Download The Role of Politics in the Defense

POLTICS, ECONOMICS AND DEFENSE SPENDING
IN SOUTH KOREA
Uk Heo* and Sung Deuk Hahm**
*Uk Heo is associate professor of political science at the University of Wisconsin-Milwaukee
(Department of Political Science, University of Wisconsin-Milwaukee, P.O. Box 413,
Milwaukee, WI 53201, [email protected]). **Sung Deuk Hahm is professor of political economy at
Korea University and faculty associate of the McDonough School of Business at Georgetown University
([email protected]). Currently, he is the SBS visiting professor of the Nitze School of
Advanced International Studies of Johns Hopkins University.
Uk Heo thanks the financial support of the Korean Institute of Presidential Studies (KIPS#
20033). Sung Deuk Hahm thanks financial supports of the McDonough School of Business of
Georgetown University and the Seoul Broadcasting System foundation.
Abstract
With the recent North Korean nuclear crisis along with President Roh Moo Hyun’s
emphasis on a self-reliance defense policy, the level of defense spending in South Korea is going
to increase by 8.1 percent in 2004 and 7.4 percent for the following year. Due to the sluggish
economy, the increase concerns the public. By developing a multi-link defense-growth model
based on macro-economic theories while still accounting for political factors, such as transition
from authoritarian rule to democratic government and electoral cycles, we tested the direct,
indirect, immediate, and delayed effects of defense spending on growth via investment,
unemployment, and export for 1963-2001. We find that an increase in defense spending has a
significant and delayed negative effect on private investment, employment, and export.
However, it has no significant direct impact on growth. We also find that democratization helps
increase private investment. However, democratization has no direct impact on growth, and
electoral cycles have no impact on either employment or growth.
INTRODUCTION
Because of the recent North Korean nuclear crisis and President Roh Moo Hyun’s
emphasis on a self-reliance defense policy,1 the level of defense spending in South Korea is
going to increase by 8.1 percent in 2004 (Digital Chosun Ilbo, September 23, 2003). This
increase is particularly large because the overall national budget decreased by a half percent.
Furthermore, another 7.4 percent increase is projected for the following year (Digital Chosun
Ilbo, September 2, 2003). These increases led to concern over the economic implications of the
increases because they come at a time of high rates of unemployment and gloomy economic
forecasts.
How is the increased defense spending going to affect economic performance in South
Korea? Is the effect direct or indirect? If indirect, through what channels does defense spending
affect growth? Is the effect immediate or delayed? What role does politics play in this process?
Literature on the subject has not provided a clear answer to these questions. That is why Chan
(1995), in his review article, concluded that significant weak links between defense spending and
economic growth still remain in our knowledge so that there is much yet to learn about the
defense-growth relationship.
Thus far, three perspectives have been developed regarding the relationship between
defense spending and economic growth in general: positive, negative, and
insignificant/inconsistent relationships. The argument for a positive relationship focuses on job
creation via contract awards, technological spillover, and enhanced aggregate demand, which in
the short run stimulate economic growth (e.g., Benoit 1973, 1978; Biswas and Ram 1986;
Mueller and Atesoglu 1993).
1
President Roh Moo Hyun came to power on a promise to deal with the United States on equal footing. Therefore,
he emphasizes the establishment of equal partnership between South Korea and the United States. This emphasis
includes a self-reliance defense policy in coping with the threat from North Korea.
1
An opposite argument is based on the opportunity cost of defense spending based on guns
vs. growth trade-offs by crowding out investment, and guns vs. butter trade-offs (e.g., Deger
1986; DeRouen 2000; Heo 1998; Kim 1994; Mintz and Huang 1990, 1991; Mok 1993; Ward and
Davis 1992). In addition, some scholars report that the effect of defense spending on growth is
not significant/consistent enough to have a meaningful impact on economic performance in the
long run (e.g., Alexander 1990; Hwang 1994; Kinsella 1990; Mintz and Stevenson 1995).2
The purpose of this paper, therefore, is to explore how the increases in defense spending
will directly and indirectly affect economic growth in South Korea. Previous studies on this
question, however, overlooked the role of politics. In South Korea, political factors are likely to
have an impact on resource allocation and economic performance because the economy was
developed under the government-led development paradigm. Democratization which started in
the late 1980’s also accelerated economic liberalization.
