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“Greece: Military Expenditure, Economic Growth and the Opportunity Cost of Defence” Emmanuel Athanassiou Centre of Planning and Economic Research & Department of Economics, University of Athens Christos Kollias Department of Business Administration, Technological Education Institute of Larissa Eftychia Nikolaidou Department of Economics, Middlesex University Business School Stavros Zografakis Department of Economics, University of Athens Abstract: Greece yearly allocates a substantial share of its national income to defence. Expressed as a share of GDP Greek military spending is about twice as high as the European Union and NATO averages. The paper examines empirically the impact of defence spending on the Greek economy using two distinctly different methodologies. The first methodology uses an augmented Feder-type model to assess the military expenditure – growth relationship in the case of Greece. The second methodology uses a CGE model to estimate the effects on the economy on the basis of the hypothesis that Greek defence spending followed an equivalent downward path in the post Cold War era as on average it did in NATO. The obtained results from the augmented Feder-type model indicate that the defence sector in Greece has had no positive effect on growth while the CGE estimations suggest that a shift of expenditure from defence into non-defence public spending would be beneficial for growth. Keywords: Greece, defence spending, economic growth, opportunity cost, Feder-type model, CGE model 1 1. Introduction Assessing the impact of military expenditure on economic performance is an area that has been growing fast following Benoit’s seminal contribution that provided a strong impetus for research, both theoretical and applied, on the subject during the past two and a half decades approximately. The diversity of the results that have been reported by the numerous empirical studies is such that not surprisingly no consensus appears to exist as to the nature and extent of the economic effects of defence outlays (Dunne, 1996; Ram, 1995; Fontanel, 1990; Gleditsch et al, 1996). This paper addresses the issue of the economic effects of military expenditure in the case of Greece. Greece, a member of NATO and the European Union, presents a particularly suitable vehicle for empirical investigation since for many years it has been allocating a relatively high proportion of its national income to defence. Compared to other countries in NATO and the EU its defence burden (military expenditure as a share of GDP) is often twice as high. At the same time, the Greek economy has gone through periods of high economic growth as well as periods of stagnation and fiscal imbalances. Without necessarily implying any correlation or indeed causation, it is interesting to note that in the past couple of years its growth rates are among the highest in the EU while its defence burden is twice as high as that of the EU average. In the sections that follow we address the impact of defence spending on the Greek economy using two distinctly different methodologies. The aim is twofold. First we want to examine the issue of the impact of military spending on the growth performance of the economy. The results obtained, namely that defence expenditure is largely neutral vis-à-vis growth, contradicts earlier findings using the same method, which indicate a negative relationship. Secondly, given the fact that a) the end of the 2 Cold War brought about significant reductions in the defence budgets of many countries and b) Greek military spending did not exhibit similar downward trends; we want to estimate the effects on the economy had the reduction in defence spending been equal to the NATO average. This scenario is used to illustrate the fact that the defence expenditure growth relationship is affected by changes in regime, but also by changes in the opportunity cost of defence. The structure of the paper is as follows. Section two is a brief overview of the main issues associated with Greek defence spending and the economy with a short literature review. In section three the defence-growth relationship is estimated for the period 1960-96 by employing an augmented Feder-type model consisting of the civilian, military, government and export sector. Then, in section four a Computable General Equilibrium (CGE) model is used to quantify the forgone benefits had Greece’s defence spending exhibited an equivalent downward trend to the NATO average. Finally section five summarises and concludes the paper. 2. Defence and the economy in Greece With a per capita GDP in 1997 of $13912 Greece, in terms of this traditional indicator of development, is placed among the developed nations of Western Europe albeit probably in the lower half of the group being in fact one of the poorest members of NATO and the European Union. The country is situated at a strategically volatile region in the crossroads of three continents. The Balkans have traditionally been an area of friction, tension and conflict and with the collapse of bipolarity the region entered a period of protracted instability as events over the past decade indicate (Glenny, 1995; Larrabee, 1992). 