Is piracy sustainable?
Résumé
We develop a model of international trade between three countries, one of which hosts pirates. When the number of pirate ships increases, the probability for one of the pirate ships (for one commercial ship) encountering a commercial (pirate) ship decreases (increases). Then, the commercial ships have an incentive to spend more on defense and pirate ships to invest less on attack. If pirates operate under free entry, they do not internalize the entry externality. Then, their number rises until it reaches a level such that their attack power has become negligible and the defense of the commercial ships has reached a high level. The economy settles in a full deterrence equilibrium. However, if the number of pirate ships is controlled by an authority, which maximizes their total profit, the economy settles in an equilibrium where piracy is active and commercial ships spend less on defense.
Piracy is a substitute for trade. Piracy depends on the terms of trade of the pirate country and on the relative efficiency of the attack versus the defense.