NOT FOR QUOTATION WITHOUT PERMISSION OF THE AUTHOR
U.S.
Sl"l2ATEGIC STOCKPILE POLICY:A CRITICAL
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OF ANTICIPATORY-
A
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ACTIONStephen P. Dresch
July 1984
WP-84-61
Working Papers are interim reports on work of the International Institute for Applied Systems Analysis and have received only limited review. Views or opinions expressed herein do not necessarily represent those of t h e Institute or of its National Member Organizations.
INTERNATIONAL INSTITUTE FOR APPLIED SYSTEMS ANALYSIS 2361 Laxenburg, Austria
STEPHEN P. DRESCH is a research scholar a t t h e International Institute for Applied Systems Analysis and chairman of t h e Institute for Demo- graphic and Economic Studies, New Haven, Connecticut.
Over t h e last several decades a number of economists, particularly i n North America, have questioned t h e extent of government regulation and intervention in many economic sectors, claiming t h a t t h e government often h a s gone f a r beyond what is necessary t o protect t h e public and in the process seriously impaired efficiency. These concerns have actually stimulated significant reforms in certain countries, as t h e recent dere- gulation of t h e airline and banking industries in t h e United States illus- trates.
In this study, Stephen Dresch moves f u r t h e r down this path by argu- ing t h a t t h e government should leave t o t h e private sector the stockpil- ing of strategic materials needed in t h e event of war. He contends t h a t t h e private sector will be more efficient a t this activity, and more likely t o accumulate t h e optimal level of stacks. In addition, he suggests t h a t reliance on private stockpiling m a y actually reduce t h e likelihood of war.
These conclusions, a s t h e analysis makes clear, depend on a number of assumptions, whose validity m a n y will want t o question. But then, t h e purpose of a working paper is t o stimulate discussion and debate, and thereby help t h e a u t h o r a n d o t h e r s understand t h e i r differences and clarify t h e i r own thinking.
John
E.
Tilton Research Leader Mineral Trade andMarkets Project
PREFACE
This paper draws upon and extends certain facets of an earlier study undertaken for the U.S. Federal Preparedness Agency [ P A ] (now the Federal Emergency Management Administration [FEMA]).* However, while t h e prior study was concerned primarily with policy recommenda- tions which would result in greater economic efficiency in stockpile activities and only ancillarily addressed t h e issue of t h e underlying jus- tification for any governmental initiatives in this domain, the present paper is explicitly addressed to this more fundamental issue.
A t the outset i must admit t h a t the paper may be viewed primarily as performing a heuristic function. While i t s critique of U.S. strategic stockpile policy, and especially t h e conclusion t h a t levels of inventories which would be accumulated by private speculators operating through competitive markets would be a t least as socially optimal a s those inven- tories which would be accumulated by a public agency, is intended seri- ously, t h e required institutional stipulations a n d related analytical assumptions (e.g., t h a t speculators do not anticipate price controls, rationing and/or expropriation in the event of military hostilities) may well be considered so unlikely to be fulfilled as t o render the analysis a purely academic exercise.
However, even if the study is judged to have little or no practical import with reference to strategic stockpile policy per se, it may yet have important derivative implications for comparable governmental action in anticipation of other types of contingencies. Specifically, if a strong, plausible case can be made against public vis-a-vis private action in this domain, in which required assumptions and institutional arrangements a r e most unlikely to be fulfilled, then arguments in favor of private action in other domains will have strong prima facie validity. Thus, the 'Stephen P. Dresch, Allocations of Fad h m a n d Ecpondituts in a Wartima B o r n m y a n d eDvelopment of Sfrategtc S o c k p i l o Objectivas: Assessment a n d RuJormulafion (Rnal Report t o the Federal Preparedness Agency by the Institute for Demographic and Economic Studies, September 1879).
study m a y have g r e a t e r relevance to more general issues of anticipatory governmental action t h a n with reference t o t h e specific issues of stra- tegic stockpiles.
Notwithstanding t h e foregoing, however, t h e paper is intended t o provide a serious analysis of and recommendations concerning U.S. strategic stockpile policy.
Stephen P. Dresch
An earlier study of U.S. strategic stockpile policy (referenced in the Pre- face) was undertaken a t t h e request a n d with the support of t h e U.S.
Federal Preparedness Agency (now Federal Emergency Management Administration) t o the Institute for Demographic and Economic Studies (Contract No. FPA-77-21). Critical reactions to this earlier work of Edward Zabrowski, Douglas Scott and Paul Kruger, all of FPA/FEMA, and of W. Allen Wallis (former chancellor of the University of Rochester;
currently Under Secretary for Economic Affairs, U.S. Department of State), Milton Friedman (Hoover Institution on War, Revolution and Peace), Julian Simon (University of Maryland and Heritage Foundation), Wassily Leontief and Faye Duchin (both of the Institute of Economic Analysis, New York University), and Adair L. Waldenberg (Institute for Demographic and Economic Studies and Northwestern University) contri- buted significantly t o t h e formulation of the analysis presented here.
Wilhelm Krelle and John Tilton, of IIASG provided invaluable comments and criticisms of an earlier draft of t h e present paper. None of these individuals, of course, is responsible e i t h e r for t h e more formal aspects of t h e analysis o r for t h e necessarily highly subjective substantive judge- ments which a r e expressed.
S.
P.
D.-
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PRECIS
Commenting editorially ("Remember Strategic Minerals?" February 17, 1982), The New York lZmes advocated development of a strategic minerals policy based upon " a close anaiysis, mineral by mineral, of t h e consequences of import dependence and t h e practical alternatives," con- cluding with t h r e e "principles" on which, 7he Times argued, such a pol- icy should be based:
[I] Stockpiles should come first
...
[z]
Private solutions a r e preferable...
[3] Keep planning flexible.
A reasonable analysis of t h e issue suggests, however, t h a t only t h e second principle is necessary. Reliance on private (market) solutions could result, under achievable circumstances, in a t least approximately optimal stockpiles of strategic minerals and would insure flexible adapta- tions of these stockpiles t o evolving technologies and patterns of minerals availability. Moreover, de facto assignment of responsibility for strategic minerals availability t o private investors would have potentially important (and beneficial) foreign and defense policy implications. The purpose of this paper is t o defend these assertions. That defense is briefly summarized here.'
Superficially, a federal strategic stockpile seems t o make substan- tial sense. If defense-related contingencies giving rise t o shortages of particular materials can be anticipated, why should t h e government not take action in advance to reduce these potential shortages? However, t h e r e are two Eundarnental reasons for responding t o this question in t h e ' ~ v e n in this rather lengthy summary it is possible, at most, only to allude to the many sig- nificant required assumptions and qualifications of the analysis. Thus, many of the objec tions which can be anticipated to the arguments advanced in this overview are at least dip cussed, if not overcome, in the body of the paper.
negative:
(1) Unless federal stockpile holdings are excessively large, they will have little o r no effect on aggregate (public and private) inventories of strategic minerals.
