DISRUPTIVE INNOVATION AND THE GLOBAL ARMS TRADE

Jonathan D. Caverley

Northwestern University

Ethan B. Kapstein

Arizona State University

April 2015

Abstract

Why has the United States’ share of the global arms market declined so precipitously since the mid-1990s? What are the consequences of that decline both for the proliferation of conventional weapons and for the relative influence of the United States and other major powers? We address these questions in three ways. First, we present data identifying changes in the international arms market. Second, we advance a new theory for American loss of influence that contrasts strikingly with other “declinist” explanations. We argue that the US defense industry builds weapons to meet the needs of its primary customer, the Pentagon, which demands expensive, sophisticated tools of power projection. The market for such weapons is intrinsically limited; many states are instead seeking to acquire anti-access or counter-intervention weapons that the United States neither purchases nor produces. This has left the market open to “disruptive innovation” from countries, such as Russia, China, and South Korea, which produce and export less sophisticated and cheaper weaponry. Third, we illustrate these new dynamics with data on missile exports, and also use a new data set to show how the price of weapons for all US customers from 1970-2013 has risen, and US market share fallen, with increases in US defense spending.

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At the Cold War’s end, the United States seemed poised to monopolize the global arms

trade. Its rivals in Europe and the former Soviet Union were reeling under sharp defense budget

cuts, and relative newcomers to the arms market, like China, were minor players. Yet despite

these promising structural conditions, the US market share of global weapons sales has

plummeted from unprecedented but fleeting heights in the 1990s to its present, historic lows.

Why does the United States appear to be losing its dominant position in the arms trade? And

what are the consequences for the global proliferation of conventional weapons, as well as for

international order and American influence in the 21st century?

Concern for this development should go beyond those interested in the health of the US

defense industrial base. A more competitive arms market will likely result in the increased

production and sale of major conventional weapons (MCW) around the world. Moreover,

weapons sold by other countries rarely have the same limitations on technology transfer and end-

use monitoring requirements of American products. Declining US market dominance, therefore,

could result in more weapons being sold with fewer end-use restrictions, making the world a

more dangerous place.

Examining the international arms market also sheds light on the shifting distribution of

international power and the consequences for international order. The United States (like all

major powers) has long promoted the sale of weapons to influence smaller states, manage

regional arms races, encourage allies’ interoperability, contain rivals’ capabilities, as well as

support its own defense-industrial base and broader economy. Arms sales are an explicit

component of the United States’ revitalized effort to “train and equip” other military forces to

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more effectively carry out joint security interests around the world.1 The loss of market share

puts several aspects of the United States’ political-economic order at risk.

To explain this decline, we argue that the United States and its firms face what Clayton

Christensen calls the “innovator’s dilemma,” the failure of high-end producers to identify and

respond to the competitive pressures emanating from their lower-end rivals.2 The dilemma

emerges in industries where leading firms focus on providing their most important customers

with superior performance in the areas these clients value most. But as one firm after another has

discovered, many consumers are quite willing to purchase large quantities of somewhat inferior

goods at a cheaper price. While the US defense industry excels at producing the type of arms that

its principal client (the Pentagon) wants—power-projecting weapons that enable policing the

“global commons”—it does not produce cheaper variants of items well-suited for the missions

that much of the world currently demands.

In this paper we show that the United States’ position in the arms trade is largely due to

the domestic defense budget and the price tag associated with building cutting edge conventional

weaponry. At the end of the Cold War, with defense spending and weapons demand falling

across the NATO countries, the United States effectively subsidized its allies and best customers

to purchase its platforms. Following the launch of the “Global War on Terror,” however, defense

budgets rose substantially and the Pentagon’s demand for both power projection and military

occupation increased. With the lack of budget constraints, conventional weapons became, to use

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!1 Department of Defense, "Sustaining Us Global Leadership: Priorities for 21st Century Defense," ed. Department of Defense, Defense Strategic Guidance (Washington, D.C.2012). 2 Clayton M. Christensen, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail (New York: HarperBusiness, 2000).

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Mary Kaldor’s term, increasingly baroque.3 As a consequence of these changes in demand, the

value proposition of US arms exports has declined over the past decade.

The paper proceeds as follows. After reviewing the literature, we first make the empirical

case that US arms market share is indeed declining, and identify an historically unusual

disconnect between arms sales and broader measurements of power. Second, we introduce the

concept of disruptive innovations in the arms market. We then present data on the global missile

market to illustrate our theory. Finally we turn to data on American arms exports from 1970-

2013. We find first that market share is inversely correlated with American defense spending.

Additionally, we find that the prices for American weapons climb sharply with rising US defense

budgets. We conclude with the ironic implication that the United States’ pursuit of cutting edge,

world-beating weapons may make its managing and securing the “global commons” more

difficult.

1. Why the Arms Market Matters

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One goal of this paper is to renew scholars’ attention to the international significance of

the arms trade, traditionally considered one of the drivers (and menaces) of world politics. In the

aftermath of World War I, for example, the “merchants of death” received a great deal of blame

for fueling that conflict.4 During the Cold War, scholars and policymakers expended

considerable efforts to analyze the spread of conventional weapons and its effects on conflict.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!3 Mary Kaldor, The Baroque Arsenal (New York: Hill and Wang, 1981). 4 Helmut Carol Engelbrecht and Frank Cleary Hanighen, Merchants of Death; a Study of the International Armament Industry (New York,: Dodd, Mead & company, 1934).

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Unfortunately, while the study of the transfer of small arms5 and nuclear capability6 is

undergoing a renaissance, analysis of the trade in major conventional weapons (MCW) has

largely stagnated since the Cold War’s end.

However, in recent years global MCW purchases have risen steeply. Moreover, even as

demand rises, the development and construction of sophisticated MCW has become so difficult

that even fewer countries can produce them indigenously.7 In short, for almost all countries,

including rising powers such as India and China, arms imports make up the bulk of their arms

acquisitions. The few states that can export weapons use them to advance a variety of

international political goals.8

Most scholars looking at the post-Cold War transfer of arms were pessimistic about the

prospects of proliferation in an era of economic globalization.9 Andrew Pierre went so far as to

predict an impending “cascade of arms.”10 Jurgen Brauer foresees a “buyers’ market” as

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!5 Mike Bourne, Arming Conflict: The Proliferation of Small Arms (Palgrave Macmillan, 2007); David Kinsella, "The Black Market in Small Arms: Examining a Social Network," Contemporary Security Policy 27, no. 1 (2006). 6 Matthew Fuhrmann, Atomic Assistance: How “Atoms for Peace” Programs Cause Nuclear Insecurity (New York: Cornell University Press, 2012); Matthew Kroenig, Exporting the Bomb: Technology Transfer and the Spread of Nuclear Weapons (Ithaca: Cornell University Press, 2010). 7 Andrea Gilli and Mauro Gilli, "The Diffusion of Drone Warfare? Industrial, Infrastructural and Organizational Constraints: Military Innovations and the Ecosystem Challenge.," Security Studies (Forthcoming). 8 Keith Krause, Arms and the State: Patterns of Military Production and Trade (London: Cambridge University Press, 1995). 9 R. A. Bitzinger, "The Globalization of the Arms Industry," International Security 19, no. 2 (1994); T. H. Moran, "The Globalization of America's Defense Industries: Managaing the Threat of Foreign Dependence," ibid.15, no. 1 (1990); R Vernon and E B Kapstein, "National Needs, Global Resources," Daedalus 120, no. 4 (1991). 10 Andrew J. Pierre, Cascade of Arms: Managing Conventional Weapons Proliferation (Washington, D.C.: Brookings Institution Press, 1997). Luis Bitencourt, "The Problems of Defence Industrialization for Developing States," in Arms and Technology Transfers: Security and Economic Considerations among Importing and Exporting States, ed. Sverre Lodgaard and Robert L. Pfaltzgraff Jr. (New York: United Nations Institute for Disarmament Research (UNIDIR), 1995). Jurgen Brauer, "The Arms Industry in Developing Nations: History and Post-Cold War Assessment," in Arming the South: The Economics of Military Expenditure and Arms Production and Trade in Developing Countries, ed. Jurgen Brauer and J. Paul Dunne (New York: Palgrave, 2002).

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suppliers became increasingly desperate to sell weapons, and the consequent rise of additional

suppliers.11 Anne Markusen has argued that emerging multinational defense would pursue their

own economic interests with greater autonomy, taking less account of the security interests of

any particular state client.12 Some identified a “gray threat,” in which the post-Cold War decline

in defense budgets would result in pressure on firms to export to states with security interests that

differed from those of the United States and Western Europe.13 Aaron Friedberg agreed that

globalization confronted US policy-makers with a choice between taking steps to maintain its

autonomy or an “ideology” of governmental non-interference that would undermine American

economic competitiveness in defense and related high-technology sectors.14 While optimistic

about the prospects for peace, Stephen Brooks advances an ambitious liberal theory in which the

complex production chain of advanced weapons constrains even the United States’ ability to

“run the tables.”15

Other scholars argue that the arms industry remains a function of the balance of power,

and that the economic and political barriers to entry into the arms market are higher than

pessimists predict.16 Privileged states have means to shape the market in spite of globalization,

and in a unipolar world there is only one such actor. Michael Mastanduno and Joseph Grieco

suggest that rising interdependence helps to consolidate American power, mitigating the spread

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!11 "The Arms Industry in Developing Nations," 107. 12 Krause, Arms and the State; Ann R. Markusen, "The Rise of World Weapons," Foreign Policy (1999). 13 Kenneth Flamm, "U.S. Defense Industry Consolidation in the 1990s," in The Defense Industry in the Post-Cold War Era Corporate Strategies and Public Policy Perspectives, ed. Gerald I. Susman and Sean O'Keefe (Oxford: Pergamon Press, 1999). 14 A L Friedberg, "The End of Autonomy: The United States after Five Decades," Daedalus 120, no. 4 (1991). 15 Stephen G. Brooks, Producing Security: Multinational Corporations, Globalization, and the Changing Calculus of Conflict (Princeton, N.J.: Princeton University Press, 2005). 16 In a comparative analysis of the inter-war and post-World War II arms trade, Harkavy examined supplier and recipient market structures and showed how they corresponded to the shifting distribution of power during these two periods. Robert E. Harkavy, The Arms Trade and International Systems (Cambridge, MA: Ballinger, 1975).