Thus, in this paper, we employ a multi-link defense-growth model by incorporating
political variables, such as transition from authoritarian rule to democratic government and
electoral cycles (see Deger 1986). Then we test the direct, indirect, immediate, and delayed
effects of defense spending on growth via investment, unemployment, and export for 1963-2001.
Findings of this paper will help us better understand the economic implications of the recent
increase in defense spending in South Korea, and also provide policy implications.
2
Frederiksen and Looney (1983) argue that a crucial determinant in the relationship between defense spending and
economic growth is a country's degree of financial resource constraint. According to them, a country with severely
constrained financial resources often faces budget reductions as the levels of defense expenditures are increased.
These reductions ostensibly come at the expense of public-supported development projects. Moreover, these
reductions also decrease the private sector investment because of the cancellation of potential privately financed
public projects. They conducted an empirical analysis on 37 LDCs and found that resource-constrained countries
had a negative association between defense spending and economic growth while a positive relationship between
defense spending and economic growth in resource abundant countries exists.
2
PREVIOUS STUDIES
There have been many studies investigating the impact of defense spending on economic
growth in South Korea (e.g., Chan and Clark 1990; Chan and Davis 1991; Heo 1996, 1999; Heo
and DeRouen 1998; Hong 1990; Hwang 1994; Kim 1994; Mok 1993; Moon and Hyun 1992;
Park 1993; Yoon 1991). Thus far, however, inconsistent findings have been reported.
Chan and Clark (1990) argue that defense spending in South Korea stimulates economic
growth since defense spending improves security, enhances aggregate demand, increases
purchasing power, and produces positive externalities, which in turn promotes growth. In other
words, high levels of growth allow high levels of defense burden, called a “virtuous cycle.” An
analysis by the Korean Institute for Defense Analysis reports that about 58 percent of South
Korean defense spending during the 1970s had value-added effects on gross domestic product
(Korean Ministry of National Defense 1988; also cited in Moon and Hyun 1992). Defense
programs also made a significant contribution to employment and had significant technological
spin-offs from industrialization by leading the industrial structure from labor-intensive to capitalintensive (see Moon and Hyun 1992).
Hong (1990), on the other hand, finds that defense spending in South Korea crowds out
investment, dampens export, and hampers economic growth for 1961-89. According to Hong
(1990), South Korea enjoyed overall high growth during the period despite the harmful effects of
defense spending because high rates of savings increased capital formation off-setting the
dampening effects of defense spending, the government’s policy promoted export, leading to
economic growth, defense spending contributed to enhancement of the industrial infrastructure,
and high quality human resources due to high levels of education improved productivity (see
Kim, 1994; Mok 1993).
3
In contrast to these findings, Park (1993) reports an insignificant relationship between
defense spending and economic growth in South Korea. According to Park (1993), a developing
country’s political economy is dependent on international division of labor, and politics plays an
important role in economic policy making. Therefore, he develops a defense-growth model
incorporating the power of state, stock of foreign direct investment, and world economic
expansion in addition to defense burden. His analysis reveals that state power plays a significant
role in South Korea’s economic growth, but defense spending has no statistically significant
impact (see Hwang 1994).
Heo (1996), using Mintz and Huang’s (1990; 1991) three-sector production function
based defense growth model, also finds that the direct economic effects of defense spending on
growth in South Korea is not statistically significant. In another study, however, criticizing
Hong’s (1990) under-specified models, Heo (1999) reexamined the direct and indirect effects of
defense spending on economic growth in South Korea for 1954-1995 using Mintz and Huang’s
(1990; 1991) investment model and a mathematically derived four-sector production function
based defense-growth model along with an export model. He finds that defense spending in
South Korea does not directly hamper economic growth, but indirectly hurts the economy by
dampening investment and export in the long run.
