Measuring hard power: China’s economic growth and military capacity

Abstract

China’s rapid economic growth is facilitating massive increases in its military spending and causing increased security concerns in Asia and the Western Pacific. But there is uncertainty over how large China’s military spending is relative to other countries, or how fast it is growing in real terms. We address this issue by deriving a relative military cost price index based on the relative unit costs of inputs. We find that China’s real military spending is much larger than suggested by exchange rate comparisons, and even larger than standard purchasing power parity comparisons. We also find, however, that the real growth of China’s military spending has been smaller than conventionally thought. This is due to rapidly growing wages in China and the large share of personnel in China’s military budget.

Keywords:

• China
• International comparisons; International Security
• Military spending

JEL Codes:

• H56
• O53
• F5
• C43

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Corrigendum

Acknowledgments

We are grateful for comments from two anonymous referees of this journal, Ron Smith, Hugh White, Bob Carr, Tim Huxley, Pierre Noel, Konstantin Matthies, Bates Gill, Gordon Flake, Robert Hill, Harry, X. Wu, Peter Neary and seminar participants at IISS Asia, the United States Studies Centre, University of Sydney, and University of Western Australia. Peter Robertson acknowledges the hospitality of St. Antony’s College Oxford and The Centre for the Study of African Economies (CSAE) in Department of Economics at Oxford University. An earlier version of this paper appears as UWA Economics Working Paper 13.32.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Chen and Ravallion (2010) report that the number of people in China living below the $1.25 per day poverty line fell by 600 million since 1980. For general overviews of the economic impacts, see The Economist (2011) and Robertson (2014).

² The Economist (2010, 2012a, 2012b) are also useful summaries of the issues. See also Fravel (2005, 2008a, 2008b); Legro (2007); Layne (2009); Thompson (2010).

³ In contrast to the literature on military spending, the focus is not on the accuracy of military spending data, or on its effects, but on the appropriate way to compare spending levels across countries.

⁴ This is related to the Balassa–Samuelson effect. See Baumol and Bowen (1966); Baumol (1967); Balassa (1964); and Samuelson (1964).

⁵ For discussion of various measures of China’s political power, see Subramanian (2011); Beckley (2012); Shifrinson, Itzkowitz, and Beckley (2012) and Shambaugh (2013).

⁶ Alternatively, we could consider the stock of military capital. Wolf (2002) finds that the ratio of China to USA military capital was 0.44 in 2010. If similar quality data were available, the current stock is a better measure of actual immediate military capacity, reflecting past investments, while current spending can be thought of a measure of longer term relative capacities. Ideally, a comparison would use both stocks and current flows of spending. However, calculating a stock poses much greater data and conceptual challenges. Furthermore, Wolf (2002) results suggest that the ratio in terms of stocks and flows are of a similar dimension.

⁷ See, for example, Hill and Hill (2009); Diewert (2010) and Heston (2013) for general discussions and Deaton and Heston (2008), Feenstra et al. (2013) with respect to China.

⁸ They note that ‘no specific PPP rate exists for the military sector’ and urge caution when interpreting their economic data since ‘there is no definitive guide as to which elements of military spending should be calculated using the PPP rates available’ (IISS 2012, 215–216).

⁹ The ICP project does not produce price headings for military spending and various non-priced government service price headings are based on labor costs (Heston 2013).

¹⁰ Across all countries, military budgets in 2012 averaged 1.9% of GDP and only 4 countries had a military budget that exceeded 5% of GDP (SIPRI 2012).

¹¹ As discussed below, these are also the only expenditure categories available for China. In the USA, these three categories currently account for around 80% of the total budget. The remaining items are research, development and testing, and military construction (O’Hanlon 2009).

¹² The justification for constant returns to scale follows from the standard replication argument. That is, two identical armies provide twice the services as one of these armies on its own.

¹³ Indices satisfying this properly are referred to as ‘superlative’. Hill (2006) shows that quadratic-mean-of-order-r superlative indices with high values of r are sensitive to extreme values. The Fisher index is the mean-of-order-2 (r = 2) superlative index, and the Törnqvist is the r = 0 superlative index. Though there are an infinite number of superlative indices, the Fisher and Törnqvist are the most widely used. Hill (2006) also notes that the Fisher and Törnqvist indices have additional axiomatic properties that make them preferable.

¹⁴ Naturally, more factor inputs can be included if there is sufficient data.

¹⁵ See also Blasko et al. (2006) who discusses the properties of these shares in more detail.

¹⁶ For example, Blasko et al. (2006) explain that equipment storage and maintenance is included in Operations in the USA, but in Equipment in China.

¹⁷ An alternative approach is to use labor compensation data. The Bureau of Labor Statistics data do not include China, they have commissioned studies to look at China separately (Banister and Cook 2011; Banister 2013). Using these data instead of manufacturing, however, makes very little difference to the results.

¹⁸ Given that defense is a service sector, this is arguably the most significant source of productivity in the military sector since it reduces training costs. There may be differences in the efficiency at which inputs are combined to produce military inputs which are not accounted for. In the analysis, we simply assume any such differences are constant over the relevant time period. Differences in ‘technology’, in the colloquial sense of the word, are captured through differences in spending on Equipment.

¹⁹ Alternatively, we could assume that there is imperfect arbitrage such that , where δ is a constant. This would acknowledge some error in the comparisons of spending levels across countries, but the changes in the relative prices over time would remain the unaffected. This is one reason why the measures of the relative growth in spending across countries, is likely to be more accurate than the comparisons of speeding levels across countries. Another improvement might be to use an imported weighted average exchange rate.

²⁰ It is also an element of the ‘Penn effect’, (Samuelson 1994). Likewise, it can also be thought of the same as the ‘Dutch Disease’ or ‘Gregory Thesis’, but with productivity growth rather than export prices driving the changes (Gregory 1976; Corden and Neary 1982).

²¹ For example, the ratio of China’s to USA GDP deflated by the RMC exchange rates effectively gives the relative military spending of each country that would exist if both countries spent the same fraction of GDP on military services. In 2010, this ratio is between 90 and 96% using the Törnqvist and Fisher indices, respectively.

²² These data are from the World Bank (2014), World Development Indicators and are implicit in the series showing real GDP growth in China relative to the USA using the local currency GDP deflator in Figure 4.

²³ An alternative possibility is that the military has recruited personnel without commensurate wage rate increases, for example, using conscription. This, however, means that there is some increased level of implicit subsidies to the military sector or similar increased burden on Chinese economy. Nevertheless, there is a great deal of anecdotal and official evidence that the wages of military personnel have risen steeply. In particular, a unified wage adjustment policy for all personnel of Chinese government and State enterprises has resulted in rising wages faced by the military sector along with increases in social security and medical benefits (Peoples’ Republic of China’s 2004).

²⁴ According to Thompson (2010) and White (2012), the first Gulf War showed how a large army, in terms of personnel, could be overcome by technological advantage, which led China to respond with a policy of modernization. Shambaugh (2013) also points to the 1995–1996 Taiwan Strait missile crisis where the USA demonstrated its capacity to project its military presence, and its use of stealth technologies in Serbia in 1999 and in Afghanistan and Iraq since 2001. See also US Department of Defense (2011) and IISS (2012).