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of technology and military capability to weaker states.17 Ethan Kapstein specifically links the

massive economies of scale found in its domestic industry to the American potential for an arms

trade monopoly, predicting that the United States would take advantage of this power to sell only

finished products to select customers.18 Jonathan Caverley claims that the United States can

leverage arms sales for influence, giving up some economic benefits in exchange for its clients’

agreement to refrain from competing with US products or to selling to such rivals as China.19

Stephanie Neuman gives several qualitative examples of the United States using its market

leverage to influence other states’ international behavior.20

This line of reasoning helps explain some broader empirical findings on the arms trade

and international behavior. Blanton finds that since the end of the Cold War (and only since

then), both the level of democracy and the protection of human rights have become significant

considerations in US arms export policy.21 Kinsella shows how dependence on a single state for

arms can dampen a state’s tendency towards conflict.22

Possibly excepting Brooks, all sides in the debate appear to agree that, in the absence of a

dominant weapons supplier, a more competitive marketplace would result in more weapons

being sold, and the diffusion of more sophisticated killing technologies to more states,

particularly in the developing world. Considerable evidence suggests that increased volume of

weapons exacerbates arms races and stimulates crises. At the global level, more arms exports !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!17 Joseph M. Grieco, "Anarchy and the Limits of Cooperation: A Realist Critique of the Newest Liberal Institutionalism," International Organization 42, no. 3 (1988); Michael Mastanduno, "Economics and Security in Statecraft and Scholarship," ibid.52, no. 4 (1998). 18 Ethan B. Kapstein, "America's Arms-Trade Monopoly," Foreign Affairs 73, no. 3 (1994). 19 Jonathan D. Caverley, "United States Hegemony and the New Economics of Defense," Security Studies 16, no. 4 (2007). 20 Stephanie Neuman, "Power, Influence, and Hierarchy: Defense Industries in a Unipolar World," Defence and Peace Economics 21, no. 1 (2010). 21 Shannon Lindsey Blanton, "Promoting Human Rights and Democracy in the Developing World: U.S. Rhetoric Versus U.S. Arms Exports," American Journal of Political Science 44, no. 1 (2000). 22 David Kinsella, "Arms Transfer Dependence and Foreign Policy Conflict," Journal of Peace Research 35, no. 1 (1998).

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correlate to the number of states involved in wars and militarized disputes.23 Drawing on a

variety of cases, Brzoska and Pearson found that increased arms imports influence states’

decisions to go to war and that arms deliveries prolong and intensify ongoing wars.24

More recently, policy analysis has refocused on the ability of non-top tier countries

(particularly China) to design (often from stolen blueprints), build, and operate advanced

conventional weapons rivaling the United States’. While the claim that US market dominance

was declining was a controversial statement not long ago, among contemporary policymakers,

there is a strong sense that the United States may be losing its competitive edge.25 !

2. The State of the Global Arms Market

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To describe the state of the international arms market, we turn to data collected by the Stockholm

International Peace Research Institute (SIPRI).26 SIPRI draws on a variety of publically available

sources to generate an annual report on global arms transfers using a “Trend Indicator Value”

(TIV, in constant 1990 USD). The TIV enables analysts to compare flows (rather than prices) of

different types of weapons exported around the world, in an effort to make them comparable

across time and across countries.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!23 Cassady B. Craft, Weapons for Peace, Weapons for War: The Effects of Arms Transfers on War Outbreak, Involvement, and Outcomes (New York: Routledge, 1999); William J. Durch, Constructing Regional Security: The Role of Arms Transfers, Arms Control, and Reassurance (New York: Palgrave, 2000). 24 Michael Brzoska and Frederic S. Pearson, Arms and Warfare: Escalation, De-Escalation, and Negotiation (Columbia, S.C.: University of South Carolina Press, 1994), 214. 25 J. Thomas Moriarty et al., "Outgunned? A Debate over the Shifting Global Arms Market," Foreign Affairs (2013); Robert Work, "The Third U.S. Offset Strategy and Its Implications for Partners and Allies," (Washington, D.C.: Center for a New American Security, 2015). 26 SIPRI, "Sipri Arms Transfers Database," ed. Stockholm International Peace Research Institute (Stockholm, Sweden2014).

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Figure 1 presents the 4-year moving average annual TIV for US exports as well as total

world exports since 1950. Some basic points are readily apparent. First, contrary to the

pessimists’ prediction of widespread proliferation of conventional weaponry, arms exports

plummeted from the Cold War’s end to about 2003. Since then, overall exports have once again

started to rise. For the last two decades of the twentieth century, the United States exported

roughly the same amount of weapons each year, but its exports began dropping after 1998. While

in the past few years US export volume has recovered somewhat, the United States continues to

lose market share, as the world now imports an even larger amount of weapons from other

sources.

While American market share is at its lowest level since 1950 (the first year in SIPRI’s

data set), another interpretation of Figure 1 is that this represents a “return to normal” after the

anomalous 1990s. This in itself would be a remarkable development since arms sales have

traditionally reflected the larger balance of power, and the current distribution looks nothing like

the bipolarity of the Cold War era, the last time US exports were at similar levels.

To distinguish between these interpretations, Figure 2 shows trends in both military

spending and arms exports as a percent of global share from 1988-2013 for the world’s largest

arms exporters. The link between defense spending and exports makes intuitive sense; assuming

a great power has the ability to produce its own arms, the more weapons a state acquires for its

own purposes, the more competitive its exports become due to economies of scale and scope.

While the traditional relationship between arms exports and “power” in the form of military

spending looks tightly correlated at the beginning of the time period, it grows less consistent over

time.27

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!27 1988 is the first year SIPRI provides military spending data. Correlates of War data on spending is difficult to compare across countries and time, as its codebook readily attests.

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While the link between spending and arms sales appears to break down, the variation

among countries conveys significant information. Russia has recovered much of its market share

despite relatively weak increases in domestic spending levels. Until very recently, the European

exporters, traditional competitors with the United States in selling cutting-edge weapons,

punched above their weight relative to their defense budget. The rest of the world’s export share

is steadily rising but is still much lower than its collective budget would predict.28 On the other

hand, United States market share has plummeted even as it became responsible for over forty

percent of global defense spending. Indeed, among the major exporters, the United States is the

only state that exports less than its defense spending would predict.29

Together, these figures suggest some puzzles. The 1990s did not see an increase in

proliferation and the entrance of many new exporting countries, but the United States also failed

to consolidate the privileged position it briefly held in this market. There does not appear to be

much of a link between the balance of power in the world and market share, an historic anomaly.

Finally, the United States’ relationship between its spending and arms exports looks unusual

compared to other exporting countries.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!28 GDP is an even poorer predictor of market share. Also, contrary to much over-heated rhetoric in the United States, China does not seem to be exporting much more than its share in the late 1980s. 29 To further explore the link between military spending and exports, we regressed arms exports on military spending for each of the last decade’s twenty-five largest arms exporters for the years 1988-2013. We divided these countries by whether the regression coefficient was positive or negative, and whether the relationship was significant at the p=0.05 level (two-tailed). In 16 of the 25 countries, defense spending correlates to more exports. What is more, the states showing the positive relationship tend to be “up-and-coming” exporters; seven of them (in bold) were not in the top-25 list for 1950-1960. On the other hand, states (mostly in Europe) with long histories of defense industrial competence have a negative if weak (in the statistical significance sense) relationship between spending and exports. This may reflect these countries’ firms increased drive to export in times of lower domestic procurement. Finally, the United States is a unique case. Not only do American exports vary inversely with defense spending, unlike any other country, this relationship is statistically significant (over a mere 26 years of observations).

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3. Building Hegemony while Destroying Market Share

Basic economic logic and the historical data would suggest that American defense

spending and its share of the global arms market should be positively correlated.30 The

unmatched size of its superpower-sized economy and defense budget provides massive

economies of scale and learning effects in the production of armaments compared to any other

country, where relatively small production runs drive up unit costs.31 As a consequence, US

weapons should be relatively cheap given the marginal costs of production, making it easy to win

foreign sales.

To be sure, many reasons exist to not buy American. Rather than buy weapons “off the

shelf” from foreign suppliers, governments may seek to create jobs at home through work-share

agreements and offsets. In order to jump-start their own weapons production and midwife a

larger high technology manufacturing industry, importers often demand significant levels of

technology transfer.32 Policy-makers consider the effects of arms sales on their foreign policies

and alliance relations. Corruption also plays a role in arms sales, as with Britain’s notorious Al-

Yamamah deal with Saudi Arabia or, earlier American sales to South Korea that prompted

passage of the quite stringent Foreign Corrupt Practices Act (FCPA).33

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!30 Krause, Arms and the State. 31 Caverley, "United States Hegemony and the New Economics of Defense."; Andrea Gilli and Mauro Gilli, "The Diffusion of Drone Warfare? Industrial, Infrastructural and Organizational Constraints: Military Innovations and the Ecosystem Challenge.," ibid. (Forthcoming); Kapstein, "America's Arms-Trade Monopoly." 32Jurgen Brauer and J. Paul Dunne, Arms Trade and Economic Development: Theory, Policy and Cases in Arms Trade Offsets (London: Routledge, 2004). 33Mark Phythian, The Politics of British Arms Sales since 1964 (Manchester, United Kingdom: Manchester University Press, 2000), 218-26.. The FCPA became American law on the heels of a scandal involving the sale of Lockheed fighter aircraft. See Miles Koehler, "The Story of the Foreign Corrupt Practices Act," Ohio State Law Journal 73, no. 5 (2012)..

