International Governance and Risk Management

273 Pages·2019·4.892 MB·English

by  Toshihiro Ihori, Martin C. McGuire, Shintaro Nakagawa

Advances in Japanese Business and Economics 24
Toshihiro Ihori
Martin C. McGuire
Shintaro Nakagawa
International
Governance
and Risk
Management
Advances in Japanese Business and Economics
Volume 24
Editor-in-Chief
RYUZOSATO
C.V.StarrProfessorEmeritusofEconomics,SternSchoolofBusiness
NewYorkUniversity
SeniorEditor
KAZUOMINO
ProfessorEmeritus,KyotoUniversity
ManagingEditors
HAJIMEHORI
ProfessorEmeritus,TohokuUniversity
HIROSHIYOSHIKAWA
Professor,RisshoUniversity;ProfessorEmeritus,TheUniversityofTokyo
TOSHIHIROIHORI
ProfessorEmeritus,TheUniversityofTokyo;Professor,NationalGraduateInstituteforPolicyStudies
(GRIPS)
EditorialBoard
YUZOHONDA
ProfessorEmeritus,OsakaUniversity;Professor,KansaiUniversity
JOTAISHIKAWA
Professor,HitotsubashiUniversity
KUNIOITO
ProfessorEmeritus,HitotsubashiUniversity
KATSUHITOIWAI
ProfessorEmeritus,TheUniversityofTokyo;VisitingProfessor,InternationalChristianUniversity
TAKASHINEGISHI
ProfessorEmeritus,TheUniversityofTokyo;Fellow,TheJapanAcademy
KIYOHIKONISHIMURA
ProfessorEmeritus,TheUniversityofTokyo;Professor,NationalGraduateInstituteforPolicyStudies
(GRIPS)
TETSUJIOKAZAKI
Professor,TheUniversityofTokyo
YOSHIYASUONO
Professor,OsakaUniversity
JUNJIROSHINTAKU
Professor,TheUniversityofTokyo
MEGUMISUTO
ProfessorEmeritus,WasedaUniversity
KOTAROSUZUMURA
ProfessorEmeritus,HitotsubashiUniversity;Fellow,TheJapanAcademy
EIICHITOMIURA
Professor,HitotsubashiUniversity
KAZUOYAMAGUCHI
RalphLewisProfessorofSociology,UniversityofChicago
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Toshihiro Ihori Martin C. McGuire
(cid:129) (cid:129)
Shintaro Nakagawa
International Governance
and Risk Management
123
Toshihiro Ihori Martin C.McGuire
Economics University of California, Irvine
National Graduate Institute forPolicy Irvine,CA, USA
Studies
Tokyo,Japan
Shintaro Nakagawa
Konan University
Kobe,Japan
ISSN 2197-8859 ISSN 2197-8867 (electronic)
Advances in JapaneseBusiness andEconomics
ISBN978-981-13-8874-3 ISBN978-981-13-8875-0 (eBook)
https://doi.org/10.1007/978-981-13-8875-0
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Preface
This book develops a theory of risk management in an alliance with public goods.
There has been an explosion of research in the last 10 years in a broad variety of
areasinthisliterature,andthetimeseemsrightforasurveyofthiswork.Thisbook
integrates likelihood of loss, magnitude of loss, and isolation from loss into a
consolidatedmodel.Itextendsexistingconceptsofindividualriskmanagementby
a single person to decision theory for an entire country, managed by government
bureaucracyandlodgedinauniverseofoverlappingalliances.Wealsopresentthe
classic results to place the new developments in context.
Thisbookisappropriateforadvancedundergraduates,forgraduatestudentswho
wish to learn the latest research in this area, and for practitioners who want to
broaden their knowledge outside their own area of expertise. We present the
backgroundforeachresultandtrytogivethereaderafeelforhowaparticulararea
of the literature developed. The technical results are provided and an intuitive
explanation for them is also given. Each chapter is reasonably self-contained.
