Models of alliances: Internalizing externalities and financing

This paper extends the joint product model of military alliances to apply to the new strategic doctrine adopted by NATO in the 1990s. In particular, a choice must be made between protecting one's own territory and pooling forces for an alliancewide rapid reaction force. This new model accounts for a host of externalities and their implications for burden sharing, full financing, and allocative efficiency. The Pigouvian taxes that adjust for force thinning and attack deflection are shown to finance optimal border-protecting forces under a variety of circumstances. Second-best considerations arise owing to the pure publicness of rapid reaction forces. The ideal toll arrangement does not currently characterize NATO financing, nor is it likely to do so.