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Relative to many other suppliers, the United States is quite stingy on all these fronts, a

luxury it can afford given the great many advantages its industry enjoys.34 It has strict technology

transfer controls, relatively comprehensive anti-corruption standards for its companies, and

makes quite onerous demands on importing states to ensure that weapons do not get transferred

to third parties. Moreover, the United States has in the past cut off countries over policy

differences, such as the sanctions that crippled India’s Tejas light combat aircraft program

following that country’s testing of nuclear weapons.

Nonetheless, the United States has historically been adept at convincing countries to buy

American, for which it provides compensation by delivering a better product at a lower, even

subsidized, price. The controversial Joint Strike Fighter (F-35), so expensive that one critic calls

it the “Jet that Ate the Pentagon,” illustrates American advantages.35 Despite its sizable cost, the

United States has successfully sold the plane abroad though a combination of industrial

incentives, the promise of increased security cooperation, and, at times, muscular diplomacy.36

International procurement decisions about the F-35 have been unusually fractious and

controversial, yet the F-35 has not lost an international contract to a rival (in Israel, Italy, Japan,

Netherlands, Norway, South Korea, Turkey, and Great Britain). On the other hand, the visible

losses of American aircraft to foreign competitors, such as in India and Brazil, have been in

markets where the F-35 was not offered.

3.1 The Innovator’s Dilemma !

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!34 Transparency International, "Watchdogs: The Qulity of Legislative Oversight of Defence in 82 Countries," (London, UK: Government Defence Anti-Corruption Index, 2013). 35 Winslow Wheeler, "The Jet That Ate the Pentagon," Foreign Policy, http://foreignpolicy.com/2012/04/26/the-jet-that-ate-the-pentagon/. 36 Srdjan Vucetic and Rebecka S. Rydberg, "Remnants of Empire: Tracing Norway’s F-35 Decision," Contemporary Security Policy 36, no. 1 (2015).

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Our explanation for declining US market share despite all its advantages is based on an

underappreciated aspect of the arms trade: different states want different weapons.!The United

States has been in the business of developing and buying globe-straddling weapons for power

projection for decades, and its demand for such products dramatically rose alongside its

ballooning post-2001 US defense budgets. The massive but distorted US defense market leaves

a hole in the global arms trade for entrants producing less sophisticated products that are

nonetheless sufficient for buyers with fewer strategic ambitions (i.e. all of them).

Much of the vast literature on military innovation focuses on the failure of major powers

to identify and nurture “disruptive” innovations that will dramatically alter the military balance.

This is not our concern. Indeed, for good reason, we argue that it is not the primary concern of

the United States military either. To do so we employ Clayton Christensen’s immensely

influential work in business administration on the “innovator’s dilemma,” which distinguishes

between “disruptive” and “sustaining” innovations.37 The latter term describes improvements in

existing products that give a firm’s most important (and profitable) clients superior performance

along the parameters they value. Building on Christensen’s theory, Dombrowki and Gholz

demonstrate that: 1) many of the innovations sought by the US military are essentially sustaining

innovations and 2) the American-based defense industry is quite adept at serving the needs of its

primary customer (i.e. the Pentagon) by providing them. Indeed, the bias towards sustaining

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!37Christensen, Innovator's Dilemma.. For some applications to security policy see Michael Horowitz, The Diffusion of Military Power: Causes and Consequences for International Politics (Princeton, N.J.: Princeton University Press, 2010); Gautam Makunda, "We Cannot Go On: Disruptive Innovation and the First World War Royal Navy," Security Studies 19, no. 1 (2010).. We invoke Christensen with some trepidation because of the ubiquity of his term “disruptive innovation” in business and economic discourse in general and the US Department of Defense (DoD) in particular. When DoD entities address “disruptive” technologies, they are more often than not describing advanced systems, such as high-end drones or network-centric warfare that, while potentially “revolutionary,” remain beyond the capability of all but the most advanced militaries and defense firms, at least at the present time. The DoD thus often uses the term “disruptive” in ways unintended by Christensen.

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innovations is over-determined in military acquisitions compared to other industries, given the

general lack of hard budget constraints, the dense network of defense industrial lobbyists, the

thicket of regulations that firms must master to even contemplate selling to the Pentagon, and the

Congress’s aggressive role in steering funds to local firms.38

Dombrowksi and Gholz focus on how the Pentagon can achieve its innovation goals, and

therefore do not pursue the larger implications of Christensen’s theory: American defense firms

are unlikely to produce disruptive innovations because the demand for them is unlikely to come

from their principal customer. Christensen’s novel argument is that truly “disruptive”

innovations often result in reduced performance but at a greatly diminished price. Established

firms do not invest in these simpler, cheaper products due to their lower margins and smaller

profits. Disruptive innovations thus tend to be first commercialized in emerging or seemingly

insignificant markets, where “good enough” performance is sufficient.39 These less-established

customers might also use the product for quite different purposes. It is this combination of

functionality and price, what we term “value,” that drives a disruptive innovation.

Over time, these new entrants can use the resulting revenue and experience to work their

way up the “quality ladder.” Honda initially gained a foothold in the US motorcycle market not

by building powerful, luxury products like those of Harley-Davidson and BMW, but through

selling cheap, fun “Supercub” bikes to an entirely different set of customers. Honda now !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!38Peter J. Dombrowski and Eugene Gholz, Buying Military Transformation: Technological Innovation and the Defense Industry (New York, NY: Columbia UP, 2006), 19-26.. On the congressional politics of defense contracting see Kenneth Mayer, The Political Economy of Defense Contracting (New Haven, Ct.: Yale University Press, 1991).. 39 In later work, Christensen and co-authors (Seeing What's Next: Using the Theories of Innovation to Predict Industry Change (Boston: Harvard Business School Press, 2004), 5-14.) distinguish between “non-market” disruption (which creates a new market from previous non-consumers), and “low-end” disruption (which serves less demanding customers largely ignored by established industry leaders. This distinction does not appear germane to this paper, although almost all states buy weapons for similar reasons, so the arms market largely falls in the “low-end” category. While initial “non-market” disruptive innovations may be high in price (like early cellular phones), compared to alternatives all disruptive innovations offer lower prices relative to the dominant alternatives.

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competes effectively at every level of this and many other markets.40 Korean Aerospace

Industries (KAI) has built on its experience producing licensed versions of Lockheed’s F-16 to

produce a trainer aircraft (the T-50) sufficiently capable (and affordable) that the Philippines

purchased it for combat missions. KAI now seeks to develop a high-end aircraft to compete

against the F-16 in future export competitions.41

To reiterate, disruption emerges because established firms provide only the products that

its best, most sophisticated customers demand, leaving space for competitors at lower levels of

price and performance. As already noted, the ties between the defense firms and their most

important client are more intimate and numerous than those of any other corporate relationship.

By giving their best customer, the Pentagon, exactly what it wants, both the firms and the US

government are losing influence over increasingly critical segments of the global market,

including many nations in the “pivotal” Asia-Pacific region.

3.2 Giving the Customer What It Wants !

The United States’ privileged position in the world and the ambition of its foreign policy

have ensured that it produces the materiel necessary for what Barry Posen calls “command of the

commons.” The requirements for this capability are extremely demanding, and are unlikely to be

matched by any other state in the “near to medium term.”42 Posen describes at length the massive

physical and organizational infrastructure requirements for such a mission and the consequently

enormous barriers to entry for other states.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!40 Christensen, Innovator's Dilemma. 41 Richard Weitz, "South Korea’s Defense Industry: Increasing Domestic Capabilities and Global Opportunities," (Washington, DC: Korea Economic Institute of America, 2013). 42 Barry R. Posen, "Command of the Commons: The Military Foundation of Us Hegemony," International Security 28, no. 1 (2003): 7.

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Elliot Cohen uses the United States’ uniquely ambitious post-Cold War tactical fighter

acquisition strategy to reveal the massive scale and unique nature of US procurement efforts:

simultaneous investment in two new fighters (F-22 and F-35), upgrading its pre-existing tactical

fighter force (F-15s, F-16s, and F-18s), while developing an entirely different platform through

its many UAV programs.43 Put simply, no other country has the fiscal luxury of such formidable

acquisition plans, nor the geopolitical ambition justifying them.

Indeed, even the United States has difficulty making these massive projects work. The F-

35 Joint Strike Fighter is one obvious case of a troubled, ambitious weapons program, but it

remains a relative success compared to the now defunct Army Future Combat System and the

Coast Guard’s Deepwater program.44 Building cutting edge weapons is hard; former Lockheed

Martin CEO Norm Augustine famously observed that “the last 10 percent of performance

generates one-third of the cost and two-thirds of the problems.”45

Few other states possess the systems engineering ability to develop such a military, the

defense industry needed to produce it, or the organizational capital required to operate it

effectively.46 Then again, most countries do not seek to do so, and any state that did harbor such

ambitions (perhaps China and possibly India) would be unlikely to depend on the current

hegemon.47 The global market therefore appears to be inherently limited.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!43 E. A. Cohen, "Change and Transformation in Military Affairs," Journal of Strategic Studies 27, no. 3 (2004): 398. 44 Goverment Accountability Office (GAO), "Defense Acquisitions: Assessment of Selected Weapons Programs," (Washington, D.C.2012). 45 Norman R. Augustine, Augustine's Laws (New York, N.Y., U.S.A.: Penguin Books, 1987). 46 Richard A. Bitzinger, "The Revolution in Military Affairs and the Global Defence Industry: Reactions and Interactions," Security Challenges 4, no. 4 (2008); Eugene Gholz, "Globalization, Systems Integration, and the Future of Great Power War," Security Studies 16, no. 4 (2007). 47 Gardiner Harris, "World’s Biggest Importer, India Wants to Buy Local," New York Times, March 7 2014.

