consumption, military spending, and the current account in an intertemporal optimization model for a small open economy. Based on our analysis, the major findings are as follows. In the face of an anticipated foreign military threat, if the utility function is separable between consumption and the weapons stocks, the economy in advance decreases both butter and guns on impact, accumulates foreign assets, maintains a smooth constancy of butter and guns prior to the implementation of foreign military threat, and then increases guns by selling foreign assets at the time of foreign threat realization. However, if the utility function is nonseparable between consumption and the weapons stocks, the economy may exhibit two patterns of adjustment. The first response is similar to that of the separable case, except that consumption displays a discontinuous rise or fall at the instant of foreign threat implementation. In the second response the economy in advance increases both butter and guns when news of anticipated foreign threat comes, decumulates foreign assets, keeps a smooth constancy of butter and guns prior to the enactment of foreign military threat, and then decreases butter, but either increases or decreases guns, at the time when the foreign threat comes into force. As documented by Brzoska (1995) and Deger and Sen (1995), for many developed and developing countries, military expenditures take up a large share of their national income. Accordingly, changes in military expenditures should have a very significant effect on the current account. From this perspective, more theoretical and empirical analysis is a priority for future research.14 In addition, there is a natural extension from our analysis that the country is modelled as a developing economy with an external borrowing constraint as proposed by Bardhan, 1967, Obstfeld, 1982 and Pitchford, 1989, and Fisher (1995). Specifically, when the economy faces an imperfect world capital market, it has an upward-sloping supply function of debts and is not able to borrow or lend at the world interest rate. The other extension is to introduce adjustment costs of investment in home weapons stocks into the model. This can capture the stickiness in their evolution that prompts countries to invest in weapons in anticipation of military threats. One more ambitious extension is a two-country setting in which we can study the strategic aspects of competitive arms accumulation in a dynamic game along the lines of Van der Ploeg and de Zeeuw (1990). Finally, in line with Calvo (1985) and Turnovsky, 1985 and Turnovsky, 1987, introducing money into our theoretical framework can help construct an open-economy monetary model of arms accumulation under flexible exchange rates. Such a modeling strategy allows us to analyze the effects of a foreign military threat on the current-account implications and exchange-rate adjustments. These interesting issues mentioned above constitute subjects for future research and can be settled in future studies.