3 In the pursuit of national security, Greece has over the years allocated substantial human and material resources to defence. In comparative terms, Greece is the most militarised country in NATO and the EU (Kollias, 1995a). Expressed as a share of GDP Greek military spending has invariably been higher than the EU and NATO averages. In fact, over the last decade or so, the Greek milex/GDP ratio has been about twice as high compared to the EU and NATO averages. For example in the period 1985-97 Greece on average allocated 5.1% of GDP to defence while the corresponding averages for NATO and the EU were 2.9% and 2.4% respectively (Figure 1). Furthermore, in a period when most defence budgets have been shrinking in real terms, Greek defence spending has increased. For example, according to SIPRI data, in the ten-year period 1989-98 military spending in Greece increased by about 24.2% from $5001 mil. in 1989 to $6211 mil. in 1998 (constant prices). By comparison, total NATO spending fell by about 26.3% from $601 bil. to $443 bil. and total EU defence spending fell from $209 bil. to $183 bil. a reduction of about 12.4% for the same period (constant prices). 4 Figure 1: Military expenditure as a share of GDP in Greece, NATO and the EU Greece ΝΑΤΟ European Union 7 6 5 4 3 2 1 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 In many respects, when compared to other EU and NATO members, Greek security concerns present a unique case that is reflected in the level of resources – both human and material - the country yearly allocates to defence. The Greek defence effort that the various indices reflect cannot be explained only in terms of the broader western security priorities as they have evolved during the bipolar era as well as in the post-bipolar period. Thus, during the Cold War the country’s external security concerns were not only the WTO countries but also its neighbour and NATO ally, Turkey. In fact, Turkey has long been regarded as the main and most imminent source of external threat to Greek sovereignty and national interests. The Greek-Turkish conflict is well documented in the international relations literature (Kurop, 1998; Gurel, 1993; Constas, 1991; Larrabee, 1992). It has also attracted considerable attention in the defence economics literature. A number of studies that have estimated demand functions for Greek military expenditure have reported results indicating that the ongoing conflict with Turkey appears to be an important determinant of Greek military expenditure (Avramides, 1997; Kollias, 1996; 1995a; Kapopoulos and 5 Lazaretou, 1993). Using causality analysis other studies have empirically investigated the hypothesis of a Greek-Turkish arms race with mixed findings. Depending on the methodology, the data and the time period of the study, unidirectional, bidirectional and no causality have been reported (Majeski, 1985; Majeski and Jones, 1981; Georgiou, 1990; Kollias, 1991; Stavrinos, 1992; Georgiou et al, 1996; Kollias and Makrydakis, 1997; Dunne et al, 2000; Smith et al, 2000). Given the well-documented ongoing Greek-Turkish conflict as well as the broader security environment of the region, Greece is forced to allocate a substantial part of its national income to defence at a period when the defence budgets of many European countries are shrinking. This undoubtedly hinders Greece’s efforts to achieve economic convergence with other EU members. In fact, Greece was the only member of the EU that wanted but was not eligible to join the Euro currency area. It hopes to do so in 2000 when its application will be reassessed. On a broader level, despite some impressive rates of growth during the first two and a half post-war decades (Figure 2), the Greek economy has since about the mid-70s been facing serious structural and fiscal problems (Alogoskoufis, 1995; Jouganatos, 1992). Only after a number of successive stabilization programs has the country been set on the road to economic recovery in the last few years, correcting its fiscal imbalances and reducing the rate of inflation. Currently the economy is exhibiting relatively high growth rates 3.2% in 1996-97 and 3% in 1997-98 compared to the EU averages of 2.7% and 2.9% for the same periods. Figure 2: Military expenditure as a share of GDP and GDP growth rates 12 10 8 6 4 2 6 Given the relatively high defence burden, the economic effects of Greece's high defence burden is a subject that has been attracting attention in the relevant literature. The results from the available studies that have attempted to empirically evaluate and quantify these effects are not conclusive. Again, depending on the methodology used - adopting single equation or multi-equation models - and the time period covered by the relevant tests the reported findings are mixed, as Brauer (1999) notes in a comprehensive survey of the studies. A number of them have shown that growth has been retarded through various channels while others have reported stimulative effects through aggregate demand generation (Kollias and Makrydakis, 