On the other hand, Moon and Hyun (1992) argue that the defense-growth nexus in South
Korea should be analyzed on two levels—aggregate and disaggregated levels—because the
aggregate analysis alone can mislead the economic effects of defense spending on growth.
According to them, defense spending seems to help economic growth in South Korea at the
aggregate level on the grounds that South Korea enjoyed high rates of economic growth while
maintaining high levels of defense burden. However, a disaggregate, contextual analysis reveals
4
the negative impact of defense spending on growth due to the opportunity cost of defense
spending in terms of excessive tax burden, uneven resource allocation, guns vs. butter trade-off,
and structural distortion of the economy. Thus, they contend that South Korea is unlikely to be
able to maintain the high level of defense burden.
THEORIES AND MODELS
The Defense-Investment Nexus
According to the investment reduction perspective, there exist various types of trade-offs
(the opportunity costs) between defense spending and investment: 1) competition for the nonconsumption portion of total economic output; 2) budget-induced trade-off (budgetary
opportunity costs); and 3) “pre-empting” a significant share of the capital stock (Chan 1987,
1988, 1995; DeGrasse 1983; Huisken 1982; Mintz and Hunag 1990, 1991; Smith 1980; Smith
and Georgiou 1983).
The reason for the trade-off is that defense increase competes with demand for
investment due to limited available capital resources. Thus, the government often raises taxes or
turns to budget deficit to meet defense needs, which is not healthy in terms of long-term
economic growth. In South Korea, about 30 percent of the national budget goes into the military
sector. Moreover the military sector owns a large amount of capital stock (i.e., land, buildings),
which could have been used for something else. Given that private investment is critical to
economic growth, this investment reduction perspective focuses on the negative indirect effects
of defense spending on growth (see also Hong 1990; Kim 1994; Mok 1993).
To test the economic effects of defense spending on private investment, we employ a
revised version of Mintz and Huang's investment model (1990; 1991) incorporating political
5
factors, which is a modified version of the flexible accelerator model.3 Studies on regime types
and economic performance have shown that regime types affect investment patterns. For
instance, some scholars (Huntington 1968; Rao 1984) argue that democratization hampers
economic growth by unleashing pressure for immediate consumption, which in turn dampens
investment. Furthermore, when people are allowed to organize labor unions and vote, the wages
go up, investment goes down, and governments tend to take people’s income away from
investment by tax for government programs and wealth redistribution purposes (Przeworski et al.
2000: 142-143).
Others (Barro 1990; Przeworski 1990) assert that democratic governments are more
effective in resource allocation because they are concerned about electoral outcomes (see
Przeworski et al. 2000: 142-145). Moreover, democratization improves individual property
rights, which leads to higher private investment. For instance, Olson (1993) contends that
democracy is more conducive to economic growth than autocracy because of its commitment to
the protection of property rights, which helps enhance private investment (see Heo and Tan
2001).
Democratic transition in South Korea was triggered by popular demonstrations in June
1987. Since then, the pressure for political and social democratization as well as economic
liberalization and internationalization has increased. In the process, the legitimacy of
authoritarian executive and bureaucratic arrangements was undercut as a result of challenges
against the government and its marginalization as an effective actor in economic growth.
3
In order to find the best working investment model Clark (1979) compared five different investment models: the
generalized accelerator model, the so-called accelerator cash flow model, the neoclassical model, the so-called
modified neoclassical model, and a securities-value model. After the comparison, he concluded that the flexible
accelerator model performs best compared to other models because of its superior statistical performance and
possibility of estimation. In addition, the model reveals the putative effect of military spending on investment
(Mintz and Huang 1990, 1991).
6
Therefore, the findings of this paper will tell us how democratization affects investment in South
Korea.
In order to keep the theoretical nature of the mathematically derived model of Mintz and
Huang (1990; 1991), we include regime change (democratization) using a dummy variable,
which appears below.
