National Security and Public Goods

We can make better sense of the national security argument if we classify it in the context of the theory of the second best. In this case, we must note that the national security argument is actually incorporating a market imperfection into the story to justify the use of a protective tariff. The market imperfection here is a public good. National security is a public good and public goods are excluded from the standard assumptions of perfect competition. Thus, whenever a product has public good characteristics, we can say that a market imperfection is present. Traditionally, the literature in economics refers to concerns such as national security as noneconomic objectives. The effects that food production may have on the nation’s sense of security, for example, were thought to fall outside the realm of traditional economic markets.

In general, public goods have the following two consumption characteristics: they are nonexcludable and they are nonrival. Nonexcludability means that once the product is produced, it is impossible to prevent people from consuming it. Nonrivalry means that many people can consume the produced product without diminishing its usefulness to others. Here are a few examples to explain the point. First, consider a nonpublic good: soda. A soda is excludable since the producer can put it into a can and require you to pay for it to enjoy its contents. A can of soda is also a rival good. That’s because if you consume the can of soda, there is no way for anyone else to consume the same can. This implies that a can of soda is not a public good. On the other hand, consider oxygen in the atmosphere. (This is an odd example because oxygen in the air is not formally produced, but let’s ignore that for a moment.) Atmospheric oxygen is nonexcludable because once it is there, everyone has free access to its use. It is impossible (or at least very difficult) to prevent some people from enjoying the benefits of the air. Atmospheric oxygen is also nonrival because when one person takes a breath, it does not diminish the usefulness of the atmosphere for others. Thus, if atmospheric oxygen did need to be formally produced, it would be a classic example of a pure public good.

The typical examples of public goods include national security, clean air, lighthouse services, and commercial-free television and radio broadcasts. National security is the public good we are most concerned with in international trade. It is a public good because, once provided, (1) it is difficult to exclude people within the country from the safety and security generated and (2) multiple individuals can enjoy the added safety and security without limiting that received by others.

We know from the theory of the second best that when market imperfections are present, government policies can be used to improve the national welfare. In most cases, trade policies can be used as well. It is well known in economic theory that when a good has public good characteristics, and if private firms are free to supply this good in a free market, then the public good will not be adequately supplied. The main problem occurs because of free ridership. If a person believes that others may pay for a good and if its subsequent provision benefits all people—due to the two public good features—then that person may avoid paying for the good in a private marketplace. If many people don’t pay, then the public good will be insufficiently provided relative to the true demands in the country. It is well known that government intervention can solve this problem. By collecting taxes from the public, and thus forcing everyone to pay some share of the cost, the public good can be provided at an adequate level. Thus national welfare can be increased with government provision of public goods.

A similar logic explains why a trade policy can be used to raise a country’s welfare in the presence of a public good. It is worth pointing out, though, that the goods highlighted above, such as agricultural products and steel production, are not themselves public goods. The public good one wishes to provide in greater abundance is “national security.” And it is through the production of certain types of goods locally that more security can be provided. For example, suppose it is decided that adequate national security is possible only if the nation can provide at least 90 percent of its annual food supplies during wartime. Suppose also that under free trade and laissez-faire domestic policies, the country produces only 50 percent of its annual food supply and imports the remaining 50 percent. Finally, suppose the government believes that it would be very difficult to raise domestic production rapidly in the event that imported products were ever cut off, as might occur during a war. In this case, a government may decide that its imports are too high and thus pose a threat to the country’s national security.

A natural response in this instance is to put high tariffs in place to prevent imports from crowding out domestic production. Surely, a tariff exists that will reduce imports to 10 percent and subsequently cause domestic production to rise to 90 percent. We know from tariff analysis that in the case of a small country, a tariff will cause a net welfare loss for the nation in a perfectly competitive market. These same gains and losses and net welfare effects can be expected to prevail here. However, because of the presence of the public good characteristics of national security, there is more to the story. Although the tariff alone causes a net welfare loss for the economy, the effect is offset with a positive benefit to the nation in the form of greater security. If the added security adds more to national welfare than the economic losses caused by the tariff, then overall national welfare will rise. Thus protectionism can be beneficial for the country.

The national security argument for protection is perfectly valid and sound. It is perfectly logical under these conditions that protectionism can improve the nation’s welfare. However, because of the theory of the second best, many economists remain opposed to the use of protectionism, even in these circumstances. The reason is that protectionism turns out to be a second-best policy option.

Recall that the first-best policy response to a market imperfection is a policy that is targeted as directly as possible at the imperfection itself. Thus, if the imperfection arises because of some production characteristic, a production subsidy or tax should be used. If the problem is in the labor market, a tax or subsidy in that market would be best, and if the market imperfection is associated with international trade, then a trade policy should be used.

In this case, one might argue that the problem is trade related, since one can say that national security is diminished because there are too many imports of, say, agricultural goods. Thus an import tariff should be used. However, this logic is wrong. The actual problem is maintaining an adequate food supply in a time of war. The problem is really a production problem because if imports were to be cut off in an emergency, the level of production would be too low. The most cost-effective way, in this situation, to maintain production at adequate levels will be a production subsidy. The production subsidy will raise domestic production of the good and can be set high enough to assure that an adequate quantity is produced each year. The subsidy will cost the government money and it will generate a net production efficiency loss. Nevertheless, the efficiency loss from a tariff, one that generates the same level of output as a production subsidy, will cause an even greater loss. This is because an import tariff generates both a production efficiency loss and a consumption efficiency loss. Thus, to achieve the same level of production of agricultural goods, a production subsidy will cost less overall than an import tariff. We say, then, that an import tariff is a second-best policy. The first-best policy option is a production subsidy.

Another Case in Which a Trade Policy Is First Best

There is one case in which a trade policy, used to protect or enhance national security, is the first-best policy option. Consider a country that produces goods that could be used by other countries to attack or harm the first country. An example would be nuclear materials. Some countries use nuclear power plants to produce electricity. Some of the products used in this production process, or the knowledge gained by operating a nuclear facility, could be used as an input in the production of more dangerous nuclear weapons. To prevent such materials from reaching countries, especially materials that may potentially threaten a country, export bans are often put into place. The argument to justify an export ban is that preventing certain countries from obtaining materials that may be used for offensive military purposes is necessary to maintain adequate national security.

In the United States, export bans are in place to prevent the proliferation of a variety of products. Many other products require a license from the government to export the product to certain countries. This allows the government to monitor what is being exported to whom and gives them the prerogative to deny a license if it is deemed to be a national security threat. In the United States, licenses are required for goods in short supply domestically; goods related to nuclear proliferation, missile technology, and chemical and biological weapons; and other goods that might affect regional stability, crime, or terrorist activities. In addition, the United States maintains a Special Designated Nationals list, which contains names of organizations to which sales of products are restricted, and a Denied Persons list, which contains names of individuals with whom business is prohibited. In recent years the United States has maintained export bans to several countries, including Cuba, Iran, Syria, and Sudan.

In this case, the export control policy is the first-best policy to enhance national security. This is because the fundamental problem is certain domestic goods getting into the hands of certain foreign nations, groups, or individuals. The problem is a trade problem best corrected with a trade policy. Indeed, there is no effective way to control these sales, and thus to enhance national security, using a purely domestic policy.