Economics of military outsourcing

Abstract

This thesis is concerned with outsourcing the production of defence and military activities to private providers. Theoretical approaches to the issue are reviewed and found to make insufficiently specific predictions to be useful in assessing the scope for outsourcing. Instead four empirical analyses are undertaken using publicly available data. The first estimates the elasticity of substitution between military labour and capital. It builds on Ridge and Smith (1991), using data on military wages to allow a more flexible specification. It finds the elasticity likely to be some small positive number, much lower than previous estimates suggest. The second extends the framework to incorporate civilian labour as a third factor of production. It then estimates the elasticity of substitution between military and civilian labour. This elasticity is estimated to be close to zero, suggesting that there is little scope for military outsourcing beyond that which exists without reducing capabilities in some circumstances. The next approach assesses how far increases in the use of contracting-out and competitive procurement have yielded reductions in UK aggregate military expenditure. The best model suggests that increased outsourcing is associated with lower aggregate military spending in the long-run, but a number of issues arise which raise concerns about the validity of demand for military expenditure models. The final approach uses an original dataset on control of Ministry of Defence Private Finance Initiative projects to identify the key firms involved in the UK market for military outsourcing contracts, the structure of the industry and its impact on the scope of efficient outsourcing. Whilst there is currently scope for effective competition for contracts in most market segments, this competition is vulnerable to industry consolidation. The key firms involved do not financially outperform their peers in other markets