I'm not talking about rifles here, but heavy weapons like fighter aircrafts, submarines, tanks. The problem is that even in a minarchistic libertarian system, the government will be the only buyer (it's a monopsony). Even internationally, governments will be the only buyers. If the own government doesn't corrupt the arms industry, the governments in other countries will, and the effects will spread throughout arms manufacturing.
How serious is this problem and what would be the best way to handle it?
Military budgets reach a few percent of GDP globally, so it isn't a negligable sector. Will mispricings and misallocation of resources in the arms sector spread to wider sectors like electronics, aviation and steel in an otherwise free market economy? For example, if governments pay too much for fighter airplanes, then it could make civilian airplanes cheaper as a consequence of the increased resources spent on airplane research and production capacity scale economies. Hence civilian flying will increase, affecting railroad companies negatively and so on and on.
Maybe there are more generally some ideas around here about how regulated sectors affect pricing in non-regulated sectors of the economy. Such as: If there today was a truly free market country in the world, with gold money and all, wouldn't it too go into depression now together with the surrounding world with which it trades?
It's not fascism when the government does it.
“We must spend now as an investment for the future.” - President Obama