2000; Antonakis, 1997; 1997a; 1999; Chletsos and Kollias, 1995; Kollias, 1994; 1995; Dunne and Nikolaidou, 1999, Dunne et al, 1999; Nikolaidou, 1999). Studies have also estimated the potential benefits from hypothesised defence spending reductions (Balfousias and Stavrinos, 1996; Kollias and Refenes, 1996). In next sections we address the impact of defence spending on the Greek economy using, as already pointed out, two distinctly different methodologies. The defence-growth relationship is estimated for the period 1960-96 by employing an augmented Feder-type model consisting of the civilian, military, government and export sector. Following that, a CGE model is used to estimate the forgone benefits to the economy had Greece’s defence spending exhibited an equivalent downward trend 7 to the NATO average, illustrating the dependence of the defence expenditure growth relationship on changes of regime and changes in the opportunity cost of defence. 3. Military spending and growth: a multi sector analysis This part of the paper investigates the defence-growth relationship in Greece over the period 1960-1996 by employing a commonly used supply-side model, the Feder-type. Although the Feder-type model can be employed in either the “overall” form or the “augmented” form in which case externality effects and productivity differences of each sector are separated from the total (overall) effects, this is not the concern of the present paper1. In this paper we account for as many economic linkages as possible by decomposing the economy in four sectors, the civilian, the military, the government and the export sector while the common approach is to decompose the economy in two sectors - the civilian and the military). The aim is to examine the sensitivity of the model to the inclusion of the extra sectors. 1 For an empirical application of the “augmented” Feder-type model for Greece see Antonakis (1997, 1999) and Nikolaidou (1999). 8 3.1. Model Specification In the Neoclassical framework, supply side models for the defence-growth relationship have developed from Biswas and Ram (1986) who adopted Feder’s (1982) model of the role of exports in economic growth, as a two-sector framework (military and civilian) to assess the externality effect of the military sector and the factor productivity variation between the two sectors. Since then, many versions of the Feder model have been developed (ie. assuming different sets of externalities or more sectors) with most of the studies employing cross-sectional methodologies.2 The form of the model used here assumes that the economy consists of four sectors mutually exclusive and exhaustive: the civilian sector (C), the non-military government sector (G), the export sector (X) and the military sector (M) so that total output of the economy is the sum of the civilian output, the non-military government output, the export output and the military output. That is: Y=C+G+X+M (1) Capital and labour are allocated among the four sectors at each point in time. So, that: K = KC + KG + KX +KM and L = LC + LG + LX + LM (2 a, b) where uppercase subscripts denote the civilian sector (C), the non-military government sector (G), the export sector (X), and the defence sector (M). Each of the M, G and X sectors has an externality effect on the civilian (C) sector. For this approach the production functions for the four sectors are: G = G (KG , LG) M = M (KM , LM ) (3 a, b, c, d) 2 For example Ward et al (1991), Ward & Davis (1992), Huang & Mintz (1991), Mintz & Huang (1990), Atesoglou & Mueller (1990), Mueller & Atesoglou (1993), Ward, Davis and Chan (1993). 9 X = X (KX, LX ) C = C ( KC , LC , G, X, M) where subscripts C, M, G, X denote sectoral inputs. Allowing for relative productivity differences between the “base” sector (civilian) and the other three sectors, ie by (1+∗s24 ), the ratios of the marginal productivities for the sectors are: ML /CL = MK / CK = (1 + ∗m) GL /CL = GK/ CK = (1 + ∗g) (4 a, b, c) XL /CL = XK /CK = (1+ ∗x) where the uppercase subscripts on M, G, X, C denote partial derivatives (or marginal products) of labour and capital (ie. ML=θM/θLm and MK = θM/θKm). Also, the size of M, G, X may act as “externality” factors for the civilian sector (C). In other words, the model also identifies marginal externality effects of each of the three sectors (M, G, X) on the civilian sector (C). So, we will have: GK =(1+∗g) CK and GL = (1+ ∗g) CL XK = (1+∗X) CK and XL = (1+∗X) CL MK = (1 + ∗m) CK and (5 a, b, c) ML = (1 + ∗m ) CL 24 where ∗i is the relative factor productivity between the “base” sector and the other three sectors. If for example the productivity index for defence δm is positive then the defence sector is more productive than the civilian sector. A zero value for δm would indicate the absence of a productivity difference while a negative value for δm would indicate that the civilian sector is more productive. Due to unavailability of sectoral input data the model is reformulated in terms of aggregate inputs. The equation for 10 this approach that gives the “overall” effect can be derived by manipulating the production functions (Feder, 