This paper presents a model of subsidized military production that examines
the relationship between domestic procurement and arms exports. Weapon pro
ducers satisfy the defence procurement in their own country and compete in
prices in the international market where weapons are imperfect substitutes
for each other. Importers are involved in an arms race situation and do not
have domestic military production. The model makes explicit the strategic
interaction between governments and firms in the export market. We then ana
lyze the effect of a change in the most significant parameters on the equil
ibrium. The paper suggests an explanation for the evolution of the arms mar
ket in the past few years and highlights the important role of the demand a
nd cost structures.