(Investment Equation)
I = a1 +  b11,s P  s +  b12,s NM
n1
s=0
where I =
Y=
P =
NM =
M =
DEM=
s=0
-  b M +b
n3
n2
s
13,s
s
14
DEM
e
1
s=0
Private investment
GNP
P - Pt-1, where P is private business output
NM - NMt-1, where NM is non-military government expenditures
M - Mt-1, where M is military expenditures
Transition to Democratic Presidency
The Defense-Employment Relationship
The employment effect of defense spending has both positive and negative sides. In
terms of positive effects, former US Secretary of Defense Casper Weinberger (1983) argues that
defense spending is labor-intensive, so it helps reduce unemployment.4 According to Chan and
Davis (1991), a military establishment influences the unemployment level because the rate of
conscription or recruitment of young males into the military affects the flexibility of the labor
pool. The military service period may also affect the labor market for the same reason. South
Korea has a conscription system, and the military employs about 600,000 people for active duty
alone.
4
Weinberger contends that each 1 billion dollars spent on military procurement creates about 35,000 jobs in the
United States (Annual Report to the Congress, Fiscal year 1984, Washington, DC: Department of Defense, 1983).
7
In addition, according to the Korean Ministry of National Defense’s White Book on
National Defense (1988), South Korea spent an average of 16.58 percent of its defense budget on
purchasing military equipment for 1961-1987. Since 1982, the percentage has been over 30
percent (see Moon and Hyun 1992). Defense programs also have a multiplier effect on
employment via military procurement. Therefore, defense spending in South Korea both directly
and indirectly creates jobs.5
However, defense spending involves opportunity cost. DeGrasse (1983) and Huisken
(1982) argue that dollar for dollar civilian goods and services provide more jobs than military
expenditures. The reason is that the defense industry generally requires a higher level of
technical sophistication as compared to civilian industry. Aircraft, heavy artillery weapons,
communication equipment, and computer industries all produce very specialized, highly complex
products. These industries employ a high proportion of highly skilled and relatively well-paid
engineers and scientists and a low proportion of blue-collar workers (DeGrasse 1983; Gansler
1980). This argument applies to South Korea, too.
Since professional and technical workers generally have the lowest unemployment rate of
any occupational category, the contribution of defense spending to employment, especially in the
long run, is rather small (Melman 1983). Moreover, defense programs may create serious
structural unemployment in the long run through the effects of slow economic growth, weaker
consumer demand, and declining export competitiveness (Chan 1987: 31). Thus, the question of
the relationship between defense spending and unemployment seems to be empirical rather than
theoretical.
5
Hooker and Knetter (1994) also find that defense procurement helps employment in the United States.
8
The appropriate way of modeling the employment effects of defense spending is an issue
of debate and controversy (Dunne and Smith 1990: 62). The model specification employed in
this paper is motivated by standard theories of labor market equilibrium and is built on the
studies of Dunne and Smith (1990) and Hooker and Knetter (1994).6 Following Hooker and
Knetter (1994), we assume that a country has a long-term equilibrium level of unemployment.
This equilibrium depends on environmental and labor market regulations, industry mix,
economic conditions, and other country-specific factors.
In addition, we also include electoral cycles based on the political business cycle theory.
The political business cycle theory posits that voters cast votes based on past performance rather
than future prospects (Alt and Chrystal 1983). In other words, recent past and current
unemployment rates will seriously affect election outcome. Indeed, a number of scholars (Mintz
1988; Mayer 1995) have shown that electoral cycles affect national resource allocation, which in
turn influences economic performance. The reason is that political leaders want to be reelected
and/or have coattails or have a majority in the legislature (DeRouen and Heo 2000).7 Therefore,
the incumbent president and the political party in power try to minimize unemployment when the
6
A survey of the structure of labor market is in Stephen (1990).
