War Finance and Coercive Bargaining

Many, if not most, wars are funded by debt, either domestic or from foreign lenders. Historically, losers repudiate their wartime debts, and even winners are often tempted into partial defaults, restructuring, or inflation. Since governments are normally committed to repaying their debt in peace, peace settlements become inefficient and can affect crisis bargaining and the probability of settling disputes through negotiations. I analyze a complete-information model in which players can determine the distribution of power through their military allocations during a crisis. These decisions influence the terms of any negotiated settlement they obtain and the war they fight if they fail to come to terms. When players can finance some of their spending through debt they are committed to repaying in peace or victory, then they can use this for strategic coercion. I show that sometimes players would incur debt that would trigger war under complete information even with an infinitely divisible good under dispute. This new explanation for war is not due to commitment problems or informational asymmetries but is driven by the inefficiency of peace imposed by the need to repay the debt. E-mail: slantchev@ucsd.edu. I thank Matthew Kearney for research assistance. I gratefully acknowledge financial support from the National Science Foundation (Grant SES-0850435). Presented at the Conference on Modeling Conflict and Its Governance, Institute for Mathematical Behavioral Sciences, University of California–Irvine, the Program on International Politics, Economics and Security (PIPES), University of Chicago. If money is the sinews of military power, then credit is the tendon of Achilles. Wars are generally funded by a combination of taxes and loans. Always unpopular with the citizens, taxes have traditionally fallen far short of supplying the revenue necessary to meet the extraordinary demands of war. It is on borrowed money that the heftiest burden of paying for wartime expenses is carried. Unfortunately, our models of crisis bargaining assume that military power is exogenous, and thus the issue of war finance does not arise. Even theories that do study the effect of resource allocation choices on crisis or war behavior do not tackle the issue of war finance in general, and certainly not the peculiarities of borrowing in particular. This article is a first step toward a theory of crisis bargaining and war that does so. Financing military preparation and fighting with loans introduces new dynamics in crisis bargaining and war. First, the government cannot commit to repaying the debt, especially if it loses the war. Second, it must attract lenders by offering terms that would compensate them for the risk of default. As the military situation worsens, the government’s ability to procure funds to continue the war would deteriorate as well. Furthermore, the need to honor these financial obligations may force the government to demand much larger concessions from the opponent, concessions that might prove to be too onerous compared to what the opponent expects to secure by fighting. Thus, governments that cannot mobilize sufficient resources from their existing tax base might need to borrow so that they can improve their military capabilities and avoid an unfavorable outcome at the negotiating table with a stronger opponent. If they are not sufficiently efficient at converting their resources into military capabilities, however, they might need to borrow so much that their opponent would not grant them the concession they need to repay their debt. This unhappy situation might result in an inevitable war even under complete information, providing us with a new rationalist explanation of war that relies neither on commitment problems or uncertainty. As I show in this article, contrary to the usual assumption that peace is an efficient way to distribute resources, debt financiering makes peace inefficient from the perspective of the borrower. Under certain conditions this can destroy all chance of peaceful dispute settlement: there simply might exist no deal that both sides prefer to war given that one of them has borrowed money for his military preparations. 1 Borrowing for War and Debt Repudiation The following historical excursus is primarily intended to motivate the assumptions of the model by substantiating four major claims. First, borrowing is an important, and in some instances crucial, way to increase the country’s ability to wage war. Second, despite strong interest in repaying the debt, governments can find themselves unable to meet their obligations, and might be forced to repudiate some or all of the debt. Third, debt repudiation is much more likely if a country loses a war. Fourth, lenders are generally quite aware of these risks and would take them into account when deciding what rates to demand from the government. There are several options for a government that needs to defray its military expenses: it can use accumulated reserves (or sell government property), it can tax, it can plunder or exploit the conquered territory, it can rely on foreign subsidies, it can manipulate the money supply (by printing money or debasing the currency), or it can borrow, either from its