An Essay on the Economics of National Security

This dissertation contains an essay on the optimal design of national security policy. The essay develops a theory of the national security externality. When countries bargain in the shadow of conflict, there is a strategic value to resilience to conflict because it improves bargaining power. Resilience depends on economic decisions, such as investment and trade patterns. There is a national security externality because bargaining power is not priced. The objective of economic statecraft is to intervene in the decisions that produce resilience to reduce the cost of the national security externality. Policies studied in this paper include investment subsidies to the defense industrial base, the reshoring and friend-shoring of production capacity, and various ways to weaponize trade, including sanctions. A quantitative exercise examines the value of reshoring productive capacity in a scenario where the United States faces a potential conflict with China over Taiwan. It suggests that industrial policy should target a narrow set of industries. The rise of China and the corresponding expansion of trade increased the importance of the national security externality and hence the value of reshoring by more than fivefold between 1997 and 2017.