7
There are two types of elections in South Korea. One is the congressional election to select National
Assemblymen every four years. The other is the presidential election to select the president every five years. In the
past, the tenure of a president was uncertain. Under this political circumstance, incumbent presidents strategically
influenced economic performance to be reelected and/or to have coattails. Thus, the government employs a heavy
public consumption policy to stimulate the economy. However, since 1987 the Korean president has had a single 5year fixed term limitation. This new institutional change affects the time horizon of presidential leadership and its
management style. Under this political environment, the incumbent president is more concerned about his political
party’s majority in the legislature for governing rather than his reelection. Furthermore, the new presidential
arrangement will alter the playing field of bureaucratic-executive relations. For example, bureaucrats may tend to
resist ambitious presidential initiatives for economic growth. Sensitive to presidential politics, bureaucrats see such
initiatives as temporary. Championing one might damage the bureaucrat’s fortunes under future presidents. As a
result, those with long-term career ambitions may be hesitant to dedicate themselves to short-term presidential
initiatives to improve employment.
9
election is near (Mintz 1988; Nordhaus 1975). We include both presidential and congressional
elections.8
The empirical model is:
(Employment Equation)
K
J
k=1
j=0
U it =  0 +   1 , s U i,t -k +   2 , s [M ]i,t - j   3 ELEC + e2
where U denotes the unemployment rate, M represents military spending, Y indicates GNP, and
ELEC is electoral cycles. The lagged unemployment term takes into account persistent
deviations of unemployment from its long-term equilibrium. The lagged military expenditure
term allows for the delayed effects of defense spending on unemployment.9
The Defense-Export Link
One of the main arguments against defense spending is that defense spending has an
opportunity cost. The opportunity cost involves human and capital resources. In terms of the
relationship between defense spending and export, defense programs may hamper export by
diverting resources from civilian export industries to military activities in three categories:
research and development (R&D) spending, human resources, and machinery and equipment.
According to Ram (1993), a large portion of the R&D spending comes from government
8
We also test the equations including presidential and congressional elections together and separately in our
empirical analyses.
9
There are two reasons for using a lagged military expenditure term: the impact of military contract awards on
employment may be spread over several years. Thus, its impact on the labor market may be delayed; and, as
discussed in the theory section, defense expenditures may have lagged negative effects on employment because of
the opportunity cost associated with these changes.
10
expenditures. Thus, increased military spending is likely to lower R&D spending in the nonmilitary sector, which in turn hampers economic growth (Kennedy 1987).
Defense spending not only diverts non-military R&D spending, but also has the
opportunity cost of human resources. Due to the conscription system in South Korea, most
young males spend 2-3 years in military service while they could have been used for more
productive economic activities, such as export. Therefore, military service can be seen as an
opportunity cost in terms of human resources since they are diverted from civilian export
activities to the military sector (DeGrasse 1983; Russett 1969).
In addition, Rothschild (1973: 808) contends that, “military expenditure with its large
demands on the engineering and transport sector reduces the availability of machinery and
transport equipment for export.” Given resource constraints in South Korea, these types of
equipment may not be available for export in the most dynamic sector, which in turn leads to
slower growth of export. In other words, defense programs have a bottleneck effect on civilian
resources with respect to human and machinery equipment, which in turn dampens export. Since
South Korea has developed an economy based on export, the negative impact of defense
spending on export is critical to growth.
In terms of testing the relationship between exports and defense spending, we develop a
model based on the macro-economic notion that net exports are negatively correlated with
national income (Hall and Taylor 1988: 87-90). In other words, the model assumes exports as a
function of private sector business output, military spending, non-military government spending
and import.10 Since the exchange rate also plays a critical role in export, we also include the
exchange rate as a control variable.
10
Private sector business output is immediately related to export. However, due to its delayed effect, the previous
year’s military and non-military government spending and import are likely to have an impact on export.
11
Our model is:
(Export Equation)
EX 
EX:
P:
M:
NM:
IM:
ER:
 +  P   2 M  1   3 NM  1   4 IM  1   5ER  e

3
Export
Private Business Sector output
Military Spending
Non-Military Government Spending
Import
Exchange Rate
The Defense-Growth Relationship
Previous studies on the defense-growth relationship have generally employed
longitudinal designs based on the neo-classical production function model. We also follow the
tradition and employ a longitudinal model based on the characteristics of the classical production
function. However, most previous studies have overlooked political factors in developing a
defense-growth model. Models were often based on macro-economic theories, and various
versions of the classical production function approach based on labor, capital, defense and nondefense elements have dominated the literature.