(2) If federal inventory holdings a r e sufficiently large a s t o have an effect on aggregate inventories, they will n o t only r e s u l t in levels of cost which a r e socially unjustified but may also increase t h e likeli- hood of international conflict.
Consider a situation in which t h e federal government maintains no stockpile of strategic minerals. This does not imply t h a t t h e r e will be n o inventories of these minerals. Rather, private speculators will invest in strategic minerals, balancing t h e substantial profits which will accrue in t h e (relatively unlikely) event of military mobilization (resulting in a rise in prices due to exceptional increases in demand o r reductions in supply) against the more modest losses (interest a n d storage costs, phy- sical deterioration) which will be incurred in t h e (more likely) event t h a t hostilities do n o t o c c u r (and, hence, t h a t future prices a r e relatively lower than in t h e event of h o ~ t i l i t i e s ) . ~ Private speculative investment will continue until t h e second just cancels (is equal to) t h e first. In gen- eral, private speculative investment will be g r e a t e r ( a ) t h e greater the military requirements for t h e various minerals and (b) t h e higher t h e perceived probability t h a t hostilities will occur and t h a t supplies will be disrupted; conversely, speculative holdings will be lower t h e higher t h e costs (especially t h e higher t h e real i n t e r e s t costs) entailed by mainte- nance of t h e inventory.
The configuration of strategic minerals inventories which would be voluntarily chosen by private speculators will be optimal from a social perspective if t h e following conditions a r e met: (1) Speculators m u s t correctly perceive t h e probability of hostilities and t h e effects of hostili- ties on demands for a n d supplies of t h e various minerals. (2) Inventory costs (including interest, o r discount, r a t e s and required risk premia) confronting private speculators m u s t be no higher t h a n those confront- ing the government. Within relatively narrow bounds t h e required condi- tions can be expected to be fulfilled. Thus, t h e inventory holdings of private speculators would approximate those which would be chosen by an omniscient stockpile czar, probably as closely a s would t h e holdings selected by a less than omniscient stockpile bureaucracy.
If this is t r u e , then what will be t h e effect of a decision t o c r e a t e a governmental strategic stockpile? If private speculators a r e aware of t h e government's action, a s inevitably they will be, then increases in govern- mental inventories will be offset to a g r e a t e r or lesser extent by
*As w i l l be discussed, a critical assumption here is that private speculators do not anticipate
that government will confiscate strategic materials inventories (or, equivalently, impose price controls and mandatory rationing, in the event of hostilities. Any intervention of government into t h e functioning of private markets, current or prospective, may seriously undermine the argument developed here, t h a t the private speculative solution to the p r o b lem of determining inventories of strategic materials will be, ceteris paribus, socially o p timsl.
reductions in private holdings, simply because t h e existence of govern- mental holdings will reduce the minerals prices which speculators expect to confront in t h e event of hostilities.
The extent to which increased governmental holdings will be can- celled by reduced private holdings will depend upon, first, the impor- tance of defense-related contingencies as determinants of private inven- tories, and second, t h e expectations of speculators concerning t h e cir- cumstances under which t h e government will release its stockpile hold- ings to producers. If military contingencies represent a minor motiva- tion for private speculative investment in a particular mineral (by com- parison to other anticipated sources of shoi-tage, e.g., embargos, strikes, natural calamities), and if speculators a r e confident t h a t t h e govern- m e n t will release i t s holdings to the market only in t h e event of military hostilities, t h e n governmental inventory investments will have relatively little impact on private holdings.
Unfortunately, with reference to t h e prospective effectiveness of public stockpile policy, military demands represent in excess of twenty percent of total utilization of many strategic minerals, and military con- tingencies must constitute an important motive for private as well a s public speculative investment. Moreover, t h e federal government's repeated recourse t o the strategic stockpile in t h e face of shortages unrelated to military contingencies has served t o reduce even those speculative private investments motivated by nonmilitary contingencies.
Thus, the existence of governmental strategic stockpiles m u s t imply lower p;ivate holdings of the same minerals than would be observed i n the absence of the public strategic stockpile. Only when governmental holdings become so large as t o have eliminated military contingencies (and any other circumstances under which the government would release stockpiles to the market) as a motivation for private inventory investment will a given increment in governmental holdings represent an equal increment in aggregate national inventories, public and private.
Beyond t h a t point, however. increased strategic minerals inven- tories have adverse consequences for foreign and defense policies. Any foreign policy entails some risk of military confrontation or war. The choice of a policy is to a t least some extent a function of its costs, costs which include, among o t h e r elements, t h e costs of a potential conflict and of t h e economic dislocations which i t would entail. If these costs can be camouflaged and apparently (but not in reality) reduced by exces- sively large strategic stockpile inventories,' t h e n t h e adoption of policies with excessively high probabilities of eventuating in hostilities will be encouraged. The situation is distinct but not dissimilar in its effects t o t h a t which would be observed if a monopolist were in control of private inventories: He can draw upon f u t u r e conflict-conditional speculative profits in order to raise t h e likelihood t h a t conflict will in fact occur, e.g., by fanning popular sentiment against a potential adversary or by S ~argument Bssurnes that there s is an element of "temporal illusion" in social percep t i m s of t h e costs of governmental policy, i.e., that small costs distributed over time are pol- itically acceptable while the equivalent (in present value) concentrated a t a point in time would not be acceptable.
creating hostile incidents. In t h e present c a s e t h e b u r e a u c r a t i c i n t e r e s t s of t h e military a n d s t r a t e g i c stockpile a u t h o r i t i e s ( a n d possibly of foreign policy authorities) m a y be jointly served by pursuing foreign- cum-defense policies which n e c e s s i t a t e excessive stockpiles a n d by purs- ing stockpile policies which r e d u c e t h e apparent costs of particularly provocative foreign-cum-defense policies.