1982; Ram,1986;1989; 1995) : • Y =α • é • G éæ δ ö ù • M éæ δ ö ù• X δg I ÷÷ + CG ú Gæç ö÷ + êç x ÷ + CX ú X æç ö÷ + êç m ÷ + CM ú M æç ö÷ (6) + β L+ êçç Y êë 1 + δ g ú è Y ø êëè 1 + δ x ø ú èYø ú è Y ø êëè 1 + δ m ø where α is the marginal product of capital in sector C (civilian), β is the elasticity type measure equal to CL(L/Y), and [δi/1+δi +Ci] is the sum of the externality and factor productivity differences (the overall effect of sector i on economic performance). (δi/1+δi ) alone is the relative productivity effect of the i sector on economic growth while Ci alone represents the marginal externality effect of the i sector on the civilian sector (Huang and Mintz 1991). Adding an intercept and a disturbance term, gives the equation to be estimated for Greece over the period 1960-96 to get the size (total) effect of each of the sectors on economic growth. Note that in order to estimate equation 6 we replace the instantaneous change rate of variables with their discrete • equivalents (ie. Y =∆Y/Y-1 ). The four-sector Feder-type model for Greece specified above, defines simple externalities from each of the defence, export and non-military government sector only on the base sector (civilian sector), derives values for nonmilitary government spending by deducting military spending from total government spending, provides estimates for a two, three and four-sector model in order to compare the results each time a sector is added. As such, it overcomes a number of shortcomings3 associated with this type of model. 3 For a discussion of the shortcomings and advantages of the Feder-type model, see Nikolaidou (1999). 11 3.2. Data and Empirical Findings The military expenditure data used here is drawn from SIPRI Yearbooks. Usually labour force data is not available and its growth is proxied by the population growth rate (Ram, 1986; Ward et al, 1991; Alexander, 1990). For Greece, labour force data was in fact available from 1970 onwards, with labour force growth proxied by population growth prior to 1970. Data for GDP, investment, government expenditure, exports and labour force were taken from the OECD database. All figures were first deflated in constant 1990 million drachmas and then converted to 1990 million US $ by means of exchange rates. To measure non-military government spending military expenditure was subtracted from government expenditure. This overcomes the problem exemplified by Alexander (1990) where government consumption was used as a proxy for non-military government consumption leading to an overvaluing of government consumption by the amount of military expenditure (the variables are described in the Appendix). Table 1 shows the results for the total (overall) effects of each sector (equation 6). The first column gives results from the two-sector model (military and civilian), the second column from the three-sector model (civilian, military and government) and the third column gives results from the four-sector model (civilian, military, government and export). 12 Table 1. Estimation Results (1961-1996) Dependent GDP Growth Indep.Var. Eq. 6 Eq. 6 Eq. 6 Intercept -0.03 (1.23) -0.03 (1.15) -0.03 (1.29) I / Y−1 0.33 (3.06)*** 0.27 (2.51)** 0.26 (2.39)** ∆L / L−1 -0.92 (2.50)** -0.95 (2.71)*** -0.83 (2.21)** ∆M / M −1 ( M / Y−1 ) 1.59 (1.84)* 0.43 (0.42) 0.37 (0.36) ∆G / G−1 ( G / Y−1 ) ------ 1.04 (1.92)* 1.14 (2.05)** ∆X / X −1 ( X / Y−1 ) ------ ------ 0.49 (0.90) R2 0.41 0.47 0.48 SE 0.03 0.02 0.03 DW 1.66 1.74 1.54 F-stat F(3,32)=7.3*** F(4,31)=6.85*** F(5,30)=5.61*** X2(1)=0.06 [.801] X2(1)=0.01 [.918] X2(2)=9.74 [.008] X2(1)=1.08 [.299] X2(1)=0.03 [.861] X2(1)=0.05 [.830] X2(2)=10.94[.004] X2(1)=0.18[.675] X2(1)=0.63 [.427] X2(1)=0.05 [.825] X2(2)=8.80 [.012] X2(1)=0.45 [.501] Diagnostic Tests Serial Cor. Funct.Form Normality Heterosc. The top columns give the coefficients estimates followed by the t-ratios (in parentheses) while the bottom columns give the X2 tests for Serial Correlation, Functional Form, Normality and Heteroskedasticity followed by the probabilities (in brackets). ***: significant at 1% level of significance,**: significant at 5% level of significance, *: significant at 10% level of significance. For all estimations Microfit 4.0 was used. Looking at equation 6, that describes the total (size) effects of each sector on economic growth, it is obvious that the overall performance of the model in terms of explanatory power is not very satisfactory with the R2 being 0.41, 0.47, 0.48 for the two, three and four sector models respectively. But another consideration when evaluating the overall performance of this model, concerns the coefficients on the investment and labour variables since as Mintz and Stevenson (1995) point out “In general, one would be more confident in the specification of the model if the coefficients on these variables conform to the standard predictions of the economic 13 theory”. If for example investment is found significantly negatively related to economic growth, the validity of the model should be questioned. But this is not the case for any of the three specifications of the model for Greece in all of