EFFECTS OF MILITARY SPENDING ON THE PROFITABILITY OF SPANISH DEFENCE CONTRACTORS

Abstract

The traditional view of the defence industry obtaining large profits from contracts with the Ministry of Defence relies on several assumptions. Among these are the use of such arrangements as an instrument of industrial policy, the strong market power enjoyed by prime contractors, and the inefficiency encouraged by the sector. The findings show that defence contracts have a positive effect on profits, as well as the prizes for innovation and the market power enjoyed by some defence subsectors.

Keywords:

• Defence industry
• Defence procurement
• Profits
• Spain

JEL Codes:

• D86
• H56
• L64

ACKNOWLEDGEMENTS

The authors thank the financial support from the Institute of Fiscal Studies.

Notes

¹ On these issues see Álvarez and Fonfría (2000) and García (2004).

² This is especially the case for the United Kingdom. Barker et al. (1991) show that a reduction by half in the defence budget leads to a GDP reduction by 3.5%; similarly, the employment would drop by 0.46 million jobs. However, a reallocation of resources in other sectors would lead to a reduction of unemployment by 0.52 million jobs.

³ On this, see Commission of the European Communities (2006).

⁴ Defence equipment procurement by the Ministry of Defence (MDE) was not made by a central authority but each military service had its own acquisition policy. Indeed, there was an overwhelming trend to buy weapon systems and equipment from abroad.

⁵ About 30% of total defence goods and services purchased by the Ministry of Defence were supplied by foreign contractors (Lancho de León, 1987).

⁶ Figures from the Direction General for Armament and Material. Available on http://www.mde.es.

⁷ Spain is among the 25 highest exporters of defence material.

⁸ See Brauer (2002).

⁹ A similar approach was developed by Kelly and Rishi (2003) when estimating a production function for defence expenditure.

¹⁰ Actually, this is a general characteristic of the Spanish economy. See Álvarez and Fonfría (2000).