In s h o r t , t h e optimal s t r a t e g i c stockpile is not independent of t h e optimal foreign a n d defense policies. A stockpile policy which leads t o excessive inventories c a n be t h e c a u s e a s well a s t h e consequence of foreign a n d defense policies which entail excessively high probabilities of conflict. Only if stockpile inventories a r e a c c u m u l a t e d by (private) par- t i e s who believe t h a t t h e y have n o effect on t h e probability of conflict will t h e optimal stockpile be accumulated, while t h e optimal foreign a n d defense policies will be adopted only if policy m a k e r s believe t h a t t h e y have no control over stockpiles of s t r a t e g i c minerals o t h e r t h a n t h r o u g h t h e i r influence (through t h e i r foreign a n d defense policies) o n inventory investors' perceptions of t h e probability of conflict a n d t h e consequences of conflict for minerals markets. With governmental stockpiling t h e incentives of t h e stockpile, foreign policy a n d defense policy a u t h o r i t i e s t o a c c u m u l a t e excessive inventories a n d t o engage i n excessively provo- cative policies will be mutually reinforcing. Only with private specula- tion c a n optimal inventories a n d foreign-cum-defense policies be antici- pated.
Two particularly obvious a n d possibly highly significant objections t o a policy of reliance on private speculation for t h e m a i n t e n a n c e of s t r a - tegic minerals inventories require consideration. First, if speculators f e a r t h a t t h e i r inventories will be expropriated (with compensation a t preconflict prices) o r subjected t o price controls a n d rationing i n t h e event of a military contingency, t h e n t h e i r motivation for holding t h e s e inventories will be destroyed. This i s a fully justified c o n c e r n , implying t h a t a decision t o rely on private speculation m u s t be conjoined with inviolable g u a r a n t e e s t h a t s t r a t e g i c inventories will n o t be expropriated o r subjected t o price controls a n d rationing.4 Since t h e g o v e r n m e n t will (virtually) always be able t o bid t h e s e mineral inventories away f r o m o t h e r would-be purchasers, s u c h g u a r a n t e e s will not r e d u c e t h e government's command over s t r a t e g i c minerals. In t h e e v e n t of conflict t h e prices paid by g o v e r n m e n t will be higher, b u t t h e g o v e r n m e n t will n o t have i n c u r r e d t h e prior c o s t s of accumulating a n d maintaining s t r a - tegic inventories.
4tn principle, explicit Constitutional provisions would appear to offer a mechanism for such guarantees, in ozplicifLy constitutional political systems. However, in a parliamentary democracy without a written constitution, such as the United Kingdom, in which the actions of one session of Parliament cannot constrain the actions of another, or, t o a lesser extent, in a system such a s that of the Federal Republic of Germany, in which the Constitution itself places constraints on the capacity of one legislative session t o preempt the powers of anoth- er, explicit constitutional protections of speculative investors may be foreclosed. And, even when constitutional protections can be provided, a constitutional provision may itself be ei- ther altered or ignored. l l u s , one can legitimately question whether there exist any cir- cumstances under which investors could plausibly be expected t o believe that an entity with the inherent powers of the state would eschew intervention into private murkets were such intervention perceived t o be in the interest of the state.
The second objection is t h a t , in the event of hostilities and in the absence of expropriation or price controls and rationing, tremendous
"windfall gains" will i n u r e t o t h e benefit of private speculators and t h a t this would represent an undesirable redistribution of wealth. In the short r u n this may very well appear to be true. In t h e (admittedly v e r y ) long r u n , however, t h e substantial speculative profits which would be realized in t h e event of conflict will be eroded, in fact, cancelled, by t h e succession of losses which would be incurred in t h e absence of hostili- ties. Thus, issues of income and wealth distribution have n o legitimate relevance t o decisions concerning t h e assignment of responsibility for strategic minerals i n v e n t ~ r i e s . ~ Nonetheless, conventional p e r c e p t i o n s of t h e income- and wealth-distributional implications OF reliance on freely- functioning private speculative m a r k e t s may render this policy infeasi- ble, especially in times of war, when some classes of individuals (e.g., military personnel) personally bear especially high costs (even including death) while others (speculators) become (even temporarily) wealthy.'
Military mobilization or war would inevitably lead t o t h e appearance of shortages of many minerals. However, a serious analysis of t h e prob- lem suggests t h a t these shortages are unlikely to be reduced by a governmentally-owned strategic stockpile. The i n t e r e s t s of society, with reference t o both economic preparedness and to t h e conduct of foreign and defense policy, would be b e t t e r served by reliance on private specu- lative investment for t h e maintenance of stockpiles of strategic minerals. In short, a n d recalling t h e previously cited N e w York rimes editorial, a s a m a t t e r of government policy and (unless you a r e a private speculator) nongovernmental concern, f o ~ g e t s t r a t e g i c m i n e r a l s .
5 ~ l e a r l y , to impose a windfall profits or other t a x on hostility-contingent speculative profits would vitiate the motives for strategic minerals investment. Even a conventional income tax will result in suboptimal strategic minerals inventories unless (1) the tax is imposed a t a flat rate (i.e., is not progressive) and (2) inventory losses in periods of peace are fully deductible (i.e., result in negative tax liabilities).
' ~ o t e that this is an czpprrtsnf but not a r e d moral or ethical argument against reliance on a private speculative solution. Lf the private speculative market were to function aa out- lined in this paper, then t o profit from investment in strategic materials would not differ, on moral or ethical grounds, from profiting, in either peace or war, from the production of or investment in any other type of commodity or productive capacity.
CONTENTS
Foreword Preface
Acknowledgements Precis
1. Future Contingencies and Anticipatory Governmental Action 2. Contemporary U.S. Strategic Stockpile Policy:
A Descriptive Overview
3. Determinants of Anticipatory Nongovernmental Action 4. Governmental Influences on and Social Optirnality of
Anticipatory Nongovernmental Action
4.1 Actual v e r s u s Idealized Private Inventory Determination Behavior
4.2 Systematic Discrepancies between Private and Social Perceptions of Determinants of Strategic Inventory Investment
4.3 Private Strategic Inventory Investment a n d Social Optimality: A Reprise
5. Contemporary U.S. Strategic Stockpile Policy: A Critique 6. Conclusion
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111v vii
ix
US.
SI'RATEGICSTOCKPILE
POLI(=r:A CRITICAL A S S E S S N T OF ANTICIPATORY G O v E m N T A L ACCION
Stephen P. Dresch
1. Future C o n t i n g e n c i e s and Anticipatory G o v e r n m e n t a l A c t i o n
While t h e f u t u r e is necessarily u n c e r t a i n , it is not e n t i r e l y unkmown:
Contingent on c e r t a i n eventualities ( s t a t e s of t h e world), specific conse- quences c a n be anticipated. A significant fraction of governmental action is concerned precisely with mitigation of t h e m o r e adverse pros- pective consequences of u n c e r t a i n b u t conceivable events. Superficially, s u c h anticipatory g o v e r n m e n t a l action appears t o be quite defensible.
When p a r t i c u l a r exigencies c a n be anticipated, a failure of g o v e r n m e n t t o pursue anticipatory policies is commonly perceived t o be irresponsi- ble.