which investment is positive and highly significant. Labour force growth on the other hand has an unexpected significantly negative effect, which is problematic as it does not conform to the standard predictions of the economic theory although the theories underlying the impact of labour on the economy are less conclusive than that of investment. Its significance might suggest that, in Greece, increases in the workforce do not necessarily imply a more productive workforce. In fact, this is not an unusual finding as Ward et al. (1991) argue. Furthermore, Antonakis (1997) in his two-sector model for Greece found a negative but insignificant effect for the labour force4 variable justifying it on the grounds that in labour surplus economies like Greece, the natural rate of growth is not a binding constraint. As far as the total effect of the military sector is concerned (in the 2 sector model) it is positive and significant at 10% supporting the modernisation and spin off arguments for defence spending. On the second column of Table 1, the government sector (excluding the military) enters the equation with a positive sign, significant at 10%. As for the effect of the military sector, it is still positive but now insignificant. The intercept, investment and labour force growth continue to have the same signs as before with their significance slightly altered. Finally, by adding the export sector (see column 3 of Table 1), all of the variables’ signs remain the same, the significance of the government sector increases (from 10% to 5%) and the significance of investment and labour force growth drops slightly to 5%. The effect of the export sector is positive 4 Antonakis (1997) as most other studies have done, proxied labour force growth by population growth. But this can cause the impact of labour growth to be underestimated, especially in cases where the size of the labour force changes significantly while population remains stable (almost stable population is a fact for Greece). 14 but not significant, which is not surprising for a country like Greece that mainly exports agricultural products. As for the constant term, which measures an average trend rate of technological progress, it is insignificant in all three specifications. Non-nested tests indicated that the three and four-sector models are preferred to the two-sector one, while no clear cut preference could be made among the three and four-sector models (as the Akaike’s information criterion was in favour of the four-sector model while the Schwarz Bayesian criterion was in favour of the threesector one). Given this, plus the fact that results are very similar for the three and four-sector models, reliance on either model is acceptable. It would appear that the military sector in Greece does not have a significant impact on economic growth, and that the same applies to the export sector. Only the non-military government sector seems to be growth promoting in Greece. This is in contrast with earlier findings5 although this may be due to differences in the time periods used or the difference in outcome may be due to a change in regime and a resulting change in the opportunity cost of defence (Murdoch et al. 1997). 4. Change of Regime and the Opportunity Cost of Defence: As pointed out, the results concerning the effect of defence expenditure on growth of the first part of the paper conflict with earlier findings using the same methodology. It has been suggested that the relationship between public defence, public non-defence and non-public expenditure on the one hand, and growth on the other, may be affected by changes in regime, that will in turn affect the opportunity cost when undertaking different types of expenditure. In this section we attempt to illustrate this possibility through the use of a CGE model, trying to capture what the 5 Antonakis (1997) reports a strong negative effect 15 change of regime represented by the end of the Cold War would have had on the Greek economy, had no other threat to security existed. In order to circumvent the numerous problems associated with public good pricing, we make the simplifying assumption that decisions are taken in such a way so that the change in the slope of the production possibilities frontier reflects the relative marginal costs in undertaking a particular pattern if expenditure. Thus a measure of the opportunity cost would be the difference in the growth rate owing to a change in the pattern of exogenous expenditure. In this part of the paper, we attempt an analysis of the structural incidence of a hypothetical reduction of current defence spending, as opposed to investment and labour expenditures, to the average NATO level. Furthermore we obtain results for alternative substitute expenditure patterns. Given that there has been practically no reduction in the level of current defence expenditure in Greece since 1988, the calculations consist in the calculation of a set of opportunity costs cum regime change effects reflecting the particularity of Greek defence needs. The tool of analysis is a Computable General Equilibrium model for Greece, (Zografakis, 