2013 Working Papers: Managerial Economics

This study presents a framework and models for the analysis of government budget allocation into defense and civilian expenditures in situations of uncertainty about the incidence of war. The models display the intricate relationships between security levels, subjective probabilities of the occurrence of war, and potential war damages. We show that poor countries tend to perceive greater probabilities of war than their richer rivals and that the psychological burden of insecurity is larger when the country’s wealth is larger and when its preference for security is higher. We apply our models to the Israeli-Syrian arms race and show that the very different growth rates of the Israeli and Syrian economies are likely to lead to an increase in Syria’s perception of the likelihood of war and to a decrease in Israel’s perception of such a likelihood. We also show that if Syria’s regime becomes ideologically more extreme, the monetary cost of maintaining Israel's security at the level that it enjoyed prior to the change will be very high, whereas the monetary cost of maintaining  Israel’s welfare would be moderate.