Fordham (2002) has shown that the impact of political factors, such as party control of
the polity on US defense spending matters. Due to the difference in policy orientations of the
two main political parties (Republican vs. Democrat), he found that resource allocations and
economic policies varied over different parties. In South Korea, however, political parties have
not played a major role and/or shown differences in economic policy making because structural
cleavages based on policy orientation that are conducive to the institutionalization and survival
of parties have not developed.11 Instead, democratization has reduced the role of government in
11
Political parties in South Korea have been essentially organizational extensions of presidential candidates or
12
economic performance, because economic liberalization occurred as democracy became
consolidated.
In a review of the relationship between regime types and economic growth, Sirowy and
Inkeles (1990) contend that democratic processes and the exercise of civil liberties and political
rights lead social conditions to be most friendly to economic development. According to Feng
(1997), political and economic freedom in democracies improve property rights and market
competition, which in turn enhance economic growth. Thus, we include democratization in the
empirical model.
The literature indicates that military expenditures have some stimulating effects
(enhancing aggregate demand, improving economic infra-structure, financing heavy industry
(armaments), and producing positive externalities) on economic growth as well as dampening
effects (guns vs. growth trade-off and guns vs. butter trade-off). Since positive effects tend to
appear in the short-run while negative impacts tend to be delayed, we lag defense spending to
test both effects. We also add electoral cycles as a control variable for the reasons discussed in
the defense-employment relationship section.
Our empirical model is:
(Growth Equation)
Y     1I   2 L   3 M   4 NM   5 X   6 ELEC   7 DEM  e
s
0
Y:
I:
L:
M:
GDP
Investment
Population
Military Spending
political leaders. Parties have risen and fallen as the candidates have. It will be interesting to see if parties in South
Korea can free themselves from the moorings of personality and institutionalize themselves that require potential
candidates to bid for nomination.
13
NM: Non-military Government Spending
X:
Export
EC: Electoral Cycle
DEM: Democratization
DATA AND METHODS
Data
Data on GDP, government expenditures, private consumption, gross domestic
investment, exports, and imports are obtained from the International Monetary Fund’s
International Financial Statistics Yearbook. Defense Spending data are from the various issues
of the SIPRI Yearbook. According to Sen (1995), using constant US dollar value is problematic
because of the inadequate comparability of exchange rates. Thus, we employed local currency
(Korean won) data instead of constant dollar values.
Due to the lack of data availability of employed labor, population is used as a proxy,
which is also from the International Financial Statistics Yearbook and has been commonly used
as a proxy in other studies due to the lack of employed labor data availability (DeRouen 1993;
Mintz and Stevenson 1995). Data on the unemployment rate are from the Statistical Abstract of
the Republic of Korea.
All data refer to the 1963-2001 period because 1963 is the first year unemployment data
are available. All data are outlays in calendar years and in constant 1995 prices.
Methods
Estimation
Since we have four equations, there are two ways to estimate: separate
estimation of each equation and joint estimation of the entire system, referred to as Zellner’s
(1962) seemingly unrelated regression (SUR). According to Judge et al. (1985: 470), the latter is
14
asymptotically more efficient than the former only if the contemporaneous correlation between
error terms of the equations is significantly different from zero. Otherwise, separate estimation
of the individual equation is recommended (Kariya 1981: 382).
Due to several methodological issues with joint estimation, we choose to estimate these
equations separately. The issues are as follows. First, we have four equations--and error terms
of the combination of these four equations are not all correlated.12 Second, the Investment,
Unemployment, and Growth equations have a distributed lag structure while the Export equation
does not. Third, there is a collinearity issue in the Growth Equation.
