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The Poli)cal and Economic Determinants of War Finance
Rosella Cappella University of Pennsylvania
German Hyperinfla)on, 1923
Puzzle
• What determines how states choose among the mix of possible funding strategies?
• What is the rela)onship between poli)cs and economics in determining how states finance wars?
Puzzle Puzzle Argument Data Findings
Why Study War Finance?
• Military power stems from an economic base. • Figh)ng wars can be incredibly costly, resul)ng in large amounts of debt and painful infla)on.
• Wars are psychologically unique events. – ex: Rally around the flag
Puzzle
Puzzle
Puzzle Argument Data Findings
No Systema)c Understanding of War Finance
Puzzle
Puzzle
Puzzle Argument Data Findings
Three Assump)ons
• Leaders Want to Win the War – They want the military to be ouUiVed as best as possible
• Leaders Prefer to Avoid Economic Ruin – They prefer a war finance strategy that will have the least nega)ve economic impact on the state
• Leaders Want to Remain in Power – They prefer a war finance strategy that is the least poli)cally costly
Puzzle Puzzle Argument Data Findings
Taxa)on, Domes)c Debt, External Funding, Prin)ng
Puzzle
Puzzle
Puzzle Argument Data Findings
Key Theore)cal Predic)ons
• Bureaucra(c capacity to extract tax revenue – Paraguay and Paraguayan War Finance
Puzzle
Puzzle
Puzzle Argument Data Findings
Key Theore)cal Predic)ons
• Bureaucra)c capacity to extract tax revenue – Paraguay and Paraguayan War Finance
• Capacity to Cope with Low Currency Reserves – Britain and World War II: Lend-‐Lease
Puzzle
Puzzle
Puzzle Argument Data Findings
Key Theore)cal Predic)ons
• Bureaucra)c capacity to extract tax revenue – Paraguay and Paraguayan War Finance
• Capacity to Cope with Low Currency Reserves – Britain and World War II: Lend-‐Lease
• Fear of Infla(on – US and Korean War Finance
Puzzle
Puzzle
Puzzle Argument Data Findings
Interstate War Finance Data Set, 1822 – 2003
• Unit of Analysis: Country-‐War • Scale 0 – 4
– 0 = none of the cost of the war was met by X variable; – 1 = under 25% of the cost of the war was met by X variable; – 2 = between 25-‐50% of the cost of the war was met by X
variable; – 3 = between 50-‐75% of the cost of war was met by X variable;
and – 4 = over 75% of the cost of the war was met by X variable.
• Six Months Long • Primary Belligerents • N = 94
Puzzle Puzzle Argument Data Findings
Primary Findings • States are bound by their capacity – The stronger a state’s capacity to extract tax revenue, the more likely to it will finance the war via taxa)on.
– States that procure war inputs from abroad are more likely to finance their wars with external funding.
• Fear of infla)on – States in which infla)on was experienced in a previous war are more likely to finance their wars via taxa)on.
• Regime Type – Democracies are no more likely than non-‐democracies to finance a larger percentage of the war via taxa)on or domes)cs debt.
Puzzle Puzzle Argument Data Findings
Ques)ons & Comments
cappella@sas.upenn.edu
Sta)s)cal Results Taxation Taxation –
Inflation Effect Domestic Debt All Debt
(Domestic + Foreign)
External Funding Printing
Mail Volume 6.40* (3.87)
-4.93 (3.15)
-8.77** (3.68)
-4.88 (9.41)
-2.24 (5.17)
GDP Per Capita 0.001*
(0.0007) 0.0003
(0.0005) -0.0004 (0.0005)
-0.0001 (0.0006)
0.001** (0.0006)
Inflation – Previous War
0.937* (0.527)
Log Iron and Steel Production
-0.334*** (0.091)
Regime Type 0.029
(0.040) 0.049
(0.039) 0.0010 (0.033)
0.013 (0.031)
-0.073** (0.036)
-0.130** (0.053)
Log Duration -0.333 (0.339)
-0.728** (0.381)
-0.546** (0.254)
-0.764*** (0.239)
-0.244 (0.258)
1.97*** (0.418)
World War 0.356
(0.687) 0.555
(0.651) 1.35** (0.514)
1.92*** (0.564)
2.33** (0.862)
-1.06 (0.969)
Cold War 0.445
(0.712) 6.74
(5.29) -0.410 (0.538)
0.752* (0.453)
1.92*** (0.524)
-1.10 (1.00)
Observations 33 28 41 48 44 30
R – Squared 0.2744 0.2057 0.1195 0.1715 0.3343 0.3883
Independent Variables
• Bureaucra)c Capacity – Volume of Mail (Arthur Banks)
– GDP Per Capita (Angus Maddison)
• Infla)on Fear – Price change experienced in the previous war (Rogoff & Reinhardt)
• Loca)on of War Inputs – Iron and Steel Produc)on (COW)
Cost of War – United States
Cost of War – World War I
Mail Mail Per Capita Number of Employees
Mail 1.0000 Mail Per Capita 0.9490 1.0000 Number of Employees
0.7547 0.8804 1.0000
Correla)on: volume of mail and number of employees in the United States’
revenue bureaucracy
Bureaucra)c Capacity to Extract Revenue
Revenue by Speed
!Figure X: Revenue by Speed
Existing Printing Taxes Collected at Debt Direct Coffers Time of Transaction Taxes Immediate Time Consuming
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