1997; Sarris and Zografakis, 1997; Dervis et al, 1982) which incorporates the national accounting relationships of the 1988 Social Accounting Matrix (SAM) for Greece. The choice of base year for the analysis although dictated by the availability of data is fortuitous since it corresponds to the beginning of the dissolution of the command economies of eastern Europe, and the resultant defusion of East-West tensions. The SAM framework permits the inclusion in the analysis of multiplier effects that work through the distribution of income as well as through transfers between institutions. This is particularly important for countries like Greece 16 where the bulk of armaments procurements is of foreign provenance, thus the direct structural effect of such spending is minimal. The SAM adopted here, disaggregates the national accounts into fifteen sectors6. The labour input is divided into four categories according to skill, agricultural, unskilled, skilled and highly skilled. There are two classes of employment possible, salaried and self employed. Labour is assumed to be perfectly mobile between sectors of economic activity. Capital is sector specific and due to the comparative static nature of the analysis is kept fixed at the initial level. In what concerns the aims of this paper the government sector net of health and education expenditures was broken into two components, defence and non-defence. The model comprises the real sectors of the economy only, excluding the financial sector. Thus interest rates enter as a parameter into the analysis. The functioning of three types of market regulates production and exchange, that for goods, inputs and the foreign sector, so that prices and quantities are endogenous to the model. Commodities offered in the domestic market are composites of domestically produced and imported commodities. (see Appendix IIa). Aggregation is made through use of a CET function, the domestic and imported goods being considered imperfect substitutes according to the Armington specification (Armington, 1969). The same specification is adopted in order to determine the composition of production between exports and domestically offered goods. Domestic prices and wages are determined endogenously, and are determined by market clearing equations. The exchange rate is adopted as the numeraire, and thus set to unity. Prices of imports are taken as given, following the small country 6 See Athanasiou et al (1998) 17 assumption. Labour is offered as a function of the real wage rate, private investment is determined by the return on capital while public investment is a policy variable. Demand of commodities is formed by private consumption, investment in dwellings, government expenditure and investment, private investment, stock variations and exports. These demand elements are allocated over the set of commodities. Production technology in the model is of the CES type. A multi-layered nested CES format allows the consistent aggregation of the large number of disaggregate inputs by stages, per sector of economic activity and type of input (see Appendix II). Thus, at the highest level of aggregation the production function accepts two inputs, a quantity of labour - intermediate goods and a quantity of capital - energy, each being the result of aggregation of the different specific types of inputs. There are three closure rules that characterise the model and encompass the assumptions about the working of the economy. The first concerns employment and is of the neoclassical variety, thus full employment of labour is assumed. That for investment is of the Keynesian variety, with the investment rate determining the savings rate. Finally, the external sector is dominated by exogenous transfers from abroad reflecting the importance of EU and other non-market transfers to the Greek economy. In summary the model exhibits the following characteristics: 1. It considers explicitly market clearing mechanisms, and related price formation, in the economy; prices are computed by the model as a result of supply and demand interactions in the markets, in which economic agents are price takers. 2. It formulates separately the supply or demand behaviour of the economic agents in the individual optimisation of their objectives, within markets that are cleared by prices that achieve global equilibrium. 18 3. The model exhibits a large degree of disaggregate detail concerning sectors, social groups, structural features and policy oriented instruments (e.g. taxation). The figures for defence spending were taken from the 1989 budget reporting realised expenditures for 1988, and were subtracted from the government consumption figures in the original SAM matrix. Elasticities used in the model are based on estimates undertaken for the HERMES7 econometric model and GEM-E3 (Computable General Equilibrium Model for studying Economy-Energy-Environment Interactions for Europe8) 4.1 Results of Simulations The question we seek to answer is what would the effects on the Greek economy be if the reduction in current defence expenditure (i.e. excluding labour and investment expenditure) were