If responsibility i s a t t r i b u t e d t o g o v e r n m e n t s for t h e consequences of events t h e o c c u r r e n c e ( a n d frequently even t h e m a g n i t u d e of t h e adverse impacts) of which c a n n o t be influenced by g o v e r n m e n t s (e.g..
floods, e a r t h q u a k e s , o t h e r "acts of ~ o d " ) , ' this attribution of govern- m e n t a l responsibility is especially common with r e f e r e n c e t o those events t h e o c c u r r e n c e of which is t h e result, directly o r indirectly, of governmental action. Thus, for example, foreign policies which a r e a t least perceived t o c o n t r i b u t e t o t h e likelihood of embargoes o r o t h e r foreclosures of a c c e s s t o imported materials lead almost inevitably (if.
occasionally. belatedly) t o governmental actions to m i t i g a t e t h e conse- quences of supply contractions. In this context, i t is perhaps n o t surprising t h a t governmental responsibility is effectively a s s u m e d with r e f e r e n c e t o t h e potential consequences of military or defense-related contingencies, a domain in which, within a n y society, g o v e r n m e n t is recognized to have a nominal monopoly of r i g h t s of action.
Whatever t h e factors, governmental o r nongovernmental, which a r e believed t o influence events, t h e fundamental issue from a social per- spective c o n c e r n s t h e optimality of anticipatory action. In general, responsibility for anticipatory action is uncritically a t t r i b u t e d t o govern- m e n t i n response t o what is uncritically a s s e r t e d to be prima facie evi- dence of t h e inadequacy a n d nonoptimality of anticipatory nongovern- m e n t a l action. However, even in m a n y (perhaps m o s t ) cases in which t h e nonoptimality of nongovernmental action c a n be demonstrated, t h a t nonoptimality is itself t h e consequence of governmental actions, often i n quite u n r e l a t e d domains. Moreover, t h e failure t o consider t h e underly- ing s o u r c e s of t h e nonoptimality of nongovernmental action is frequently ' ~ v i d e n c e of this perceived "responsibility" of governments is provided by the refusal of many regimes either to admit the occurrence of adverse events or to publically recognize the magnitude of the adverse consequences. It is apparently believed t h a t to do so would be construed by the public a s an admission of the failure of the regime or, even, of the social- political system itself.
conjoined with a failure t o consider t h e nongovernmental consequences of anticipatory governmental action. Thus, t h e u n w a r r a n t e d predisposi- tion toward governmental responsibility is generally r e i n f o r c e d by policy assessments which a r e vitiated by several particularly c r i t i c a l b u t gen- erally u n s t a t e d assumptions, specifically. t h a t anticipatory governmen- tal action
(1) h a s n o i m p a c t per se on t h e probability t h a t t h e a n t i c i p a t e d event will occur; 2
(2) does n o t a l t e r unexpectedly t h e anticipatory actions u n d e r t a k e n by nongovernmental p a r t i e s (and/or t h a t nongovernmental p a r t i e s do n o t engage in a n t i c i p a t o r y action); and
(3) does n o t influence "eventuality-conditional" behavior in s u c h a way as to n e g a t e t h e a c h i e v e m e n t of the objectives of a n t i c i p a t o r y pol- icy.
Unfortunately, in a n u m b e r of highly diverse domains of anticipatory governmental action, ranging from flood control a n d c a t a s t r o p h e i n s u r a n c e to t r a n s p o r t a t i o n policy a n d strategic stockpiles, a t l e a s t one a n d frequently all t h r e e of t h e s e assumptions a r e violated. As a result, suboptimal public policies a r e virtually assured.
2 ~ t might be objected t h a t an important, perhaps primary purpose of a strategic stockpile is precisely to reduce the probability of prospective hostilities, simply by demonstrating to a potential adversary one's own preparedness. However, this objective can be achieved, argu- ably more efficiently, viu current investments in military preparedness per se or, if more appropriate, through explicit commitments to future investments in military capabilities, relying on private markets to achieve optimal inventories of necessary inputs (conditional on correct forecasts of the spectrum of possible future governmental demands). Sirr~ilar ar- guments can be made, even more easily, with reference t o other motivations for anticipate ry governmental action.
The purpose of this study is to demonstrate the probable nonop- timality of anticipatory public policy in t h e specific case of strategic stockpile policies developed in response t o t h e economic dislocations expected t o be observed in t h e event of military hostilities. If such an a r g u m e n t c a n be plausibly made in the military domain, in which t h e t h e consequences of e r r o r would conventionally be viewed as most serious and with reference t o which t h e primacy of government as a locus of decision is commonly accepted as unarguable, then a general stance in favor of private vir-a-vis governmental responsibility for anticipatory action c a n be argued t o be virtually irrebuttable.
2. Contemporary
U.S.
Strategic Stockpile Policy: A Descriptive OverviewNotwithstanding significant "advance mobilization" after 1938, directed toward meeting t h e military demands of Britain, in particular, and of h e r allies,
U.S.
e n t r y into World War I1 in late 1941 was accompanied by t h e appearance of substantial perceived "shortages" of primary and fabri- c a t e d materials required for t h e war effort. Largely because of this experience, since t h e war t h e federal government has continuously maintained stockpiles of critical ("strategic") materials anticipated t o be in s h o r t supply in the event of military mobilization.As t h e agency charged with direct responsibility for the conduct of strategic stockpile activities, t h e Federal Emergency Management Administration (formerly t h e Federal Preparedness Agency) over t h e past decade h a s progressively elaborated t h e procedures utilized to deter- mine strategic stockpile "objectives" or "goals," i.e., to establish t h e t a r g e t level and composition of stockpile holdings. Building upon t h e
historical (and unchanged) definition of t h e stockpile objective as t h e
"gap" between anticipated wartime requirements for and availabilities of a given strategic material, t h e projections of requirements have been significantly refined, taking into account s u c h factors as
(1) t h e precise characteristics of t h e military hostilities in which i t is anticipated t h a t t h e nation m a y be i n v o l ~ e d ; ~
(2) changes in t h e composition of final demand. reflecting both enlarged military demands and also civilian austerity (reflected especially in reductions in personal consumption expenditure for durables and in residential construction);
(3) prioritization of final demands (distinguishing between defense, essential civilian and general civilian expenditures, in t h a t hierarchical order), conjoined with an associated concept of "tiered risk" (with a lesser loss or cost attached t o shortfalls of require- m e n t s from availabilities in t h e case of lower-priority expenditure categories);
(4) reliability ranking of potential sources of supply (foreign and domes- tic), considering political orientations, vulnerability to disruption of production facilities and transportation systems, etc., with differen- tial degrees of reliability of supply required for t h e various priority categories of final demand; and
3h practice, this is achieved by arbitrarily assuming a war of a specified duration (three years), with a specified number of fronts (two). In principle, however, each hostility confi- guration should be considered, in conjunction with i t s associated probability of occurrence.