Lag Structure
Since the Investment, Unemployment, and Growth equations include lags
we employ a distributed lag model technique. According to Gujarati (1988: 505-506), a
distributed lag model captures dynamic effects since it features the change of the dependent
variable over time in relation to the past values of independent variables. Due to the lack of a
priori information for the lag structure, an objective information criterion (often referred to as
SC) that is suggested by Schwarz (1978) and recommended by Geweke and Meese (1981) was
employed to determine the optimal number of lags. According to Mintz and Huang (1991: 748),
“this criterion involves a statistic that incorporates a measure of the precision of the estimate and
a measure of the parsimony of the statistical model.”
Autocorrelation
We also test for autocorrelation on the grounds that our analysis is
longitudinal. All the equations except Unemployment have shown autocorrelations (Investment,
d-w=0.84; Export, d-w: 1.35; Growth, d-w=1.32). Using a first order autoregressive model for
12
The results of error terms correlation among the four equations are available upon request.
15
Export and Growth equations, and first order autoregressive moving average model for the
Investment equation, we have corrected the error term serial correlation problem.
FINDINGS
The results of the empirical analysis are presented in Table 1. The results of the
Investment equation reveal that an increase in defense spending has a significant and delayed
negative effect on private investment. It takes about two years for the economy to feel the shock.
In contrast, non-military government spending helps increase private investment with a year lag.
Since the South Korean economy was developed under the government-led development
paradigm and the government played an important role in enhancing the infrastructure of the
economy, the finding is hardly a surprise.
As discussed in the theory section, a debate continues regarding the impact of
democratization on private investment and economic performance. Our finding indicates that
political and social democratization and economic liberalization in South Korea helps increase
private investment. Since democratization led to greater economic freedom of the private sector,
this result also makes sense.
(TABLE 1 ABOUT HERE)
Turning to the Employment equation we find that the employment effects of defense
spending are negative, delayed, and significant. In other words, increases in defense spending
are not helpful in reducing unemployment. This means that employment effects via conscription
in South Korea do not seem to be great. Instead, as Chan (1987: 31) pointed out, due to the
structural unemployment via foregone investment leading to slow economic growth, defense
spending seems to aggravate unemployment in the long run.
16
We do not find a statistically significant effect of the political business cycle on
unemployment.13 The reason might be general elections have been largely based on
regionalism.14
The Export equation shows that defense spending hurts exports almost immediately.
This may be due to limited resources in South Korea. In other words, because of resource
constraints, the trade-off in human, capital, and natural resources between the defense sector and
the private sector may hamper export growth immediately. As expected, business sector output,
as well as imports, helps exports. Greater imports of natural resources for complete products of
exports are likely to lead to increased exports (see Hall and Taylor 1988).
An unexpected surprise is that non-military government spending hurts export. Given
South Korea’s export oriented policy, this result does not make sense. The result might have
occurred because of the ineffectiveness of overall government programs on export.
Another surprise is that the exchange rate shows an insignificant effect on export. The
reason for this result may be found from the 1997 foreign exchange crisis. During the crisis, the
exchange rate more than doubled, but export declined significantly. This unusual situation might
have nullified the significance of the exchange rate on South Korean export.
These unexpected results may also reflect the marginalization of the government’s role in
export, which occurred during the democratization and economic liberalization. Since the early
1960’s the South Korean government has played an active role in economic performance through
policy making and credit allocation. However, in the process of democratization and economic
13
We also test the Employment equation including presidential and congressional elections together and separately.
However, we do not find any statistically significant effects of the political business cycle on unemployment.
14
Political parties in South Korea have been created by individual political leaders based on certain regions. Thus,
election results have often been based on regionalism. In fact, political and economic issues have not had much
impact on election outcomes.