equal with the average decrease for NATO countries over the period 1988 - 1996. In fact, since current defence expenditure in Greece has practically remained constant for the period in question, the question is what the peace dividend would be if a considerable reduction in this type of expenditure had taken place. We examined five different counterfactual cases. In the first, current defence expenditure was reduced by about 25%, the NATO average for the period under examination. Since the interest rate in our model is exogenously given, the private sector cannot compensate for the reduction in public spending, so this case can be viewed as an initial impact scenario. In fact we use it as a benchmark case to assess 7 Harmonised Econometric Research for Modelling Economic Systems, Edited by: Commission of the European Communities, North-Holland, 1993. 19 the influence of this type of defence spending on the structure of the economy, in order to better be able to interpret the results of the other scenarios. In the second case we consider the effect of a decrease in current defence spending by the same amount as above, which however is compensated by expenditure on public consumption in such a way as to leave the shares of the various non-military consumption items constant. Non military public consumption is divided into three categories, education, health and other government. The three last cases consist in exactly compensating the reduction in military expenditure by increases in expenditure of each of these categories alone. Given that the composition and share in GDP of government current expenditure in Greece has remained practically constant over the period in question, we are in fact considering a two tier “what - if” situation. First, we estimate the peace dividend, as if Greece faced a level of national security similar to that of the average NATO country. Second we examine alternative uses of this peace dividend, and hence the opportunity cost of defence spending, always remaining within the constraint that current public expenditure remains constant. Table 2: Effects on National Accounting Aggregates (percent deviation from reference) A Defence -24.9% B Defence -24.9% Gov.Cons. (non def.) 7.156% C Defence -24.9% Gov. Education D Defence -24.9% Gov. Health +40.05% E Defence -24.9% Other Gov. Cons. +13.14% GDP f. p. -0,45% 0,19% +26.4% 0,26% -0,10% 0,24% Private Investment -1,51% 0,67% 0,84% 1,48% 0,39% Total Exports 0,81% -0,40% -0,45% -0,81% -0,29% 8 The GEM-E3 model was built under the auspices of European Commission (DG-XII, co-ordinator P.Valette) by a consortium involving CORE, NTUA, KUL, Univ. Mannheim, Univ. Strathclyde and CEA. 20 Total Imports -3,27% 0,39% 0,53% 1,75% 0,02% Private Consumption -0,53% 0,37% 0,50% 0,43% 0,33% Consumer Price Index (CPI) -4,71% 2,59% 2,87% 5,74% 1,79% Real Wage Rate -1,07% 1,06% 1,17% 1,28% 1,01% Employment (Thousands) -14,67 11,55 13,29 12,73 11,16 In Table 2, column A, we see the impact of a once for all reduction in current defence spending to the NATO average level. GDP would decrease by about half a percentage point. The GDP components would all decrease except exports which would benefit. Consumer prices would decrease by close to 5%, a figure that may be compared to the actual increase of the CPI for the period ranging from 20% at the beginning and 10% at the end of the period. Real wages would drop by about a quarter of the drop in the CPI. The drop in real wages would be higher the higher the skill level of the work force. Employment would decrease, the lower skill categories decreasing relatively more. Comparing the four alternative cases, we note that if the compensation is such that the shares of the non-military expenditure categories are kept constant at the 1996 composition, the results fall in between the cases where the totality of the compensation is imputed to one category alone. This is not surprising due to the homogeneity assumptions made in the construction of the model. Generally speaking, expenditure on education seems to be the best alternative, followed by expenditure in other government. Expenditure on health is the worst alternative, and in many cases is worse than military expenditure itself. Of course both these types of expenditure affect welfare by reducing two important types of risk, and this is not taken into consideration by the static, non-stochastic framework adopted here. 21 The effect of compensating the decrease in current defence expenditure would add 0.2 of a percentage point to GDP from 1996 onwards. This is about 10% on the actual growth rate for that year. This growth could increase to 0.26% if the compensation was accomplished by increase in education alone, or become a 0.1% decrease if health alone takes up the slack. Expenditure in other government services would result in almost as high a gain in GDP as education, but with a lower increase in private consumption and private investment. An increase in GDP similar to that of education is achieved by the relative smaller impact that this combination of expenditure will have on both exports and imports. This scenario