2012 Working Papers: Managerial Economics

This study integrates military intelligence into the optimal allocation of the government budget. Intelligence activities, defined as including the process of data collection and knowledge analysis for decision making by the military and governmental hierarchies, are perceived as serving three goals: (a) evaluation of the rival’s capabilities and intentions; (b) enhancing the capability of the military by increasing the effectiveness of its weapon systems and reducing the effectiveness of the rival’s weapon systems; (c) intelligence superiority yields an advantage over the rival, particularly with respect to deterrence and preemption. We develop and analyze static (deterministic, one-period) models in which two rival countries are engaged in an arms race. Current results show that the optimal expenditure on intelligence by each rival is likely, but not necessarily, a monotone increasing function of: (a) the government budget; (b) the efficiency of the intelligence apparatus; (c) the decision makers’ degree of conservatism. We also analyze scenarios in which the two rivals participate in a knowledge race in addition to the usual arms race. In such cases, the country with the higher intelligence effectiveness (due to high-quality human capital, say) may force its rival to spend significant resources on intelligence, thus, gaining a substantial advantage in security and welfare. Finally, we present an application of the model to the Israeli-Syrian arms race.