17
liberalization, the South Korean government has made a concession with respect to its role in
economic affairs, such as helping export-oriented industries and controlling labor cost during the
military dictatorship. These changed role of the government undermined the government’s
ability to influence capital financing and export performance.15
Turning to the Growth equation, as macroeconomic theory predicts, all capital and labor
play important positive roles in economic growth. However, we find that military spending does
not have a statistically significant direct effect on economic growth. Non-military government
spending, on the other hand, has a statistically significant positive effect on economic growth. In
other words, the results show that non-military government spending has played an important
role in economic growth over the past four decades, while military spending has not. We do not
find a statistically significant effect of the political business cycle on economic growth. 16
CONCLUSION
With the recent North Korean nuclear crisis along with the emphasis on a self-reliance
defense policy, the Roh Moon Hyun administration has recently proposed an increase in defense
spending. In order to investigate the economic effects of a defense increase, we developed a
multi-link defense-growth model based on macroeconomic theories while still accounting for
political influences and empirically tested it with South Korean data for 1963-2001. Thus,
considering political influences, our contribution to the existing literature on the defense-growth
15
Once the government lost ground in controlling the marketplace, it lost its dominance over capital. In turn, the
utility of the government diminished. No longer was the government necessary as a source of financing, an ally to
suppress consumer and labor demands, or a means of providing protection from foreign competition.
16
We also tested the Growth equation including presidential and congressional elections together and separately.
However, we did not find any statistically significant effects of the political business cycle on growth.
18
trade-off is through theoretical analysis and empirical investigation of other indirect channels,
such as investment, employment, and export.
Our findings reveal that an increase in defense spending has a significant and delayed
negative effect on private investment, employment, and export. However, it has no significant
direct impact on growth. We also find that political and social democratization, which came
along with economic liberalization in South Korea helps increase private investment. However,
democratization has no direct impact on growth and electoral cycles have no impact on either
employment or growth. In other words, the South Korean case does not support the theories on
the positive contribution of democratization to economic performance. Moreover, the political
business cycle theory also needs to be refined to have more general applicability given it has no
impact in South Korea.
The policy implication of these findings is that an increase in defense spending is likely
to degenerate capital and labor resources, which in turn aggravates the current economic
downturn in South Korea. In other words, the planned increase in defense spending is likely to
have economic consequences in the long run.
19
Table 1. The Impact of Defense Spending on Investment, Employment, Export, and Economic
Growth in South Korea, 1963-2001
Variables
Coefficients
t-statistic
Investment Equation
Dependent Variable: I (Investment)
Constant
233763
P
-0.007
P-1
-0.033
NM
0.901
NM-1
4.702
M
-0.397
M-1
-1.282
M-2
-4.587
DEM
8431
Adjusted R2 = 0.98
D-W = 1.90
0.494
-0.179
-0.916
0.796
4.093***
-0.208
-0.405
-1.950*
2.394**
Unemployment Equation
Dependent Variable: U (Unemployment Rate)
Ut-1
0.989
Ut-2
-0.054
Mt
-0.0003
Mt-1
0.0002
Mt-2
0.0006
ELEC
-0.156
2
Adjusted R = 0.44
D-W =1.98
5.666***
-0.309
-0.970
0.623
1.736*
-0.476
Export Equation
Dependent Variable: EX (Export)
Constant
10008
P
0.927
M-1
-6.970
NM-1
-5.889
IM-1
0.542
ER
-9.387
Adjusted R2 = 0.97
D-W = 1.75
0.872
9.618***
-2.679**
-3.453***
2.121**
-1.165
Growth Equation
Dependent Variable: GDP
Constant
1072927
I
1.043
1.656
5.352***
20
L
26898
2.074**
M
4.418
1.449
M-1
-0.893
-0.287
M-2
-4.271
-1.271
NM
3.148
2.140**
EX
-0.026
-0.418
DEM
4074
0.485
ELEC
-252.2
-0.112
Adjusted R2=0.99
D-W=1.59

* significant at .1; ** significant at .05; *** significant at .01
Note:
Y: GNP; I: Investment; L: Population; M: Military Spending; NM: Non-Military Government
Spending; EX: Export; IM: Import; U: Unemployment Rate; P: Private Business Sector Output:
ER: Exchange Rate; DEM: Democratization; ELEC: Electoral Cycles
21
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