A variety of models are studied in each chapter and are fully described, so the
reader can open the book to any chapter and begin reading without missing any
of the notation or technique.
Thisbookwasalmost3yearsinthemaking.Duringthelonggestationperiodof
this book, we are indebted to a number of colleagues and students for helpful
conversations along the way. In particular, we would like to thank Junichi Itaya,
KeigoKameda,RaymondBatina,RobinBoadway,KaiKonrad,ToddSandler,and
Richard Cornes. ProfessorRichard Cornes gaveushisinsightfulcommentsonour
research and sadly passed away in August 2015. We also wish to express deep
gratitude to Prof. Ryuzo Sato, the Editor in Chief of the Advances in Japanese
BusinessandEconomicseries.Andlastbutnotleast, wewishtoexpressgratitude
to the editorial staff at Springer Japan for their help at various stages of the
production of this book.
v
vi Preface
Finally,wethanktheJapanSocietyforthePromotionofScience(JSPS)fortheir
support of our research. Toshihiro Ihori’s research was supported in part by
JSPS KAKENHI Grant Numbers 24243042, 15H01952, and 18H03635. Shintaro
Nakagawa’s research was supported in part by JSPS KAKENHI Grant Numbers
24243042 and 26380366.
Tokyo, Japan Toshihiro Ihori
Irvine, USA Martin C. McGuire
Kobe, Japan Shintaro Nakagawa
March 2019
Contents
1 Introduction and Summary of the Book. . . . . . . . . . . . . . . . . . . . . . 1
1.1 Purpose of the Book. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Basic Concepts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2.1 Public Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2.2 Alliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.2.3 Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.3 Outline of the Book . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.4 Implication for Japan’s Security Issue . . . . . . . . . . . . . . . . . . . . . 13
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2 Risk Management and International Security. . . . . . . . . . . . . . . . . . 17
2.1 Positive Versus Normative Economic Analyses . . . . . . . . . . . . . . 17
2.1.1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.1.2 Evolution of Security Issues. . . . . . . . . . . . . . . . . . . . . . . 18
2.2 Old Fashioned Security: The Law of the Jungle Self-seeking
Incentives and Conflict Among Countries . . . . . . . . . . . . . . . . . . 19
2.2.1 Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
2.2.2 Definitions and Notation . . . . . . . . . . . . . . . . . . . . . . . . . 21
2.2.3 Benefits and Costs of Conquest . . . . . . . . . . . . . . . . . . . . 21
2.2.4 Two Categories of Autonomy-Preserving Allocation
to Defense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2.2.5 Defense Allocations Illustrated . . . . . . . . . . . . . . . . . . . . . 26
2.2.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2.3 Optimal Preparations for Adversity . . . . . . . . . . . . . . . . . . . . . . . 30
2.3.1 Alternative Policies to Combat Supply Disruption . . . . . . . 31
2.3.2 Insurance and Investment Components of Stockpiling . . . . 32
2.3.3 Expected Welfare and Maximization: Assumptions
and Notation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
2.3.4 Optimum Protection in the Absence of Stockpiling . . . . . . 34
vii
viii Contents
2.3.5 Stockpiling and Standby Production . . . . . . . . . . . . . . . . . 36
2.3.6 The Optimal Stockpile. . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.3.7 The Optimal Mix of Stockpiling and Trade. . . . . . . . . . . . 39
2.3.8 Effects of Risk Aversion . . . . . . . . . . . . . . . . . . . . . . . . . 42
2.3.9 Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
2.4 Technical Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
2.4.1 Equivalence Between One Period-Two Contingency
and Two Period Analysis. . . . . . . . . . . . . . . . . . . . . . . . . 44
2.4.2 Inter-contingency Gains and Losses from Stockpiling . . . . 45
2.5 Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Appendix: Mutual Insurance Model. . . . . . . . . . . . . . . . . . . . . . . . . . . 48
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
3 One-Dimensional Public Goods in Models of Alliance . . . . . . . . . . . 57
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
