Military spending and growth: a small open economy stochastic growth model

Abstract

The paper analyzes the effects of military spending on economic growth in a small open stochastic endogenous growth model involving the supply-side and demand-side effects produced by military spending. We show that a rise in the military spending affects economic growth through four channels, including the crowding-out effect, the spin-off effect, the resource mobilization effect, and the portfolio effect. The net effect which depends on these four channels is ambiguous. Hence, we demonstrate that there exists an optimal defense burden that maximizes the economic growth rate.

Keywords:

• Military spending
• Stochastic growth
• Small open economy

JEL Classification:

• E22
• F41
• H56
• O40

Acknowledgments

We are grateful to the Editor and the anonymous referees for useful comments on the earlier version of this paper. Any remaining errors are our responsibility.

Disclosure Statement

No potential conflict of interest was reported by the authors.

Notes

¹ For the implications of the supply-side and demand-side effects, please also see Shieh, Lai, and Chang (2002a), Dunne, Smith, and Willenbockel (2005) Shieh, Chang, and Lai (2007), Lin and Lee (2006, 2012).

² The implications of four channels can be stated as follows. The crowding-out effect implies that an increase in military spending will reduce aggregate investment and hence has a negative effect on the expected growth rate. The spin-off effect indicates that a rise in military spending has positive externalities on private production. Obviously, the impact of the spin-off effect on the expected growth rate is positive. The resource mobilization effect implies that a rise in military spending affects the private sector’s consumption propensity and hence has an ambiguous effect on the expected growth rate. The portfolio effect argues that a rise in military spending affects the private sector’s portfolio and then has an ambiguous effect on the expected growth rate.

³ The similar specification of the utility function can also be seen in Brito (1972), Deger and Sen (1983, 1984), van der Ploeg and de Zeeuw (1990), Zou (1995), Chang, Tsai, and Lai (1996), Gong and Zou (2003), Lin and Lee (2006, 2012), Shieh, Chang, and Lai (2007), and Lee and Lin (2012).

⁴ Although these may be standard assumptions in these models, for Equation (2(2) ) point out that foreign military expenditure is exogenous, and that home military expenditure is a fixed share of output, h is a parameter it is not chosen optimally. So this is not an arms race model where military expenditure is endogenous. This point is suggested by an anonymous referee, to whom we are grateful.

⁵ For the same assumption, please see Turnovsky (2000) and Lin and Lee (2012).

⁶ We stress the importance of the supply-side effect and hence let α ≠ 0 holds.

⁷ For the same assumption, please see Shieh, Chang, and Lai (2007), Shieh, Lai, and Chang (2002a, 2002b), and Lin and Lee (2012).

⁸ Combining m = hz and Equation (3(3) ) can obtain z = (ah^α)^{1/(1 − α)}k, as shown in Equation (5(5) ).

⁹ For the proof, please see Appendix 1 which states the analytical process of macroeconomic equilibrium.

¹⁰ The expected growth rate has been derived in Appendix 1.

¹¹ Deger and Sen (1995), Shieh, Lai, and Chang (2002a), and Lin and Lee (2006, 2012) stress the importance of the crowding-out effect, the spin-off effect, and the resource mobilization effect.

¹² For the same notion, please refer to Dixit and Pindyck (1994, 107) and Kamien and Schwartz (1991, 269).

¹³ For the same notion, please refer to Turnovsky (2000, ch. 15).