Power and Resilience: On the Theory and Implications of the National Security Externality

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When countries bargain in the shadow of conflict, there is a strategic value in becoming resilient to that conflict. The reason is that the ability to withstand the economic shock caused by a potential conflict strengthens a country’s bargaining position relative to its adversary. This paper develops a theory of the national security externality. Markets do not price the value of geopolitical power and therefore the private sector does not internalize the strategic value of resilience. As a result, markets underprovide domestic resilience and may overprovide an adversary’s resilience. Resilience is shaped by economic decisions—such as investment choices and trade patterns—and optimal policy intervenes in these decisions to mitigate the externality. The policies studied include investment subsidies to the defense industrial base, reshoring and friend-shoring of production capacity, and ways to weaponize trade, such as sanctions. A quantitative exercise evaluates the strategic value of reshoring productive capacity in a scenario where the United States bargains with China over Taiwan.