will also be kindest to price increases but also will result in the lowest increase in real wages. Expenditure on health comes off badly in growth enhancing terms due to the increased requirements for imports, and the relatively important decrease in exports. Private investment would increase the growth rate the most, while the rise in private consumption would be slightly less than that seen in the case of education. The effect on prices would be considerable, while that on wages would also be greater than that of the case of education. A significant result is that current defence spending seems to be directed more towards the domestic economy than any other type of expenditure. It is the only category of government expense that is positively related to exports and negatively to imports. Given that Greece is not a major arms exporter, it would seem that current defence spending is directed to domestic goods, which are complementary in their factor requirements to exportables. 5. Conclusions The results obtained from the application of the Feder methodology for the case of Greece for the period 1960-95 indicate that the effect of defence spending on 22 growth is neutral, in contrast to non-defence public spending which has a positive effect on growth. This is in contrast to earlier findings, which showed that defence spending has a negative effect on growth. The change in the estimated coefficients may well depend on a change in regime (or set of regimes) due to the different time spans covered. While the difference in the results is interesting in itself, the policy implications do not change. A shift of expenditure out of defence and into nondefence public spending would seem to be beneficial for growth. Using a CGE model we examined such a case. In contrast to the two cases mentioned above we used data for defence expenditures excluding expenditures relating to weapons systems procurement. Our base year is 1988, which coincides with the beginning of the change in the security regime as represented by the collapse of the Warsaw Pact threat. The results indicate that there is a positive relationship between transfers of expenditure from defence to non-defence public expenditure and growth. This supports the findings of the Feder type applications to the case of Greece. Furthermore, while transfers from defence to non-defence expenditure may be favourable to growth, it is less so than when the transfer is exclusively to general government expenditure, or expenditure on education, while when expenditure on health substitutes for defence the effect is negatively related to growth. 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(1997) "Economic Policy and Impacts on the Evolution of Income Distribution in Greece: An Analytical Approach based on a Computable General Equilibrium Model", unpublished PhD Thesis, Department of Economics, University of Athens, Greece. 26 APPENDIX I Description of variables in the Feder-type model • Y = ∆s24 Y/Y-1 = GDP growth I / Y = I/Y-1 = Share of investment in GDP • ng1032 L = ∆L/ L-1 = Labour force growth • M ÷ = ∆M/ M-1 ( M/Y-1 Y • G Gç ÷ Y = ∆G/ G ( G/Y ) = Total effect of non-military government sector Mç 4 )= Total effect of defence sector -1 • Xç -1 X ÷ = ∆X/ X-1 ( X/Y-1) = Total effect of export sector Y • C M ç ÷ = ∆M/ M-1 (C/Y-1)= Externality effect of military sector Y • C æ ö Gç ÷ = ∆G/ G-1 ( C/Y-1) = Externality effect of non-military government sector èY • C X ç ÷ = ∆X/ X-1 (C/Y-1) = Externality effect of export sector Y where C=Y-M in the two-sector model C=Y-M-G in the three-sector model C=Y-M-G-X in the four-sector model δm= productivity difference of the military sector with respect to the civilian sector δg= productivity difference of the government sector with respect to the b civilian sector δx= productivity difference of the export sector with respect to the civilian sector and Y=GDP in constant 1990 mn US $ M=Military Expenditure in constant 1990 mn US $ G=Government Expenditure (excluding military) in constant 1990 mn US $ X=Exports in constant 1990 mn US $ tab I=Private Investment in 1990 mn US $ L=Labour Force in ‘000s 27 APPENDIX IIa The structure of Consumption Disposable Income Consumption Investment in Dw ellings Saving expend. for cars Durable Goods expend. for domestic appliances Non-Durable Goods Food, beverages, tobacco Medical care and health expenses Products Services Education and Culture Energy Clothing, footwear Recreation, Entertainment Heating Systems Others goods and services Communication Services Electricity Transport Services (purchased transport) Vehicle (Petrol for cars) 28 APPENDIX IIb The structure of production Production function product Aggregate: Capital - Energy CES function Capital Aggregate: Labor - Materials CES function Aggregate Labor Energy Employed Labor CES aggregate function skilled labor - Urban Materials (Factor demand Interm. Consump. of non-Energy Products) Self Employed CES aggregate function skilled labor - Urban semi-skilled labor - Urban semi-skilled labor - Urban unskilled labor - Urban unskilled labor - Urban in agricultural sector 29 in agricultural sector