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On the other hand, what Posen describes as the “weaponry of the close fight” is cheaper

to purchase, simpler to operate, and easier to develop.48 The more ready supply of potential

exporters for these types of weapons helps ensure a “contested zone” that demarcates the limits

of American (or any other state’s) hegemony.49 In the American parlance, these products are

designed for “Anti-Access/Area Denial (A2/AD)” products. Andrew Krepinevich lists the

components of A2/AD as: “[diesel] submarines, antisubmarine-warfare aircraft, anti-ship cruise

missiles, defensive mining, air and missile defenses, and military base hardening and

dispersion.” 50

Figure 3 shows graphically a stylized depiction of the tradeoffs in cost and capabilities

for the weapons needed for both command of the commons and the close fight. Many weapons

fit comfortably in one sector of the chart. Armored vehicles are relatively easy to produce and

are most useful for the “close fight.” Aircraft carriers are fabulously expensive and designed for

maximum power projection. Some weapons are nominally similar but have vastly different

cost/mission profiles; a diesel submarine is best for short-range operations of modest duration,

coastal defense, and threatening of shipping. Nuclear-powered submarines can operate

indefinitely at high speed far away from home and even those without nuclear missiles carry a

large arsenal of formidable deep-strike weapons. Finally, some categories, such as aircraft and

missiles, cover a spectrum of operations and costs.

Importantly, weapons that can perform command of the commons missions can also be

used for counter-intervention operations, but not vice versa. Embraer’s Super Tucano turboprop

plane cannot penetrate hardened air defenses, but the F-35 can theoretically perform close air

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!48 Posen, "Command of the Commons." 49 Ibid., 24. 50 Andrew J. Krepinevich, "Strategy in a Time of Austerity: Why the Pentagon Should Focus on Assuring Access," Foreign Affairs (2012).

! 18!

support and counterinsurgency operations. No one would suggest this to be an efficient use of

such an expensive plane, however. A state with no need to suppress sophisticated enemy air

defenses would not purchase the F-35. Put another way, the continuing improvement of high-end

weapons desired by the United States for its demanding missions produces “overshot”

customers, states no longer willing to pay the premium for performance improvements they have

little use for.51

The US defense industry does not bother to produce many of the weapons required for

such counter-intervention operations, and indeed in many cases has not done so for decades.

Since the 1950s, the United States Navy has deliberately refused to procure diesel submarines in

favor of nuclear-powered, ocean-spanning undersea capital ships.52 Nor does the American

defense industry build ground-based anti-ship missiles, leaving this rapidly growing export

market to smaller producers such as France, Russia, Sweden, Norway, and Italy.53

Even when the United States develops weapons ostensibly for both export and domestic

consumption, the value proposition is not always compelling for purchasers. Seeking a flexible,

multipurpose plane that can do many missions satisfactorily, Brazil recently chose the lighter,

less sophisticated, but much less expensive Gripen (made by Sweden’s Saab) over prominent

competitors that included Boeing’s F/A-18 (a “cheap” plane by American standards). In terms of

performance, the Gripen is the inferior plane in nearly every way, but as one analyst pointed out,

“If you are not a country that wants to bomb areas with really strong air defences on day one of a

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!51 Christensen, Anthony, and Roth, Seeing What's Next: Using the Theories of Innovation to Predict Industry Change, 12.. See also Adner. Ron, "When Are Technolgies Disruptive? A Demand-Based View of the Emrgence of Competition," Strategic Management Journal 23 (2002).. 52 Richard G. Hewlett and Francis Duncan, Nuclear Navy: 1946-1962 (Chicago: University of Chicago Press, 1974). 53 Terrence K. Kelly et al., "Employing Land-Based Anti-Ship Missiles in the Western Pacific," (Santa Monica, CA: RAND Corporation, 2013).

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war, you have to take the Gripen very seriously.”54 Israel considered buying Littoral Combat

Ships, developed by the United States to serve as affordable, coast-hugging vessels. Small by

American standards but larger than anything the Israelis owned to date, their spiraling costs were

too much for Israel. As one Israeli admiral noted, "As much as we sought commonality with the

U.S. Navy…we had no choice but to face the fact that, for us, it was unaffordable." 55

Demand for this counter-intervention capability is particularly acute in Asia. Sovereignty

protection, rather than power projection, appears to be the primary mission of contemporary

arms purchases in the region (which have grown by 34% between 2004-2008 and 2009-2013).56

Territorial defense not only for a state’s major landmass, but also for smaller islands and more

tenuous sovereignty claims, underpins much of Asian strategic planning. 57 As an example,

Indonesia aspires to build a “Green Water Navy,” quintupling its diesel submarine inventory to

ten by 2024. In the past five years it acquired four Dutch missile frigates as well as four Landing

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!54 Sash Tusa quoted in Carola Hoyos, "Gripen Outmanoeuvres Bigger Rivals in Brazilian Dogfight," Financial Times, December 13 2013. 55Barbara Opall-Rome, "Israel Eyes Locally Built Warship Drops Lcs in Favor of German Design," Defense News, June 29 2009.. One LCS shipbuilder claimed in 2006 that “A reported 26 potential buyers exist worldwide for the ship and its companion equipment with two near-term contenders and four others that have expressed active interest.” http://www.austal.com/en/media/media-releases/06-12-11/Austal-Wins-Second-Littoral-Combat-Ship-Order.aspx Not one LCS has been exported to date. 56 Worldwide demand only grew 14% over that same period. SIPRI 57 Many of the “white papers” of states in the region contain similar language to Japan’s, which describes its security environment as “becoming increasingly tangible, acute, and serious.” Ministry of Defense of Japan, "Digest: Security Environment Surrounding Japan," in Defense of Japan 2013 (Tokyo, Japan: 2013).. See also Ministry of National Defence (Socialist Republic of Vietnam), "Vietnam: National Defence," ed. Socialist Republic of Vietnam Ministry of National Defence (Hanoi, Vietnam2009), 9-12; Ministry of National Defense (Republic of Korea), "2012 Defense White Paper," (Seoul, Republic of Korea2012), 142-43; Department of National Defense (Republic of the Philippines), "Transforming the Department of National Defense to Effectively Meet the Defense and Security Challenges of the 21st Century," ed. Department of National Defense (Quezon City, Philippines: Republic of the Philippines, 2012), 13-15..

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Platform Dock ships (licensed from South Korea), each carrying up to 400 troops and five

helicopters.58

Unipolarity therefore contains an ironic dynamic in terms of the arms market in Asia and

elsewhere. Almost by definition, the hegemon is not arms racing with any particular state; its

very preeminence means there is little market for the type of hardware its own arms industry

specializes in building. On the other hand, defense spending in East Asian states is rising for

types of weapons that the world’s superpower has little interest in producing or purchasing.

3.3 Alternate Explanations !

Several alternate, but not necessarily competing, explanations for declining US arms

market share exist. Indeed, we find that some of these mechanisms do provide additional insights

into the structure of the international arms market. We do not believe, however, that these

alternative theories undermine our argument that disruptive innovation has become a significant

feature of the contemporary arms market.

A first set of explanations link market share to broader international power. Perhaps the

recent loss of market share by the United States is a natural consequence of the rise of other

powers; arms sales historically reflect the broader balance of international power. When the

United States is powerful, other countries may seek to curry favor with it (i.e bandwagoning).59

Conversely if the United States looks relatively weak, then states may seek to diversify their

defense suppliers. On the other hand, a “soft balancing” argument could link American power

inversely with market share; states may prefer not to be so dependent on an actual or aspiring

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!58 Andrew T. H. Han, "The Emergence of Naval Power in the Straits of Malacca," Defence Studies 12, no. 1 (2012). 59 S Walt, "Alliances in a Unipolar World," World Politics 61, no. 1 (2009).

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hegemon, especially if they disagree with that hegemon’s foreign policy.60 Moreover, allies of

the United States might be tempted to free ride on a country spending so much on defense.

Second, perhaps the United States is simply uninterested in selling weapons to many

countries. Indeed, the United States restricts what products may be sold through policies such as

the Missile Technology Control Regime (MTCR) or the more informal “Qualitative Military

Edge” for Israel. Some examples exist of deliberate denial of weapons sales to potential

importers. For example, South Korea is buying long-range air-to-ground missiles from the

German-Swedish joint venture Taurus Systems because the United States will not sell it Joint

Air-to-Surface Standoff Missiles (JASSM).61 But most of these policies have been in place for

decades, while the US decline in market share is a recent development. Further, the Obama

administration has greatly increased its efforts to sell weapons abroad, for example by reducing

the number of technologies on the United States Munitions List (which are subject to strict

export controls) and by generally modernizing the export regime.62 Nonetheless, American

market power does allow it to restrict weapons sales and attach caveats; and so we expect a

correlation between the competitiveness of the international market and demand.

Third, declining exports could be the result of rent-seeking by an increasingly

concentrated American defense sector that drives up prices for both the Pentagon and for

potential export clients. The Pentagon’s senior procurement officer recently accused Lockheed

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!60 Seth G. Jones, The Rise of European Security Cooperation (Cambridge: Cambridge University Press, 2007); Robert A. Pape, "Soft Balancing against the United States," International Security 30, no. 1 (2005). 61 Agence France-Presse, "S. Korea to Buy European Missiles," Agence France-Presse, June 19 2013. 62 The White House, “Fact Sheet: US Conventional Arms Transfer Policy,” January 15, 2014. The UN Arms Control Treaty, rather than restricting US arms sales, instead tries to bring other states up to the American level of transparency.