On this basis, am "expected" gap between requirements and availabilities, corlstituting t h e strategic stockpile objective, could be determined. As will be discussed, this discrepancy between practice and principle is simply one instance of a general class of inadequacies as- sociated with current policy.
(5) specification of differential degrees of anticipated feasible substitu- tion of nonshortage for shortage m a t e r i a l s (again r e l a t e d t o t h e priority ranking of t h e expenditure category).
Superficially, t h e s e relatively elaborate a n d apparently sophisticated procedures for d e t e r m i n i n g stockpile objectives r e p r e s e n t a substantial improvement over t h e simple fixed-coefficients e s t i m a t e s of shortfalls of aggregate "availabilities" from aggregate "requirements" previously employed, permitting a m u c h m o r e sensitive a d j u s t m e n t of stockpile holdings t o evolving economic, technological a n d security conditions a n d considerations t h a n could heretofore be achieved. Whether this is i n f a c t t h e case, however, will depend on a n u m b e r of factors, especially includ- ing
(1) t h e statistical reliability of t h e highly disaggregated quantitative d a t a required for empirical implementation of this m o r e sophisti- c a t e d approach;
(2) t h e correspondence between t h e behavioral assumptions implicit i n t h e approach a n d t h e economic behavior which would actually b e observed in t h e e v e n t of military mobilization; a n d
(3) t h e absence of premobilization reactions t o s t r a t e g i c stockpile accu- mulations which offset or negate t h e objectives of stockpile policy.
Each of t h e s e is a c r i t i c a l prerequisite for t h e effectiveness of c u r r e n t procedures, a n d with r e f e r e n c e t o e a c h serious questions c a n be raised. \
Data r e q u i r e m e n t s for t h e m o r e disaggregated approach will rise rapidly, roughly by a t l e a s t t h e s q u a r e of t h e degree of a t t e m p t e d disaggregation. In l i g h t of t h e costs of acquiring detailed economic a n d
technological data and of t h e likelihood of decreasing statistical reliabil- ity a t more disaggregated levels, t h e benefits of greater disaggregation and refinement may be m o r e apparent than real, falling significantly short of the costs involved. Various techniques by which to reduce data requirements may, of course, be employed, such as deriving coefficients for a disaggregated sector from a more basic s e t of coefficients a t an aggregated sectoral level. If bases for making such adjustments a r e rea- sonably firm, the results m a y significantly improve on t h e conclusions t h a t would be reached a t t h e more aggregated level. However, in prac- tice this approach may r e s u l t in conclusions which differ only trivially (and not significantly) from those t h a t would be reached on the basis of a less apparently refined analysis. In this event, t h e benefits of more refined procedures will be ephemeral. On the other hand, if t h e conclu- sions are found to differ substantially, i t is important both to determine the source of the differences and t o verify their validity and reliability.
In general, t h e procedures by which stockpile objectives are deter- mined do not r e s t upon explicitly s t a t e d and justified behavioral- economic and p u b l i ~ - p o l i ~ ~ stipulations and assumptions. Thus. changes in economic behavior, e.g., t h e "austerity reduction" in durable con- sumption expenditure a n d in residential construction, a r e stipulated, but t h e mechanisms by which t h e s e changes are induced are not identi- fied. Unless economic behavior in t h e event of military mobilization corresponds to t h a t assumed in t h e formulation of stockpile objectives, the level and composition of t h e stockpile may have little relationship to the patterns and magnitudes of t h e material shortages which in fact emerge as a consequence of t h e final demands which are actually
observed.
Premobilization r e a c t i o n s t o t h e level a n d r a t e of investment i n t h e s t r a t e g i c stockpile a r e e n t i r e l y ignored in t h e c u r r e n t approach t o t h e formulation of stockpile objectives. However, if nongovernmental inven- tory i n v e s t m e n t behavior is significantly influenced by governmental stockpile actions, t h e n t h e n e t augmentation of economic capabilities associated with t h e s t r a t e g i c stockpile may fall s h o r t of t h a t augmenta- tion superficially implied by t h e gross level of stockpile holdings. In fact.
a s will be demonstrated, t h e r e a r e substantial reasons t o believe t h a t nongovernmental i n v e n t o r y holdings of strategic m a t e r i a l s will respond t o governmental holdings. First, if governmental stockpile acquisitions lead t o current-period i n c r e a s e s i n prices of t h e s e m a t e r i a l s (absolutely or relative t o expected f u t u r e prices), t h e n t h i s will imply reductions i n desired private holdings of t h e s a m e materials. Second. t h e anticipation of f u t u r e flows from t h e s t r a t e g i c stockpile, by increasing expected f u t u r e availabilities a n d reducing expected f u t u r e prices, will also s e r v e t o r e d u c e desired private inventory holdings.
A detailed critique of contemporary U.S. s t r a t e g i c stockpile policy, however, requires t h a t t h e economic context of s t r a t e g i c stockpile activity be articulated, c a p t u r i n g (a) those a s p e c t s of private economic behavior which would be influenced by governmental stockpile a c c u m u - lations a n d dispositions a n d (b) t h e internal dynamics of governmental policy.
3. Determinants of Anticipatory Nongovernmental Action
In broadest terms, strategic stockpiles represent inventories of materi- als deemed to be critical t o military mobilization. Thus, t h e issue of t h e optimal strategic stockpile policy can be viewed a s a special case of t h e more general issue of optimal inventory policy: By what criteria a n d on what basis should inventories of various materials be determined? This question is conventionally approached a t t h e outset from t h e specific vantage point of governmental policy, with particular attention to two possibly distinguishing features of the strategic stockpile: (1) its pur- poses and (2) its governmental ownership. Critical insight, however, may be facilitated by a less restrictive consideration of the strategic stockpile within the context of inventory theory, examining t h e economic role and determinants of strategic materials inventories, whether publically or privately held.
Two functions of inventories can be identified. F'irst, inventories may be required in order t o achieve production efficiency, broadly con- ceived If a marginal i n c r e m e n t t o inventories reduces production costs (through economies of scale in purchasing or shipping, etc.) by an amount g r e a t e r t h a n t h e implicit interest, storage a n d related costs of the enlarged inventory, t h e n t h e increment in inventory holdings is economically justified.
Second, inventories may be held because of uncertainties concern- ing future conditions of supply, demand and, hence, prices. Directly or indirectly, inventory holdings (or stockpiles) motivated by uncertainty concerning future m a r k e t conditions constitute speculative inventories.
