Dynamic Causalities between Defense Expenditure and Economic Growth in China: Evidence from Rolling Granger Causality Test

ABSTRACT

This study examines the causal nexus between defense expenditure and economic growth in China using the bootstrap Granger full-sample causality test and rolling-window estimation. The full-sample result indicates a positive bidirectional causality between economic growth and defense expenditure, suggesting that more defense spending increases economic growth, and vice versa. By adopting a time-varying rolling-window approach to revisit the dynamic causal relationships, this article identifies that the causality changes over time. We find significant positive short-run causality running from economic growth to defense expenditure in most of the time investigated, thus implying that economic growth stimulates defense expenditure. However, large-scale disarmaments break such positive linkage. Conversely, both positive and negative effects of defense expenditure on economic growth are demonstrated, showing that more defense spending has ambiguous effect on economy. Consequently, economic growth mainly drives defense expenditure rather than the other way around. The impact of defense expenditure in China on national economy is affected by multiplier effect and crowding-out effect as well as institutional factors.

KEYWORDS:

• Defense expenditure
• economic growth
• rolling window
• bootstrap
• time-varying causality

JEL CODES:

• F42
• H56
• O1
• O53

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. According to Waller (1997), China’s defense spending may well be underestimated as a result of budget falsification on the PLA’s revenue and the purchasing power parity of Yuan. The defense spending reported by the Stockholm International Peace Research Institute (SIPRI) Yearbook is widely used in the literature. On the one hand, the accuracy of the spending from the official publication and SIPRI Yearbook cannot be determined either. On the other hand, as noted by Lai, Huang, and Yang (2005), the relationship between defense spending and economic growth in China remains qualitatively the same irrespective of the data source. Therefore, we apply the data from China Statistical Yearbook because such data cover a longer period.

2. Although an interpretation for the selection of 25-year window size was provided earlier, we implemented different bootstrap rolling-window causality tests using 20-, 25-, 30-year window sizes. Furthermore, we estimated the magnitude of the effect of defense spending on economic growth and that of economic growth on defense spending. The results are similar to those from the causality test based on a 25-year window size, indicating that the results based on a 25-year window size are robust. The details of these results are available upon request from the authors.