Download Global Determinants of Defense Budgets: Economic

Global Determinants of
Defense Reform: Economic Liberalization
Robert Looney
Professor, National Security Affairs
Naval Postgraduate School
Conference on Global Determinants of Defense
Reform at the Naval Postgraduate School
Monterey, California, September 9-10, 2005
Outline

Main Issues – Economic Liberalization, and Defense
Expenditures.

Policies of International Financial Institutions -Neoliberalism in the 1990- period.

Operational Measures of Economic Liberalization.

Economic Liberalization and Defense Expenditures –
General Patterns.
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Contrasting Environments of Economic Liberalization,
Institutions, and Defense Expenditures – Resulting
Patterns of Defense Expenditures and Economic Growth.
Implications for Defense Reform.
Main Issues:
Effectiveness of Security Expenditures

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Every society must choose between direct productive
allocation of its resources and reservation of some of
those resources to protection of that production.
From this perspective, resources allocated to defense or
to security are themselves no less potentially productive
than resources allocated to direct economic activities.
Defending persons and property, however, has its dark
side. Powers of enforcement, coercion and punishment
are vested in individuals and institutions.
Will these be effective in their task, contributing to
growth and development, or will they be corrupt,
inefficient and thus detrimental to economic activity?
Main Issues (contd.)
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A complicating factor has been the post-cold war ascendancy
of neo-liberal free market economic policies and associated
expansion in globalization. In theory, both should be
conducive to improved growth and development.
However, each has tended to place pressure on “unproductive”
expenditures. In many instances this has been translated into
declining security budgets, especially in situations where
macroeconomic instability exists.
In many cases the resulting reduction in security expenditures
has created a vicious circle of increased violence, instability
and further macroeconomic instability.
It is becoming increasingly clear that more knowledge is
needed to assess the broader impact of security expenditures.
Specifically, in which situations are productive aspects of
security expenditures likely to prevail over the unproductive?
Does economic liberalization tend to increase or decrease the
effectiveness of security expenditures?
Trilemmas, Economic Integration,
Liberalization and Defense Expenditures
Pot ent ial for
Improved
Economic
Performance
but
Vulnerable t o
Increased
Insecurit y
and
Inst abilit y
Trilemma of
The World
Economy
Implicat ions
for Global
Peacekeeping
Unclear
Increased
Global
Int egrat ion
Golden
St rait jacket
Global
Federalism
Democrat ic
Polit ics
Bret t on
Woods
Compromise
Moderat e
Const raint s
on Nat ional
Defense
Expendit ures
Pot ent ial for
Improved
St abilit y but
at t he
Expense of
Economic
Performance
Severe
Const raint s
on Nat ional
Defense
Expendit ures
Nat ion
St at e
IMF, The World Bank
and the “Washington Consensus”

Adoption of the “Washington Consensus” in the Late
1980s.

Shift from Failed State-Led Development Strategies of
the 1960s and 1970s to Market Led Development.

Fiscal Discipline – Limit Budget Deficits.

Macroeconomic Stability Key Objective of Policy

Public Expenditure Priorities – Redirect Expenditure
Toward Human Capital and Infrastructure.

Tax Reform – Broaden Tax Base and Cut Marginal Tax
Rates.
Washington Consensus (contd.).

Financial Liberalization – Abolish Interest Rate Controls.

Exchange Rates – Introduce Unified and Competitive
Exchange Rate.

Trade Liberalization – Replace Quantitative Restrictions
by Tariffs then Reduce Tariffs Over Time.


IMF and World Bank Empirical Studies Suggested
Defense Expenditures Have Negative Impact on
Macroeconomic Stability and Economic Growth.
In this framework defense expenditures viewed as
unproductive and a threat to macroeconomic stability.
Concern over “excessive” defense expenditures.
Measures of Economic
Liberalization – Fraser Institute
Equates Economic Liberalization With Economic Freedom:
Personal Choice, Voluntary Exchange, Freedom to Compete
and Protection of Person and Property:

Size of Government: Expenditures Taxes and Enterprises.

Legal Structure and Security of Property Rights.

Access to Sound Money.