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Martin of trying to “squeeze every nickel out of the Joint Strike Fighter program.”63 It is true that

the American defense firms have consolidated since the Cold War, resulting in a concentrated,

and potentially less competitive, industry. However, the intensive lobbying, adverse selection,

and asymmetric information that distort the American defense market are even more starkly

present in competitor nations. While the United States undoubtedly faces a diminishing number

of domestic prime contractors, other export-oriented states face actual local monopolies, as in

France’s Dassault and Russia’s United Aircraft Corporation, and thus should be even more prone

to this behavior.64

4. Platform Data Analysis

To begin testing our theory that the arms market is diverging due to disruptive

innovation, we examine export trends for three weapons platforms. Analyzing export data by

platform allows us to tease out the divergence of the market between American demands and

those of the rest of the world. As illustrated in Figure 3, armored vehicles are relatively simple

products to produce and are not the primary tool for hegemonic power projection. Combat

aircraft, on the other hand, are some of the most sophisticated and expensive products on the

market, a vital tool for command of the commons as well as the “American way of war.” Finally,

missiles vary widely in terms of sophistication and cost based on whether they are used for

power projection or for counter-intervention. Comparing the military value versus the number of

units exported can also give us a window on market divergence.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!63 Michael Hoffman, "Incoming F-35 Acquisition Chief Blasts Lockheed Martin," http://www.dodbuzz.com/2012/09/18/incoming-f-35-acquisition-chief-blasts-lockheed-martin/. 64 Marc R De Vore, "The Arms Collaboration Dilemma: Between Principal-Agent Dynamics and Collective Action Problems," Security Studies 20, no. 4 (2011).

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Figure 4a and 4b present US market shares in three weapons categories expressed in

terms of SIPRI TIV and unit numbers (reported by the UN Office of Disarmament Affairs,

UNODA), respectively. Figure 4a suggests that the US is holding on to much of the market in

aircraft (a high cost, low volume instrument of power projection), and has little share in the

armored vehicle market (a much less complex platform). The broad category of missiles, which

ranges widely from very sophisticated to extremely simpler, lies somewhere in between. But if

one looks at unit numbers instead of TIV (Figure 4b), US market share has plummeted in every

category.65

We focus further on the global missile market for several reasons. First, missiles are an

important and unexamined market relative to military aircraft, which takes up the lion’s share of

market and academic analyses. These weapons are an essential component of an A2/AD arsenal.

They also represent a major proliferation problem, as evidenced by the arms control regimes that

have been set up around them. Mettler and Reiter show empirically how ballistic missiles in

particular enable aggressive behavior by states that possess them.66

Second, as depicted in Figure 3, the term “missile” covers many different types of

weapons ranging from the ubiquitous Strela portable anti-air missile (made by a several

countries), to the Russian Buk anti-aircraft system used to down a Malaysian airliner over

Ukraine, to the sophisticated JASSM, which the United States exports to only a handful of close

allies.

Comparing these SIPRI and UN missile export data allows us to look at the relative

sophistication of American imports relative to the market. Figure 5a depicts the TIV for the

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!65 The uptick in US exports of armored vehicles may be due to the United States divesting itself of thousands of armored vehicles over the Iraq and Afghanistan drawdowns. 66 Simon A. Mettler and Dan Reiter, "Ballistic Missiles and International Conflict," Journal of Conflict Resolution 57, no. 5 (2013).

! 24!

United States and the rest of the world; Figure 5b shows these two values in terms of number of

missiles exported.67 Both figures show a gradual decline in the value and number of US missile

exports, even as the total market has risen over the past decade. But whereas the TIV of global

missile exports has risen gradually, the actual number of (non-American) missiles being exported

has skyrocketed. Clearly, states are buying less sophisticated missiles than the type that

American firms are likely to produce and the US military is likely to buy. Finally, Figure 6

depicts the financial value of guided missile exports from the US Census Bureau for years 2000-

2014.68 Although the previous graphs show the United States exporting fewer missiles, its

revenue has risen, providing further evidence that the United States remains focused on (and

successful in) selling to its most profitable customers.

Taken together, the data demonstrate that the United States is not selling the type of

weapons many states want. The weapons it does export in low numbers are very expensive.

Finally, and perhaps most importantly, the global missile market is booming and most missiles

are not bought from the United States.

5. Analysis of Market Share and Export Premium

We next test hypotheses about US market share among its export customers. To better

specify the causal path, we then move on to a novel measurement of the cost of US exports, the

export premium, and whether it rises in response to changes in the domestic defense budget. We !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!67!Bear!in!mind!that!the!UN!data!relies!on!countries!reporting!their!imports!and!exports!

and!so!almost!certainly!undercounts!the!number!of!missiles!sold!by!the!rest!of!the!world.!68 U.S.!International!Trade!Statistics,!“Guided missile and space vehicle manufacturing, as well as parts and auxiliary equipment,” Data retrieved for NAICS 336414, 15, and 19 from http://censtats.census.gov/naic3_6/naics3_6.shtml; comparable global data does not exist.

! 25!

use these data also to test other potential factors that shape export pricing: the

balancing/bandwagoning logic, rent collection by increasingly oligopolistic US defense firms,

and exploitation of its global market power by the United States itself.

5.1 Hypotheses

The innovator’s dilemma links the mismatch between American arms production of high-

priced hegemonic weapons and world demand for cheaper technologies to lower US market

share. Put schematically, our theory suggests:

GRAND STRATEGY → EXPORT VALUE → EXPORT SHARE

We operationalize, and describe below, these three variables in the following way:

US DEFENSE SPENDINGYEAR → US EXPORT PREMIUMCOUNTRY,YEAR →

US MARKET SHARECOUNTRY,YEAR

Out first hypotheses link the three steps of this causal chain:

Hypothesis 1: A higher US budget leads to lower US export market share

Hypothesis 2: A higher US export premium leads to lower US export market share

Hypothesis 3: A higher US budget leads to higher US export premium

Combined, the above three hypotheses suggest that the effect of higher US defense spending on

its export market share is mediated through higher-priced exports. We expect that, when market

share is regressed on both US defense spending and export premium, the effect of the former

should weaken, due to the inclusion of the mediating variable.69

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!69Our approach to mediation, based on linear models using continuous treatment and mediating variables is described in Reuben M Baron and David A. Kenny, "The Moderator–Mediator Variable Distinction in Social Psychological Research: Conceptual, Strategic, and Statistical Considerations.," Journal of Personality and Social Psychology 51, no. 6 (1986).. For an overview of mediation, see Kosuke Imai,

! 26!

Importantly, taken together these hypotheses contrast with the simpler balancing and

bandwagoning logics. If states are free-riding on or soft-balancing against American ambition,

increased US demand for power projection (proxied by defense spending) would correlate to a

drop in market share. But it should also correlate to a drop in price, as demand for US weapons

declines. Conversely, if states are reducing their US arms imports as a reaction to American

decline, lower US spending should correlate to lower demand (and lower prices), but market

share should also fall. Table!1 illustrates these contrasting predictions.

We also use the export premium to test two hypotheses based on alternate explanations

for higher prices. We first test if lack of competition (and thus increased rent-seeking by firms)

leads to a less competitive product:

Hypothesis 4: A more concentrated US defense industry leads to higher export prices

Finally, we test to see if the United States takes advantage of its existing market dominance to

charge higher prices, or whether it seeks to maintain this position by subsidizing export sales:

Hypothesis 5: A more concentrated international arms market leads to higher export prices

5.2 Dependent and Explanatory Variables !

We proxy the demand for high-end weapons by the Pentagon, as well as its military

ambition, by using domestic defense spending (in billions of constant 2009 USD, from 1962-

2013) by the United States government on “National Defense.” This covers not only the

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !

Luke Keele, and Dustin Tingley, "A General Approach to Causal Mediation Analysis," Psychological Methods 15, no. 4 (2010).. Our “treatment” (defense spending) is clearly not random; we do make any definitive causal statement.

! 27!

Department of Defense’s budget, but also related spending by other departments (such as

Energy) and on “overseas contingency operations.”70 Obviously, this is an annual figure.

Our dependent variables vary by both country and year. The first, US market share, is the

portion of a country’s annual arms deliveries (TIV, from SIPRI) from the United States over total

arms imports. Figure 7 shows the distribution for each country (roughly 40% of the world’s

states do not import any American weapons). The mean US market share over all importing

countries has dropped over time. On average, however, countries get about half their imported

weapons from the United States, a quite high number.

Our second dependent variable, US export premium, is a ratio of two data sources

associated with the physical transfer of weapons from the United States to other countries. The

denominator is SIPRI’s TIV, described in detail above. The numerator is the annual financial

value in constant 1990 US dollars of all reported weapons transfers to another state, contained in

the US Defense and Security Cooperation Agency’s (DSCA, available from 1970-2013). The

ratio, which has attractive econometric qualities besides being an accurate measurement of the

dependent variable takes the following form:71

!"#$%&!!"#$%&$! = ! !"#$#%"$&!!"#$%!!"!!"#!!"#$%&'!"#"$%&'!!"#$%&'"#!!"#$%&'""'( !=!"#$!!"#$%!"#$"!!"# !

Figure 8 depicts each country-year observation over time, using a logarithmically scaled

y-axis, as well as the annual mean. The graph makes clear the extremely wide range taken by the

premium across countries in any given year, especially considering the logarithmic scale. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!70 Office of Management and Budget, “Historical Tables: Outlays by Budget Enforcement Act Category,” https://www.whitehouse.gov/omb/budget/Historicals 71 Ron P. Smith and Ali Tasiran, "The Demand for Arms Imports," Journal of Peace Research 42, no. 2 (2005).

! 28!

