Revisiting the Defense–Growth nexus in European countries

Abstract

This study revisits the long run and dynamic causal linkages between defense spending and economic growth in 15 selected European countries for the period 1988–2010 by utilizing recent developments in non-stationary panel data analysis. To this end, the series properties of per capita defense spending, per capita real capita stocks, and per capita real GDP are investigated by the panel unit root tests with and without breaks that support evidence on unit root. The panel cointegration tests with and without breaks are also subsequently employed to investigate whether there exists a long-run equilibrium relationship between these three variables. Finally, our causality analysis from panel vector error-correction model suggests that there is a feedback relation between real capital stock and real GDP in both short and long run, a one-way Granger causality running from real GDP to defense spending in both short and long run, and defense spending only Granger causes real capital stock in the long run.

Keywords:

• Defense spending
• Economic growth
• Panel vector error correction model
• European countries

JEL Codes:

• H56
• O11
• O52
• C33

Acknowledgments

The authors would like to thank the Editor, Professor Christos Kollias, and the anonymous referees for their highly constructive comments.

Notes

1 In order to save space, we omit the details of the first- and second-generation panel unit root tests. We refer an interested reader to Baltagi (2005) for those.

2 To investigate the existence of cross-section dependence, we carry out the LM test by Breusch and Pagan (1980), the CD (cross-sectional dependence) test by Pesaran (2004), and the bias-adjusted LM test by Pesaran, Ullah, and Yamagata (2008). We do find that there is strong evidence on cross-section dependency among the European countries.

3 To test for the validity of the homogeneity assumption, we applied the slope homogeneity test developed by Pesaran and Yamagata (2008) and find that the null hypothesis of the slope homogeneity hypothesis could not be rejected.