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