Excepting a period of decline correlating with the dominant US market share of the 1990s, the

premium clearly and consistently rises over time. The premium spikes sharply as US market

share declines to an historic low in what appears to be an increasingly competitive market.

5.3 Other Independent Variables

To determine if American firms employ increased market power to collect rent through

arms exports, we operationalize US firm power by including the Herfindahl-Hirschman Index

(HHIfirms) of the top 100 recipients of Defense Department prime contract awards.72 This lack of

competition can also result in inflated US defense budgets, resulting in a spurious correlation

between our explanatory and dependent variables if we do not include it.

Our final independent variable captures global market competitiveness by constructing a

Herfindahl-Hirschman Index (HHIstates) of exporter states (not firms) from SIPRI’s TIV data.

Obviously, the HHIstates incorporates American market share (i.e. one of our explanatory

variables), but it also captures the role of other exporters. The HHI increases both as the number

of states exporting weapons decreases and as the disparity in market share between those states

increases.73 A lack of competitiveness in the global export market could conceivably raise both

US spending as well as export prices, again leading to a spurious correlation.

5.4 Methods of Analysis

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!72 Data generously shared by the authors of Ryan R Brady and Victoria A Greenfield, "Competing Explanations of U.S. Defense Industry Consolidation in the 1990s and the Policy Implications," Contemporary Economic Policy 28, no. 2 (2010).. The HHI approaches zero when a market consists of a large number of firms of relatively equal size. The US Department of Justice used the HHI for anti-trust regulation, and considers markets in which the HHI is between 1000 and 1800 points to be “moderately concentrated,” and those in which the HHI is in excess of 1800 points to be “concentrated.” http://www.justice.gov/atr/public/testimony/hhi.htm 73 Over the 61 years that SIPRI provides data, the mean global market competitiveness is 2672. It peaked at 3603 in 1992, and hit its historic low (i.e. most competitive market) of 1554 in 2009.

! 29!

While the unit of analysis of our dependent variable is the country-year, our explanatory

variables only vary by year. We are consequently left with relatively few observations for

statistical analysis. Before turning to the pooled data, we therefore first analyzed each state in

separate regressions across time (see appendix). While there was variation in coefficient size

across states, in general an increase in US defense spending in roughly two out of every three

countries is associated with a drop in market share and a rise in export premiums.

Because we are testing relationships of US-specific factors on our dependent variables,

and because the country-specific regressions show an unsurprising amount of heterogeneity in

their coefficients, we take the very conservative approach of analyzing the data using OLS with

country-specific fixed effects.

Arms deals are years in the making and deliveries of a product take place over a long

time period. Export numbers thus move slowly. While the small number of annual observations

makes this a demanding approach for finding significant correlations, we include lagged

dependent variables in all regressions. In short, we take a very conservative approach to the

data’s analysis at the risk of Type II errors. Finally, while our fixed effects absorb (for better of

worse) any country-specific influences on the dependent variable, the possibility exists that time-

related antecedent factors may produce a spurious correlation between defense spending, export

premiums, and market share. Year fixed effects are not feasible due to the annual nature of our

explanatory variable. We therefore include the two broadest indices of system-wide factors that

vary over time: global change in GDP (IMF) and global military spending (SIPRI).

6. Results

! 30!

Table!2 presents the OLS results. Model 1 simply regresses US market share on US

defense spending and finds a significant, negative relationship. Even with country fixed effects

and a lagged dependent variable, a 100 billion USD increase in spending (roughly one standard

deviation) appears to reduce market share by 1.4%. The effect of defense spending, while still

negative, essentially disappears in Model 2 which incorporates our theorized mediating variable

of export premium. A one standard deviation increase in export premium reduces US market

share by 10.5%, a large effect.

The remaining models take the US export premium as the dependent variable. Model 3

shows a strong and significant relationship between how much money the United States spends

on defense and the price of its arms exports. By providing evidence in support of this

relationship, Model 3 also serves as the third leg to suggest that defense spending’s influence on

market share is mediated by the export premium.74

Models 4 and 5 regress export premium on the competitiveness of the international arms

market and the US domestic market, respectively. Perhaps counterintuitively, a more

concentrated international market correlates to a drop in the export premium. This supports the

claim that United States has, at times, aggressively subsidized its arms exports. While a

concentrated domestic arms market correlates to higher premiums, the effect does not achieve

statistical significance. Rent collection by US defense firms does not appear to be a strong

predictor of whether other states will buy American.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!74 Using the Stata code of Raymond Hicks and Dustin Tingley, "Causal Mediation Analysis," The Stata Journal 11, no. 4 (2011)., we estimate the “Average Causal Mediation Effect” (ACME) of defense spending acting through export premiums. We simulated the effect of a “treatment” of increasing defense spending from the mean by one standard deviation (about $100 billion). The results suggest that over 70% of defense spending’s effect on market share is explained by movement in the premium correlating to spending increases.

! 31!

The final two models re-examine the effect of defense spending on export prices while

controlling for potentially confounding variables. Spending alone among all these potential

correlates remains a good predictor of how reliant a country will be on American weapons.

Given the results, we can safely claim that the relationship between export premiums and

defense spending is by far the strongest in our analysis. On balance, it appears that any

economies of scale provided by increased US defense spending do not translate into lower export

prices. Instead, the shifting of the demand curve appears to make buying American more costly,

which provides evidence in favor of our innovator’s dilemma argument.

It appears from our statistical analysis that the less competitive the international market

the lower the prices charged. This suggests that the US has indeed subsidized its exports to

maintain market share at various points of time. The weakest relationship, perhaps surprisingly,

is that between firm concentration (as a proxy for domestic firms’ power to collect rent) and

price. If a less competitive domestic arms industry in the United States leads to higher prices

abroad, it is a very weak effect.

7. Conclusions and Implications

!

Brooks and Wohlforth make a simple but powerful argument that the post-Cold War

distribution of power is so skewed that balancing against the United States is no longer

feasible.75 We identify another transformation to international politics wrought by the divergence

between the United States and other states: the disappearance of Waltz’s socialization effect in

which competitive pressures encourage states to imitate the practices of the most “successful”

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!75 Stephen G. Brooks and William Curti Wohlforth, World out of Balance: International Relations and the Challenge of American Primacy (Princeton: Princeton University Press, 2008), 3.

! 32!

country.76 The result is a bifurcation in grand strategy and thus the “disruptive” splitting of the

international arms market. Unlike Brooks and Wohlforth, the mechanism we propose may

actually undermine the United States’ international position, removing an important foreign

policy tool in the short- and making balancing easier in the long-term.

The massive American military acquisition budget should provide economies of scale

that enable the United States to shape the international arms trade, and consequently the

international security environment, to suit its interests. This paper’s theory and empirical analysis

suggest that countervailing forces have undermined this effect. The quest for primacy, which

correlates to both the size of the defense budget and the type of weapons acquired with it,

undermines the effectiveness of a classic tool of great power management: the sale of arms to

client states. Ironically, as the US government aims to both “pivot” to Asia and “train and equip”

its allies, its defense industrial efforts are fixated on building weapons that much of Asia, from

potential foes (China) to potential friends (Philippines), is trying to overcome.

We employed the concept of disruptive innovation to explain the loss of global market

share for US weapons exports. The Pentagon, the US defense industry’s main customer, has very

different and demanding needs for its weapons compared to the rest of the world. As such, other

exporting states can fill this breach with better value products appropriate to the strategic needs

of non-hegemonic states and regional powers. By estimating the annual premium paid by states

for American weapons deliveries, we demonstrated a strong correlation between large US

budgets to both lower market share and higher export prices. This supports our argument that US

domestic demand is skewing the export value of the weapons produced by its suppliers, and

undermines an alternative explanation that states are either simply balancing against or

bandwagoning. !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!76 Kenneth Waltz, Theory of International Politics (New York: McGraw-Hill, 1979), 127-28.

! 33!

While correlations of our novel measurement of weapons prices and US spending provide

suggestive evidence for our theory that is robust across a large number of countries and years, we

view this empirical analysis as a first step. Finding other ways for statistically linking product

type, market share, and proliferation must be developed to establish the theory’s empirical

robustness as well as explore its causal pathways. In-depth analysis of the decisions by states and

firms to develop, export, or import new weapons will help flesh out the causal pathway. The

conditions under which new products and firms can enter into the defense marketplace both in

the United States and other countries require study. Christensen cites short-term profit concerns

as the causal mechanism behind the innovator’s dilemma, suggesting the fruitfulness of

comparatively analyzing privately-held, publically traded, and state-owned defense firms.77

Finally, the ways that states use arms exports as tools of foreign policy influence need to

be updated in the context of this newly competitive environment. More broadly, we hope this

paper’s argument and findings encourage more research on the international arms trade, a

growing and dynamic aspect of international politics. To emphasize the stakes, we conclude by

exploring three political implications of our argument.

First, we explore possible responses by the United States to a potential decline in its

international influence. Second, we argue that a more competitive arms market will result in

increased proliferation and less regulation of international weapon sales and use. Finally, the

inability of the United States to meet the demand of small states in Asia may contribute to crisis

instability in that region.

What can the United States do given the incentives we identify? The Pentagon could

build simpler weapons or the strategic benefits of arms exports in its acquisition policies, but,

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!77 Clayton M. Christensen, "The Ongoing Process of Building a Theory of Disruption," Journal of Product Innovation Management 23 (2006).

! 34!

previous experience suggest neither reform is likely. The Obama administration has

enthusiastically promoted defense exports, but if US firms are not making products other people

want, this will have limited effect.