3.2 The Theory of Public Good Provision: The Nash Equilibrium
Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
3.2.1 Private Provision of Public Goods . . . . . . . . . . . . . . . . . . 59
3.2.2 A Two-Country Model . . . . . . . . . . . . . . . . . . . . . . . . . . 60
3.2.3 The Inefficiency of Nash Equilibrium . . . . . . . . . . . . . . . . 63
3.3 Effects of Income Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
3.3.1 Neutrality Theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
3.3.2 Plausibility of the Neutrality Theorem . . . . . . . . . . . . . . . 68
3.4 Transfer Paradoxes in Three-Country Models with Impure
Public Good. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
3.4.1 Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
3.4.2 Comparative Statics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
3.4.3 Neutrality Result Revisited. . . . . . . . . . . . . . . . . . . . . . . . 72
3.4.4 Redistribution Among Allied Countries. . . . . . . . . . . . . . . 73
3.4.5 Stackelberg Equilibrium. . . . . . . . . . . . . . . . . . . . . . . . . . 76
3.5 Economic Growth and Spillover Effects. . . . . . . . . . . . . . . . . . . . 77
3.6 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Appendix: Insurance and International Public Goods . . . . . . . . . . . . . . 79
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
4 Defense Expenditures and Allied Cooperation in Conflicting
Alliances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
4.2 Cooperation Effect and Arms Race Effect . . . . . . . . . . . . . . . . . . 90
4.3 Analytical Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Contents ix
4.4 Second Stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
4.4.1 Noncooperative Case. . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
4.4.2 Intra-alliance Cooperative Case . . . . . . . . . . . . . . . . . . . . 97
4.4.3 Three Cooperative Cases . . . . . . . . . . . . . . . . . . . . . . . . . 98
4.5 First Stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
4.6 Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
5 Self-protection and Self-insurance Against Adversity . . . . . . . . . . . . 107
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
5.1.1 Object of This Chapter . . . . . . . . . . . . . . . . . . . . . . . . . . 107
5.1.2 Summation Aggregator . . . . . . . . . . . . . . . . . . . . . . . . . . 109
5.2 Self-protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
5.2.1 Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
5.2.2 Individual Optimizations . . . . . . . . . . . . . . . . . . . . . . . . . 112
5.2.3 Interior Nash Equilibria . . . . . . . . . . . . . . . . . . . . . . . . . . 113
5.2.4 Income Effects: Normal and Inferior. . . . . . . . . . . . . . . . . 115
5.2.5 Properties of Interior Nash Equilibria When the Public
Good Is Defined by Summation Financing . . . . . . . . . . . . 119
5.2.6 Normal and Inferior Income Effects: Details . . . . . . . . . . . 120
5.2.7 Normality, Inferiority and Risk Aversion: The Inferior
Goods Barrier to Public Good Provision. . . . . . . . . . . . . . 122
5.2.8 The Cornes-Hartley “Replacement” . . . . . . . . . . . . . . . . . 124
5.2.9 Effects of Change in Group Membership: Size
and the Inferior-Good Barrier to Public Good Supply . . . . 131
5.3 Self-insurance and Self-protection . . . . . . . . . . . . . . . . . . . . . . . . 134
5.3.1 Inclusion of Self-insurance. . . . . . . . . . . . . . . . . . . . . . . . 134
5.3.2 Analytical Framework for a Single Country . . . . . . . . . . . 135
5.3.3 Self-insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138
5.3.4 Interaction Between Self-protection and Self-insurance . . . 147
5.3.5 General Case: Self-Insurance and Self-Protection. . . . . . . . 150
5.3.6 Mutual Provision of Public Goods . . . . . . . . . . . . . . . . . . 154
5.4 Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
6 Exploitation Hypothesis and Numerical Calculations . . . . . . . . . . . . 159
6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159
6.2 Exploitation Hypothesis and Neutrality Results . . . . . . . . . . . . . . 161
6.2.1 Conventional Exploitation Hypothesis. . . . . . . . . . . . . . . . 161
6.2.2 Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . 163