Speculation in t h i s s e n s e c a n o c c u r only i n t h e face of u n c e r t a i n t i e s con- cerning f u t u r e s t a t e s of t h e world, u n c e r t a i n t i e s which c a n involve f u t u r e conditions of d e m a n d or of supply.
The s t r a t e g i c stockpile t h u s r e p r e s e n t s a class of speculative inven- tory. defined by t h e types of contingencies which motivate i t s acquisi- tion: c h a n g e s in d e m a n d o r of 'supply which a r e c o n t i n g e n t upon t h e o c c u r r e n c e of m i l i t a r y mobilization or war. In m o s t g e n e r a l t e r m s t h e s e contingencies lie along a multidimensional c o n t i n u u m , involving s u c h factors a s t h e n a t u r e , duration, e x t e n t a n d geographic locus of actual or potential hostilities. For purposes of t h e i m m e d i a t e discussion, however, t h i s c o n t i n u u m c a n be r e d u c e d t o two s t a t e s of t h e world, characterized a s "peace" a n d "war."
If war were a purely probabilistic event, t h e n a private speculator would approach t h e i s s u e of s t r a t e g i c stockpile or inventory investments a s follows: Supply a n d d e m a n d for each f u t u r e period would be predicted, conditional on t h e two alternative possible s t a t e s of t h e world, peace a n d war. If supply were expected to be r e d u c e d a n d / o r demand were expected t o be i n c r e a s e d in t h e event of war, t h e n prices would be expected t o be h i g h e r in t h e event of war t h a n of peace. If inventories were a c c u m u l a t e d in periods of peace, t h e n t h e y could be sold i n periods of war a t prices above peace-time purchase prices. Speculative profits would t h e n equal sales revenues less p u r c h a s e costs a n d carrying charges ( i n t e r e s t , s t o r a g e fees, physical deterioration, obsolescence, etc.). For any given probability of war, t h e r e would t h e n be a n inventory (strategic stockpile), t h e ezpected economic profit on t h e marginal (and, assuming perfect competition, average) u n i t of which would equal zero.
With freedom of e n t r y i n t o all m a r k e t s (on t h e p a r t of a c t u a l o r potential speculators), this would r e p r e s e n t t h e competitive, profit-maximizing level of stockpile inventories.
Although, in principle, t h e problem is a m e n a b l e t o solution, t h e ana- l y t i c ~ of competitive, profit-maximizing private stockpile i n v e s t m e n t become quite complex in t h e multiperiod o r infinite-time-horizon case.
However, t h e essential c h a r a c t e r i s t i c s of t h e solution c a n be meaning- fully indicated by a simplified two-period model. Period 0, a s s u m e d t o b e one of peace, is c h a r a c t e r i z e d by t h e current-period supply a n d d e m a n d curves for commodity
X
(exclusive of n e t speculative inventory demands) depicted in Figure 1 by4
a n d S. Period 1 supply is also assumed, for simplicity, to be r e p r e s e n t e d by t h e curve S, regardless of t h e s t a t e of t h e world (peace versus war). Period 1 demand, however, i s r e p r e s e n t e d a s contingent on t h e s t a t e of t h e world,Dp
in t h e event of peace a n dD,
i n t h e e v e n t of war. Any s t r a t e g i c inventory a c c u m u l a t e d in period 0 is a s s u m e d t o be sold in period 1 regardless of t h e s t a t e of t h e world which actually eventuates. Increasing speculative inventory d e m a n d s will raise t h e period 0 price a n d lower t h e period 1 price, w h e t h e r war o c c u r s in period 1 or not. Assuming z e r o inventory carrying costs o t h e r t h a n i n t e r e s t a t t h e r a t e r , private stockpiles will be accumu- l a t e d u n t i l t h e condition is fulfilled t h a twhere Z is t h e probability t h a t a s t a t e of war will exist in period 1, (1-Z) is t h e probability of peace in period 1,
&
i s aggregate inventory investment,Po(&)
is price in period 0, a function of4 ,
Figure 1. Determinants of Competitive Private Stockpile Investment
P1,,(&) is t h e war-conditional price in period 1.
P19(&) is t h e peace-conditional price in period 1, a n d
T is t h e i n t e r e s t r a t e .
The prices
Po, P1,,
a n dP19
will be functions of period 0 stockpile inven- tory investment (period 1 stockpile inventory disinvestment),A ,
with t h e precise functions d e t e r m i n e d by t h e p a r a m e t e r s of t h e c u r r e n t period d e m a n d a n d supply functions, Dp, Dw and S. Thus, equation 1 c a n be solved for t h e competitive profit-maximizing level of stockpile invest- m e n t ,&,
a t which expected economic profits would equal zero.Ignoring transactions a t disequilibrium prices (or, assuming t h a t a process of Walrasian tantonnement Edgeworthian recontracting contin- u e s u n t i l all m a r k e t s clear, with n o transactions a t disequilibrium prices),4 t h e n a t t h e final solution a period 0 c o n t r a c t for for f u t u r e delivery (and payment) in period 1 will involve a p r e d e t e r m i n e d p r i c e which will just equal (a) t h e c u r r e n t (spot) period 0 price plus i n t e r e s t a n d (b) t h e expected period 1 price. Thus, competitive private specula- tive investments will insure effective equality between c u r r e n t s p o t prices a n d futures prices. Although exchange a t disequilibrium p r i c e s m a y qualify this conclusion, t h e g e n e r a l tendency will be toward interest-rate-adjusted equality between all prices.5
4The assumption of a process of t a n t o n n o m e n t or "recontracting," thus precluding the o c currence of disequilibrium transactions, insures that the e z d o and e t post equilibria will be identical. Otherwise, disequilibrium transactions, through their influence on the distri- bution of wealth, could have the effect of zltering the equilibrium. The alternative solution t o this problem is Marshall's a s u m p t i o n of the constancy of t h e marginal utility of money (as reflected in his development of the pure theory of exchange, with reference to t h e "corn market"). See: Leon Walras, Eldments d'dconomie politzque pure ( N o r i a do La Tichussu su- c i a i s ) [1874-71, 5th edition (Paris and Lausanne, 1926); Francis Ysidro Edgeworth, Mathumat- u d h c h u s (1881); and Alfred Marshall, A n c i p l e s of Etonomics [1890], 4th edition (Lon- don, 1888).