Freedom to Exchange With Foreigners

Regulation of Credit, Labor and Business.
Measures of Economic Liberalization:
Wall Street Journal, Heritage Foundation
Focus on the Relative Progress Made by
Countries in Moving to a Deregulated, Limited
Government Free Market Environment:
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Trade Policy.
Fiscal Burden of Government.
Government Intervention in the Economy.
Monetary Policy.
Banking and Finance.
Economic Liberalization: Wall Street
Journal/Heritage Foundation (contd.)
Measures of Economic Freedom (contd.):
 Capital Flows and Foreign Investment.
 Wages and Prices.
 Property Rights.
 Regulation.
 Informal Markets.
World Bank Governance Indicators
Key Dimensions of Governance:
 Voice and Accountability – Extent to Which Citizens Able
to Participate in the Selection of Governments.


Political Stability and Absence of Violence.
Government Effectiveness – Competence of Civil
Servants – Credibility of Government’s Commitment to
Policies.

Rule of Law.

Control of Corruption.
Economic Liberalization,
Governance and Defense Expenditures
Environments and The Economic Effectiveness of Defense
Expenditures – Main Issues:

Previous Studies Have Found Positive Links Between Defense
and the Economy in Resource Unconstrained Environments
and Negative Links in Resource Constrained Countries – Do
Similar Patterns Apply to the Relative level of Economic
Liberalization/Governance Reform?

To What Extent Do Economic Environments Control the Level
of Defense Expenditures?

How Do These Environments Influence the Economic
Effectiveness of Defense Expenditures?

What types of Economic Liberalization/Governance are Most
Significant in This Regard.
Differences: High/Low
Defense Expenditure Countries
Key Differences Countries Above/Below Mean for Defense
as a Share of GDP: 2000-2003.


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Foreign Direct Investment – Much Higher in Low
Defense Countries.
Low Defense Countries Better Macroeconomic
Aggregates – Lower Government Consumption – Higher
Savings Rates, but Similar Investment Rates.
Low Defense Countries Had Higher Rates of Growth –
Late 1990s and Early 2000s.
Differences: High/Low
Defense Expenditure Countries (contd.)
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Wall Street Journal/Heritage Economic Freedom Index – Low
Defense Countries Score Consistently Higher. Only Area High
Defense Countries Higher is in Fiscal Burden.
Frasier Index – Low Defense Countries Superior Progresses
Except in Access to Sound Money.
Main Areas of Difference are in Governance – Low Defense
Countries Score Much Higher in All Categories, Especially in
Voice and Accountability – Gap Widened from 1990s.
Regression of Defense Burden on Economic Liberalization –
Statistically Significant Variables: Voice and Accountability,
Fraser Summary Economic Freedom Index, Fraser Legal
Structure Index and World Bank Rule of Law Index – Explain
43% Variance in Defense Burden.
Economic Impact:
High/Low Defense Countries -- Model

Model:
GDPYPG = F(GFCY, AIDPER, GFDIY, GCNPY, MILXY).
+
+
+
?

GDPYPG = Growth Per Capita Income.

GFCY = Gross Capital Formation Share of GDP
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MILXY = Defense Expenditures Share GDP

GFDIY = Gross Foreign Direct Investment Share of GDP

GCNPY = General Government Consumption Share of
GDP.
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Economic Impact:
High/Low Defense Countries -- Results
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Main Results (Statistically Significant):
Total Sample
GDPYG = (+)GFCY (–) MILXY
(consistent with IMF/World Bank View)
High Military Expenditure Countries
GDPYG = (-) MILXY
Low Military Expenditure Countries
GDPYG = (+)GFCY
Interpretation of Results
Previous Research Has Shown That Defense Expenditures:

Have Both Positive and Negative Effects on The
Economy.

The Environment in Which They Occur Dictates Which
Will Predominate.
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High Defense Countries Lagged the Low Defense
Countries More in Economic Liberalization and
Governance Than in Basic Macroeconomic Aggregates.
For the High Defense Countries Positive Linkages
Associated With Defense Expenditures May be
Suppressed by the Their Relatively Low Levels of
Governance and Economic Liberalization.
Economic Liberalization and
Defense Expenditures--Linkages
With High and Low Defense Countries Now Defined With
Regard to their Position Above and Below A Regression
Equation of Defense on Economic Liberalization and
Governance Indices -- Hypothesis:

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Countries Where Key Economic Liberalization and
Governance Indicators Are High Relative to Defense
Expenditures Should Have Positive Economic Effects
from Increased Military Expenditures.
Those Countries Who Have High Defense Expenditures
Relative to Economic and Governance Reforms Should
Have Negative or Neutral Linkages Between Military
Expenditures and the Economy.
Country Groupings:
Main Differences
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Defense Burden (Defense Share of GDP):
Old -- 5.49%(H) vs. 1.49%(L)
New – 3.19%(H) vs. 1.67%(L)
Growth in Per Capita GDP
Old –2.32%(L) vs. 1.88%(H)
New 1.94%(H) vs. 1.76%(L).
Economic Liberalization/Governance
Old -- Low Consistently Better
New – Nearly Balanced With Each Group Superior in
Some Areas.
New Country Groupings
Trends in Defense Burdens
Military Expenditure % GDP
8
7
6
5
4
3
2
1
1988
1990
1992
1994
1996
1998
2000
2002
Legend
Total Sample
Relatively Low Defense Countries
Relatively High Defense Countries
New Country Groupings:
Patterns of Growth
Average Annual % Growth in GDP
3
2.5
2
1.5
1
0.5
0
-0.5
-1
-1.5
1988
1990
1992
1994
1996
1998
2000
2002
Legend
Total Sample
Relatively Low Military Group
Relatively High Military Group
New Country Groupings:
Comparisons of Capital Formation
Gross Capital Formation (% GDP)
24
23.5
23
22.5
22
21.5
21
20.5
20
1988
1990
1992
1994
1996
1998
2000
2002
Legend
Total Sample
Relatively Low Military Group
Relatively High Military Group
Economic Impact: New Groupings
High/Low Defense Countries -- Results
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Main Results (Statistically Significant):
Relatively High Military Expenditure
Countries
GDPYG = (+) GCFY
Relatively Low Military Expenditure
Countries
GDPYG = (+)GFCY (+) MILXY
Summary: Economic Liberalization,
Governance and Defense Impact
Analysis of
Defense
Expenditures
Governance Defense
Environment
New
Country
Groupings
Defense
Higher than
Predicted
Regression of
Governance/
Economic
Liberalization
on Share of
Defense
Expenditures
in GDP
Defense/GDP
Function of:
Voice and
Accountability,
Fraser
Summary,
Fraser Legal
Structure
Rule of Law
Defense
Lower than
Predicted
Group
Profiles
Relatively High
Growth With
Better Levels
of: Openness,
Fiscal Burden,
Voice
Accountability,
Political
Stability
Relatively
High Savings,
Investment
With Better:
Monetary
Policy,
Property
Rights,
Government
Effectiveness
Rule of Law,
Control of
Corruption,
Economic
Liberalization
Defense Growth
Defense -No
Statistically
Significant
Impact on
Per Capita
GDP Growth
Defense -Statistically
Positive
Impact on
Per Capita
GDP Growth
Implications For Defense Reform
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World Bank, IMF View Of Defense Expenditures Implicitly
Assumes Negative Links With Economy--Biased Towards
Arbitrary Budgetary Cuts in Defense Often Neglecting Security
Considerations.
The Trilemma Between Institutions, Nation State and
Globalization May Not be As Binding as Commonly Believed.
There May Be a Variety of Alternative Approaches to Economic
Growth and Globalization Consistent with Good Economic
Performance and Productive Defense Expenditures.
Results Here Suggest A Constructive Approach is Possible -Letting Countries Define Their Security Needs While The
IMF/World Bank Can Push for Complementary
Economic/Governance Reforms.
Implications For
Defense Reform (contd.)
Specifically:

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Rather Than Considering Defense Expenditures as Excessive or
Not Based on Their Absolute Amounts or Share of GDP,
Defense Expenditures Should be Assessed in their Economic
and Institutional Settings.
Within this Context Economic Strategies Should be Designed
in Conjunction Improvements in Key Areas of Governance and
Economic Reform To Reinforce the Positive Linkages of
Defense Expenditures With the Economy.
Selective Economic Liberalization and Improved Governance in
Key Areas Rather Than Across the Board Efforts May Be
Sufficient for This Purpose.
The Key is to Coordinate Economic Liberalization and
Governance Reforms in the Civilian Sector With the
Requirements of Improved Security in the Defense Sector.