Still, the United States remains the unrivalled maker of certain systems and services that

even less powerful states want. The United States will continue to aggressively sell advanced

products to wealthy allies such as Japan, Australia, and South Korea. For example, Japan and

South Korea’s participation in the Aegis-based missile defense system incorporates two states

unlikely to bilaterally cooperate into something resembling a collective security network. The

United States still enjoys unmatched expertise in intelligence collection and information

management. Even the anti-access weapons discussed above require significant amounts of

upgrading in both the human capital and the information-intensive C4SIR capability of small

states’ militaries.78 As with the larger US economy, providing software and services may not

bring with it the economic advantages of “bending metal,” but can still enhance American

interests.

Even if the United States will not produce many weapons smaller states need, it can

encourage sales within a larger arms network that it continues to dominate. Sweden’s Gripen

contains so much American technology that, from a regulatory standpoint, it might as well be

exported from the United States.79 South Korea’s quite successful T-50 Golden Eagle multirole

trainer is largely a Lockheed Martin derivative. These countries would be hard pressed to export

these products (or service the ones already in operation) without American approval. Choking off

as large a percentage of the Russian export market as possible, starting with India, in favor of the

products of more closely aligned countries, appears to be in the US interest. Better for Vietnam

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!78 “Command, control, communication, computers, intelligence, surveillance, reconnaissance.” 79 Hans G. Andersson, Saab Aircrft since 1937 (London: Putnam, 1997), 181.

! 35!

to buy German or South Korean submarines, rather than Russian. This will have the added

benefit of diminishing the quality of the products Russia will export to states, like Syria, that

cannot buy arms from anywhere else.

The United States has used such indirect influence successfully in the past. In one sense,

India’s 2004 ordering of the Phalcon Airborne Warning and Control Systems from Israel,

represents a $1.1 billion dollar loss to the US defense industry, which is largely responsible for

the technology transfer that helped build the thriving Israeli arms export sector. But the deal still

required American approval, which it had withheld in 2000 for a similar sale to China.80 An

American-dominated arms network can still be designed to keep China down, Russia out, and

friendlier states in.

Disruptive innovation will lead to increased proliferation of advanced conventional

weapons. Monopolistic industries tend to sell to fewer customers. In general the United States is

relatively circumspect in its arms exports in areas where it has a dominant advantage. Higher US

market share likely results in fewer weapons going to states that are politically unstable or

human rights violators. Historically, the United States has foregone exporting its highest-

capability weapons to a region until a viable competing product from another country emerges.

The United States for example refused to deliver AMRAAM missiles to Asian states until China

purchased the Russian AA-12 Adder.81 A more competitive market will place pressure on

existing American regulations. The recent removal of many technologies from the United States

Munitions List was driven in part because American industry has convinced the government that

it is losing competitive advantage abroad. Consequently, many weapons transfers may no long !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!80 Efraim Inbar and Alvite Singh Ningthouham, "Indo-Israeli Defense Cooperation in the Twenty-First Century," Middle East Review of International Affairs (MERIA) Journal 15, no. 4 (2011). 81 "Three Asian Countries to Get U.S. Missiles," Arms Control Today 33, no. 7 (2003).. For a recent restatement of this policy see Gregory M. Kausner, "Conventional Arms Transfer Policy: Advancing American National Security through Security Cooperation," ed. State Department (2014)..

! 36!

be subject to rigorous human rights vetting and end-use monitoring by the US State

Department.82 In short, American market dominance of high-end weapons makes it more likely

that it will “exercise unilateral restraint” in their sale.83 Lower levels of proliferation, technology

diffusion, and corruption result from US power not because it is a “nicer” country but because it

can afford to use its competitive advantage to restrict these nuisances.

Finally, the declining competitiveness of US arms may undermine regional stability given

the large number of Asian maritime disputes. One of the benefits provided by arms exports is the

ability to manage clients’ excess aggressiveness, what Stephen Van Evera calls the “drunk tank”

approach to alliance politics.84 While the regional spread of anti-access weapons may appear to

favor the defense, consequences exist if small states gain the tools to act unilaterally. In 2010,

then-Secretary of State Hillary Clinton claimed an American “national interest in freedom of

navigation, open access to Asia’s maritime commons, and respect for international law in the

South China Sea.” The interests of Indonesia, Malaysia, Vietnam, and the Philippines are much

more parochial. The acquisition of anti-access weapons such as Kilo diesel submarines and

Yakhont anti-ship missiles will not only enable these countries to defend themselves against

Chinese revisionism, it will also allow them to threaten Chinese (and other states’) freedom of

navigation through vital sea lines of communication such as the Straits of Malacca. This could

lead to more arms racing, regional crisis instability, and “extreme self-help” even without

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!82 Government Accoutability Organization (GAO), "Export Controls: U.S. Agencies Need to Assess Control List Reform’s Impact on Compliance Activities," ed. Government Accountability Office (Washington, D.C.2012). 83 Barack Obama, "Presidential Policy Directive: United States Conventional Arms Transfer Policy," in PPD-27, ed. White House (Washington, D.C.2014). 84 Stephen Van Evera, "Primed for Peace: Europe after the Cold War," International Security 15, no. 3 (1990-1991)., see also Jeremy Pressman, Warring Friends: Alliance Restraint in International Politics, Cornell Studies in Security Affairs (Ithaca: Cornell University Press, 2008).

! 37!

American regional disengagement.85 Nor can the possibility of conflict between these small

countries be dismissed.

As it pivots towards Asia, the United States appears to be contemplating intensification

and hardening of its power-projecting military, even as that region acquires weapons designed to

deter such a force.86 An ironic consequence of the US focus on “anti-anti-access” weapons will

be an increasingly competitive market in counter-intervention capabilities, largely beyond

American control. Anti-access will grow cheaper, while power-projecting strategies such as

AirSea Battle will grow more expensive.87 Empirically, this paper does not yet find that

declining US arms market share is a result of other states’ balancing. However, our analysis

suggests that United States’ acquisitions policy is leading to a market that makes balancing

against it increasingly cheap.

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!85 Nuno P. Monteiro, "Unrest Assured: Why Unipolarity Is Not Peaceful," International Security 36, no. 3 (2011). 86 Abraham Denmark and Hames Mulvenon, "Contested Commons: The Future of American Power in a Multipolar World," (Washington, D.C.: Center for a New American Security, 2010)., see also Evan Braden Montgomery, "Contested Primacy in the Western Pacific," International Security 38, no. 4 (2014). 87 Air-Sea Battle Office, "Air-Sea Battle: Service Collaboration to Address Anti-Access & Area Denial Challenges," ed. Department of Defense (Arlington, VA2013)., Montgomery 2010

! 38!

!

Figure 1: United States and Global Arms Transfer Levels (4 year moving average, 1950-2013)

! !

010

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!

0.2

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Figure 2: Comparing Arms Exports and Defense Spending as Percentages of Global Totals, 1988-2013

! 40!

Figure 3: Notional Representations of Weapon Category Costs and Missions

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!

Figure 4a and 4b: US Share of Export Markets by Military Value (SIPRI) and Unit Numbers (UN), 1992-2013

! !

010

000

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Figure 5a and 5b: Total and US Missile Exports by Military Value (SIPRI) and Unit Numbers (UN), 1992-2013

! 42!

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CHLTAWPAK

LEBYUGBRA

JOR

TUR

KEN

ROM

MOR

KUW

SPN

TRI

EGY

ITA

KZK

COS

CANOMAPOR

ARG

FRNSAL

COL

AFG

BEL

QAT

THI

PAN

SIN

AUL

SAU

SAF

PERINDUKG

SWZ

GHA

PAR

ROK

ISR

GRC

IRQ

POL

SWD

MEX

HONINS

TAW

CHA

THI

SIN

BNG

ROM

MOR

ROK

AFG

KUW

BRA

INDTUN

EGYITAAUL

UAE

NTH

TUR

INS

YEMCOL

CAO

SAU

BAH

IRQCAN

BOL

CHLLEB

SWZ

GRCFRN

ARG

BRU

UKG

PAR

ISR

JPNPAK

NOR

JOR

OMA

MEX

FINSWDHUN

PHI

.1

1

10

100

1000

10000

100000

1000000

Ratio

of F

inan

cial t

o Pr

oduc

tion

Valu

esof

US

arm

s ex

ports

(log

ged)

1970 1980 1990 2000 2010Year

Figure 8: US Export Premium, 1970-2013 (Source: SIPRI and DSCA)

! 44!

Table 1: Competing Theories Predicted Effect of Increased US Defense Spending

!

Balancing Bandwagoning Disruptive Innovation

Dependent Variable

US Arms Market Share ⬇ ⬆ ⬇

US Arms Export Premium ⬇ ⬆ ⬆

!45!

Tab

le 2

: Reg

ress

ion

Res

ults

for

US

Arm

s E

xpor

t Mar

ket S

hare

and

Exp

ort P

rem

ium

s !

(1)!

(2)!

(3)!

(4)!

(5)!

(6)!

(7)!

!US!Market!

Share ti!

US!Market!

Share ti!

Export!

Prem

iumti!

Export!

Prem

iumti!

Export!

Prem

iumti!

Export!

Prem

iumti!

Export!

Prem

iumti!

US!Defense!!

@0.000141***!

@0.00000851!

0.00216***!

!!

0.00285***!

0.00514+!

Spending

t!(logged)!

(0.0000392)!

(0.0000646)!

(0.000408)!

!!

(0.000727)!

(0.00271)!

!!

!!

!!

!!

Export!!

!@0.0523***!

!!

!!

!Prem

iumti!

(logged)!

!(0.00388)!

!!

!!

!

!!

!!

!!

!!

Global!M

arket!

!!

!@0.000613***!

!@0.000341**!

@0.000312!

Concentration t!

!!

!(0.0000830)!

!(0.000113)!

(0.000192)!

!!

!!

!!

!!

US!Firm!

!!

!!

0.000571!

@0.000665!

@0.000449!

Concentration t!

!!

!!