5This conclusion is, in fact, a specific instance of the general requirement (the "Hotelling"
I t m u s t be stressed t h a t this solution assumes t h a t stockpiles (inventories) a r e accumulated by competitive private speculators and t h a t both producers and consumers of commodity
X
a r e perfectly com- petitive. If, in contrast, stockpiles a r e accumulated only by a monopolis- tic private speculator ( o r by a cartel), t h e n t h e monopolist's (cartel's) investment in inventories,A*,
, would be determined so as t o maximize the present value of expected profits, E(IT), whereand i t will always be t r u e t h a t
&., < &.
6 Thus, monopoly in speculative markets will inevitably lead t o underinvestment in stockpiles from a social perspective. because. as will be indicated below, t h e level of com- petitive private stockpile investment will represent a lower bound on t h e socially optimal stockpile.?Although this discussion of private stockpile behavior has been cast in partial equilibrium t e r m s , clearly t h e actual process of competitive private stockpile investment m u s t be conceived in a general equilibrium or "emmetropic" rule) that, in intertemporal equilibrium, prices of resources (nonproduced materials) and of speculatively-inventoried materials generally must rise a t the real rate of interest. See H. Hotelling, "The Economics of Exhaustible Resources," J o u d o f Pbliticd B o n o m y (1931), and S . P. Dresch, "Myopia, Emmetropia or Hypermetropia? Competitive Markets and Intertemporal Efficiency in t h e Utilization of Exhaustible Resources," aASA
Working A r p e r WF84-48 (June 1984).
quati ti on
1 can be viewed a s a special case of equation 2, with the maximization of equation 2 (the monopoly equation) replaced by the imposition of the zerc-profit condition of equa- tion l.'The conclusion t h a t t h e monopolist's stockpile investment will always be less than the competitive inventory investment, and hence less than the socially-optimal inventory, a s sumes that the probabilities associated with the future states of the world (peace V e n u s war) are given and not subject t o influence by the monopolist. V, in fact, the monopolist can, a t a cost, influence t h e probability of war, then i t is conceivable that t h e level of invest- ment which maximizes monopoly profits will exceed the competitive level of inventory in- vestment. Also, this monopoly investment and also the monopolistically-influenced proba- bility of war will both exceed the social optima. A parallel case will be discovered with referc ence to public stockpile investments.
framework, recognizing t h e full r a n g e of direct a n d derived demands a n d t h e i r interrelationships, including substitution possibilities in produc- tion a n d in e n d use. However, because t h e i m p o r t a n t a s p e c t s of t h e problem can be m o r e easily identified in partial equilibrium t e r m s , t h e discussion h e r e c a n be conducted within this frame of reference.
4. Governmental Influences on and Social Optimality of Anticipatory Nongovernmental Action
The essential issue t o be addressed h e r e concerns t h e conditions u n d e r which t h e process of competitive private stockpile i n v e s t m e n t will lead t o socially optimal inventories of s t r a t e g i c materials. In t h e absence of externalities,' t h i s question c a n be reduced to one of ( a ) divergences of private inventory i n v e s t m e n t behavior from t h a t stipulated in t h e uncon- s t r a i n e d competitive model a n d (b) possible discrepancies between t h e m a r k e t (private) a n d governmental (social) perceptions of t h e critical factors influencing private inventory investment.
4.1. Actual versus Idealized Private Inventory Determination Behavior
In general, a p a r t f r o m monopoly influences (and possibly even including these),' a c t u a l private inventory behavior will diverge f r o m t h a t implied by t h e idealized competitive model primarily a s a r e s u l t of governmental
'~xternalities here refer t o effects which cannot be internalized in governmental final demands for goods and services. Because those externalities which can be internalized through governmental final demands will be reflected in market demands for strategic ma- terials, these do not introduce discrepancies between the competitive private and socially optimal stockpile inventories.
'kionopoly influences need n o t be excluded if t h e sustained presence of monopoly elements i s itself d u e t o public policy, a s could be argued to be generally the case. In essence, I would argue t h a t the poTsistonco of any monopoly (or of u. collusive oligopoly or cartel) requires a t least t h e de facto support of government.
intrusions into t h e market. In t h e context of strategic s t o c b i l e policy t h r e e important classes of intrusions can be identified. First, govern- mental intrusion into market functioning, in t h e event of military or other contingencies, may undermine t h e motivations of private specula- tors to accumulate inventories which would otherwise be privately (and, as will be discussed, potentially socially) optimal. Second, general governmental policies, e.g., tax policies, may have seriously distorting effects. Flnally, governmental stockpile policies, possibly motivated by t h e deficiencies of private investment resulting from t h e foregoing governmental influences, may well f u r t h e r vitiate private stockpile investment activity.
Perhaps t h e most serious source of private market failure with reference to inventories of strategic materials is the prospect of govern- mental intrusion into market functioning in t h e event of military (and possibly o t h e r ) contingencies. The most obvious and likely of these intrusions involves expropriation of private inventories (with compensa- tion at premobilization prices) and/or imposition of price controls (with attendant rationing) in response t o t h e "shortages" which materialize as a result of military mobilization.1° The expectation of e i t h e r expropria- tion or price controls a n d rationing will undermine the incentives of private speculators to accumulate strategic inventories.
'hie
expropriation nppears to differ from imposition of price controls and rationing, this difference is only apparent. In essence, these represent identical public policy actions. Inthe case of expropriation, the government commandeers the available stock, providing such compensation of prior owners as i t deems fit, and then directly allocates that stock to alter- native uses (and users). The some result can be achieved by f i ~ n g prices ( a t t h e desired compensatory levels) and then achieving the desired allocations via rationing. Thus, although the mechanisms are slightly different, t h e end result is effectively the same. In both cases there is an excess demand a t prevailing (governmentally determined) prices,
w i t h the actual allocation of the scarce supply determined not by the market but rather by
governmental decree.
Superficially, expropriation o r price controls and rationing a p p e a r to be n e c e s s a r y in o r d e r to assure adequate governmental c o m m a n d over s c a r c e s t r a t e g i c m a t e r i a l in t h e e v e n t of military hostilities. HOW- ever, because t h e g o v e r n m e n t presumably could outbid o t h e r prospec- tive p u r c h a s e r s of s t r a t e g i c materials in t h e event of war, even if i t were forced t o acquire t h e s e m a t e r i a l s on free a n d open markets," t h e optimal g o v e r n m e n t a l policy, if fear of expropriation or price controls a n d rationing is a s o u r c e oE private market failure, is to certify nonin- t e r f e r e n c e with n o r m a l m a r k e t functioning, even in t h e e v e n t of war.
Such a certification of governmental noninterference i n t h e func- tioning of Eree private m a r k e t s , even under conditions of military c r i s i s a n d mobilization, will h a v e t h e desired effect only if i t is credible t o actual a n d potential i n v e n t o r y investors, i.e., only if i t is believed.