(0.000935)!

(0.000959)!

(0.00209)!

!!

!!

!!

!!

Global!GDP!

!!

!!

!!

@0.0326!

Growth

t!!

!!

!!

!(0.0805)!

!!

!!

!!

!!

Global!Defense!

!!

!!

!!

@0.000341!

Spending

t!!

!!

!!

!(0.000751)!

!!

!!

!!

!!

DVt@1!

0.486***!

0.355***!

0.323***!

0.285***!

0.319***!

0.270***!

0.300***!

!(0.0129)!

(0.0207)!

(0.0265)!

(0.0278)!

(0.0299)!

(0.0301)!

(0.0427)!

!!

!!

!!

!!

Intercept!

0.222***!

0.719***!

4.108***!

6.941***!

5.034***!

5.236***!

4.426**!

!(0.0193)!

(0.0399)!

(0.245)!

(0.331)!

(0.274)!

(0.620)!

(1.629)!

N!

4709!

1731!

1392!

1286!

1140!

1140!

601!

Year&Range&

!!

!!

!!

!R2!

0.246!

0.240!

0.145!

0.153!

0.098!

0.141!

0.175!

OLS!with!lagged!dependent!variable!and!country!fixed!effects.!Standard!errors!in!parentheses.!+!p<0.10,!*!p<0.05,!**!p<0.01,!***!p<0.001!

! 46!

Supplemental Material

8. Notes on the Data

8.1 SIPRI (Export volume and market share)

Because of licensed production and the provision of US subcomponents, the American

share of the arms market is likely to be quite underestimated by existing data. Measurement of

services might be another source of downward bias, as this is a strength of the larger American

economy. Of course, the relatively high life-cycle costs of American weapons (i.e. servicing

them is expensive) is one of the most important reasons why US weapons have grown less

competitive. In short, SIPRI may indeed be underestimating the size of US exports, but the

trends are unmistakable.

To generate the Trend Indicator Value (TIV) SIPRI measures the production costs of

similar products. For example, the same variant of an F-16 being sent to Pakistan and to Poland

by the United States would be assigned the same TIV, regardless of the price these two

governments paid for it. The TIV data has several limitations. SIPRI uses a fixed comparison of

used weapons with new weapons (the former are given a 60% discount), and it considers the

transfer of a weapon into a country and the licensed production of that same weapon within that

country as equivalent “imports.” Since SIPRI relies on open source information, there are no

doubt biases involved in the information gathered, as many transfers will remain secret. For

example, the countries that produce official data on their arms exports account for over 90% of

! 47!

the total volume of deliveries of major conventional weapons, so while there is some bias in the

data, it is only likely to matter at the margins.

8.2 DSCA (Financial Value of US Arms Exports)

The Defense Security Cooperation Agency (DSCA) report lists the total financial value

of all weapons transactions for every country and every year. It reports both Foreign Military

Sales (transactions directly involving the US government) and Commercial Military Sales

(transactions in which the importing state negotiates directly with the arms-producing

company).88

DSCA captures many, but not all, aspects of American subsidization by reporting the

values of various programs that defray the client state’s costs of purchasing weapons. These

include grants given directly to purchasers of American arms through the Foreign Military

Financing program, and other, smaller subordinate programs such as the Excess Defense Articles

Program and the now-defunct Military Assistance Program. However, it does not assess the costs

of offset agreements that are normally negotiated by the client state directly with the American

corporation producing the weapon for export. 89 Nor is it likely to accurately assess the follow-on

service agreements that normally accompany these sales. Some sales are classified, but a recent

GAO report states that this amount is small relative to overall export totals.90

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!88 There is legitimate reason to believe that the Commercial Military Sales (CMS) reported to DSCA are of poor quality, to the point that the Congressional Research Service will not report them. That said, not including them could potentially introduce systematic bias into our analysis, whereas we make the assumption that errors in the CMS is unlikely to be skewed in any particular direction. For discussion see Richard F. Grimmett and Paul K. Kerr, "Conventional Arms Transfers to Developing Nations, 2004-2011," (Washington, DC: Congressional Research Service, 2012). 89 A FOIA request for these data was denied by DSCA. In general, the evidence appears overwhelming that the costs of offsets are passed on to the purchaser, Brauer and Dunne 2011, 251-254. As such, offsets are best described as a means of an importing state of shifting resources within its own borders, and is less relevant to our purposes. 90 United States Government Accountability Office 2010.

! 48!

Turning to the TIV data, SIPRI cautions against directly comparing these values with

“the sales values or the financial value of export licenses” in order to “measure the economic

burden of arms imports or the economic benefits of exports.” We do not abuse the data in this

manner; rather we seek to study the ratio of one cross-sectionally and longitudinally comparable

measurement over another one. These caveats aside, the data are the best available means to

analyze a large cross-section of countries across several decades.

8.3 UNODA (Arms Exports in Unit Numbers)

The United Nations defines a missile as “(a) Guided or unguided rockets, ballistic or cruise

missiles capable of delivering a warhead or weapon of destruction to a range of at least 25

kilometres, and means designed or modified specifically for launching such missiles or rockets”

(that are not artillery or other vehicle). It does not include armed unmanned aircraft, but does

include “remotely piloted vehicles” but not ground-to-air missiles.” Man-Portable Air-Defense

Systems (MANPADS) are also included as a subcategory.91

9. Regressions by country

Figure 8 presents graphically the coefficient for the export premium paid by each country

market regressed on US defense spending, with 90% confidence intervals. The procedure is a

useful way to diagnose data with where we are trying to describe the relationship between the

same annual explanatory variable in multiple cases across time.92 About two thirds of the

coefficients are positive, that is higher US spending is associate with higher premiums. Note that

the maximum number of observations for a country is 43 (few countries import US weapons

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!91 http://www.un-register.org/Background/Index.aspx

! 49!

every year from 1970-2013), and thus the fact that we have so many coefficients significant at

p<0.01 is remarkable.

In!similar!fashion,!Figure!9!presents!the!coefficients!when!market!share!is!regressed!on!the!

US!defense!spending.!An!even!higher!proportion!of!countries!have!a!negative!coefficient,!as!

predicted!by!our!theory.!

!

!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !92!Jennifer!Hill!and!Andrew!Gelman,!2007,!159!describe!this!“secret!weapon.”!Data$Analysis$Using$Regression$and$Multilevel/Hierarchical$Models,!Analytical!Methods!for!Social!Research!(Cambridge!;!New!York:!Cambridge!University!Press,!2007),!159..!Stata!code!is!included!in!the!onWline!replication!files.!

! 50!

!

!

!

!

!

AfghanistanBruneiLibyaAlgeriaHaitiQatarIranBangladeshCameroonKazakhstanTanzaniaYugoslaviaRomaniaPortugalBahamasLuxembourgLithuaniaPakistanUruguayTrinidad and TobagoChileBoliviaIsraelAustraliaCanadaPeruLebanonNorwayEl SalvadorSaudi ArabiaSouth AfricaBrazilBotswanaUnited KingdomSouth KoreaEcuadorIndiaJordanNigeriaColombiaSingaporeArgentinaThailandIndonesiaSwedenUnited Arab EmiratesTunisiaNetherlandsPhilippinesMexicoPanamaEgyptMoroccoJamaicaKuwaitJapanBelgiumGhanaItalyOmanSpainFranceDenmarkNew ZealandIrelandHungaryMalaysiaHondurasAustriaTaiwanTurkeyVenezuelaGreeceFinlandBahrainIraqSri LankaSwitzerlandPolandGuatemalaKenyaMyanmarGeorgiaCosta RicaDominican RepublicSudanChinaPapua New Guinea

-.075 -.05 -.025 0 .025 .05

Significant at p<0.1

Figure 9: Coefficients for Regressing Arms Export Premium on US Defense Spending, by Country

! 51!

!

Figure 10 : Coefficients for Regressing US Arms Market Share on US Defense Spending, by Country !

! !

BelizeBosnia and Herzegovina

FijiHaiti

NicaraguaLiberia

LuxembourgDominican Republic

IranCambodiaMyanmar

BoliviaJordan

UruguayEthiopiaThailand

NetherlandsDenmarkBarbados

SwitzerlandGabon

PanamaSaudi Arabia

VenezuelaLaos

AustriaTurkeyGreece

IndonesiaTaiwan

New ZealandParaguay

NorwayColombia

BruneiBelgium

SpainCroatia

SloveniaMalaysiaLesotho

GermanyItaly

SudanBrazil

South KoreaJamaica

ChileEstonia

NamibiaUgandaEcuador

MaliMorocco

KenyaPhilippines

NigerLibya

FinlandFrance

GuyanaMadagascar

RwandaDemocratic Republic of the Congo

AlbaniaMauritania

NigeriaIsraelPeru

United KingdomJapan

SingaporeSierra Leone

GuineaSouth Africa

Sri LankaBangladesh

SenegalMexico

Czech RepublicGhanaIrelandBeninTogo

SurinameAlgeria

PortugalBulgariaCyprus

North KoreaAngola

AzerbaijanCongo

Burkina FasoTanzania

Equatorial GuineaChina

GeorgiaIndia

KazakhstanLebanonPakistan

ZimbabwePapua New Guinea

GuatemalaSweden

KuwaitCosta Rica

LithuaniaYemen

ChadSeychelles

MalawiNepal

DjiboutiIvory Coast

CanadaHonduras

BahrainCentral African Republic

BotswanaCameroon

AustraliaRomania

ArgentinaYugoslavia

OmanEgypt

PolandEl Salvador

Trinidad and TobagoLatvia

TunisiaMacedonia

QatarHungaryMauritiusSomalia

BahamasUnited Arab Emirates

AfghanistanIraq

Malta

-.015 -.01 -.005 0 .005

Significant at p<0.1

! 52!

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