Clearly, this r e q u i r e s substantially m o r e t h a n a simple s t a t e m e n t of
"policy" (e.g., a n Executive Order of t h e President) on t h e p a r t of t h e government. S u c h a s t a t e m e n t will lack credibility because investors can anticipate c i r c u m s t a n c e s u n d e r which t h e government m a y c h a n g e (leading to a concomitant change in price policy), while even in t h e absence of a political c h a n g e a governmental policy may be altered i n
'The one possibjy significant exception to this statement involves demands of the military opponent which might be satisfied, directly or indirectly, on domestic markets. This possi- bility exists because, if optimal strategic inventories are to be accumulated, private specu- lators should be free t o engage in transactions on world markets, both prior to and in t h e event of military conflict. However, even this exception may be argued t o be more apparent than real, in t h a t t h e foreign and defense policies of the various countries should take into account t h e resources which a potential adversary would choose to devote t o a military con- frontation. More generally, even in the case of military opponents there exist "gains from trade," a s reflected, e.g., in differential demands for strategic materials, exploitation of whch should benefit both parties. Ln other words, if the opponent values a given flow of ma- terial a t a higher rate than does the own country, then the own country can profit from ex- change. Of course, t h e relative valuations should include consideration of the consequences of the trade for probabilities of military victory and defeat.
response t o c h a n g e d circumstances. While i t is probably not possible t o consider any c o n s t r a i n t on any governmental e n t i t y t o be strictly inviol- able, specific devices in c e r t a i n institutional contexts m a y offer substan- tial real a n d p e r c e w e d protection t o investors.
With r e f e r e n c e t o U.S. governmental i n s t i t u t i o n s a n d history, it c a n be a r g u e d t h a t a prohibition against m a r k e t interference which takes t h e form of a C o n s t i t u t i o n d g u a r a n t e e of nonintervention will impose sub- stantially g r e a t e r c o n s t r a i n t s on governmental action t h a n would, e.g., an executive o r d e r o r a s t a t u t o r y provision. Clearly, as t h e history of t h e Civil W a r ( a n d s u b s e q u e n t wars) will indicate, even Constitutional con- s t r a i n t s have been significantly loosened in periods of national crisis.
However, even in t h e s e cases t h e existence of Constitutional prohibitions h a s served t o l i m i t t h e degree of eztraConstitutiona1 action on t h e p a r t of government, a n d in m o s t cases even t h e s e m o r e limited ezh-aconsti- tutional a c t i o n s were eventually censured, with provision for a t l e a s t limited compensation of victims (although in m a n y cases, e.g., t h e i n t e r n m e n t of citizens of Japanese a n c e s t r y during World War 11, t h e compensation was seriously delayed a n d was significantly less in p r e s e n t value t h a n t h e c o s t s incurred).
Even if an effective g u a r a n t e e of nonintervention could b e devised, i t might be a r g u e d t h a t expropriation or price controls a r e necessitated n o t by t h e n e e d t o i n s u r e governmental c o m m a n d over s c a r c e resources b u t in o r d e r t o p r e v e n t t h e income and wealth redistributions t o which private speculation would give rise in event of war. Thus, for example, if t h e probability of war were very low, then t h e level of competitive inven- tories of s t r a t e g i c m a t e r i a l s would, ceteris paribus, be correspondingly
low; t h e very low probability of a large speculative gain in t h e event of war, due t o the small size of t h e strategic inventories, would be just offset by t h e high probability of a succession of small losses on these small inventories should war not occur (as is likely). However, if war did indeed occur, then t h e large gain, regardless of how unlikely, would actu- ally be realized, implying possibly major redistributions of income and wealth.
In fact, on average and over very long periods of t i m e s u c h infre- quent large gains would be fully offset by frequent small losses. Of course, over the short a n d intermediate runs, these war-conditional redistributions might be quite substantial. And while arguably not unac- ceptable in their own right, t h e i r political implications in a period of national emergency might be seriously deleterious, simply due t o t h e rnisperception of t h e source of t h e s e gains (and of corresponding, peace- conditional losses) on t h e part of t h e populace. However, as will be dis- cussed subsequently, t o a t t e m p t t o mitigate o r offset these redistribu- tions through, e.g., t h e imposition of high r a t e s of taxation on specula- tive profits, by reducing the r a t e of r e t u r n t o inventory investment, would itself vitiate t h e motive for private stockpile accurnulations.12 Thus, political considerations may virtually force what a r e effectively confiscatory rates of taxation. despite t h e fact t h a t these undermine t h e
''This would be the case unlem (a) taxes on strategic inventory profits (and losses) are levied at a flat rate, (b) private inventory investments are entirely debt financed (in which case all inventory costs are fully deductible for t a r purposes), (c) private inventory invest- ments generate, in the long term. zero economic profits (expected net losses in periods of peace just equal, in present value, expected net profits in periods of war), and (d) private in- ventory losses in periods of peace lead to immediately rebateable negative tax liabilities. If these conditions are fulfilled, the inventory-profits t a r will simply amount t o governmental sharing in both the profits and losses of private stockpile investors, with the governmental share of losses just offsetting the governmental share of gains.
efficiency of private i n v e n t o r y investment. 13
As noted, more g e n e r a l public policies may have similarly deleteri- ous consequences for t h e performance of private speculative markets.
While t h e effects of t a x e s specifically targeted on "windfall gains" of private speculators i n periods of military mobilization would be espe- cially adverse, even g e n e r a l income taxes, by driving a wedge between i n t e r e s t r a t e s a n d r a t e s of r e t u r n t o stockpile investment, would have t h e consequence of r e d u c i n g levels of strategic inventories below t h e i r socially optimal levels. Thus, taxes, and especially income taxes, r e p r e s e n t t h e m o s t seriously intrusive element of public policy influenc- ing private inventory i n v e s t m e n t .
In this regard, however, i t is important t o note t h a t t h e effects of tax policy for s t r a t e g i c inventory investment a r e qualitatively no dif- f e r e n t t h a n the effects for o t h e r categories of investment. Thus, s t r a - tegic inventories c a n n o t be a s s u m e d t o be more suboptimal t h a n , e.g., investment in o t h e r inventories or in physical plant and equipment.
Moreover, to t h e d e g r e e t o which these nonoptimally depressive effects of t a x policy a r e c o m p e n s a t e d by o t h e r policy i n s t r u m e n t s (e.g., invest- m e n t t a x credits), t h e r e m a y be no n e t adverse consequences for r a t e s of investment, including s t r a t e g i c inventory investments (assuming t h a t t h e s e a r e also eligible f o r favorable compensatory t r e a t m e n t ) .
