The Impact of Defense Investment on Economic Growth in the Perspective of Time Series: A Case Study of China

The Impact of Defense Investment on Economic Growth in the Perspective of Time Series: A Case Study of China

Bin Pan (Academy of Finance Research, Wenzhou University, Zhejiang, China), Shih-Yung Wei (Academy of Finance Research, Wenzhou University, Zhejiang, China), Xuanhua Xu (School of Business, Central South University, Changsha, China) and Wei-Chiang Hong (Department of Information Management, Oriental Institute of Technology, New Taipei, Taiwan)
Copyright: © 2014 |Pages: 15
DOI: 10.4018/IJAEC.2014100104

Abstract

By considering the demand and supply effects of defense investment and the uncertainty of the stochastic process of the production and defense investment, this study proposes a stochastic endogenous growth model to explore the impact of defense investment on economic growth. The results suggest that the relationship between defense investment and economic growth rate is nonlinear and obtains the optimal percentage of defense investment to maximize economic growth. Moreover, the impact of defense investment volatility on economic growth rate is subject to production and defense investment interference term's covariance and representative private investment risk preference. Finally, the empirical data are used to illustrate the applicability of the proposed model.
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1. Introduction

There are many empirical studies on the impact of the defense investment on economic growth. For example, Landau (1993, 1996) and DeRouen (1995) found that the relationship between defense investment and economic growth is non-linear. In other words, when the proportion of defense investment is not high, defense investment and economic growth are positively correlated. On the contrary, the defense investment proportion is above a certain level, defense investment and economic growth are negatively correlated. In developing countries, the percentage of defense expenditure against the budget of the central government has been relatively high.

In recent years, the defense expenditure proportion has been declining due to the implementation of the streamlining program of national army of Taiwan. It remains at 15% of the total budget of the central government. Therefore, the impact of defense investment on economic growth is self-evident. In general, defense investment is not a productive governmental investment. From the perspective of resource allocation, an increase in defense investment will crowd out other economic activities, such as private consumption, private investment, public construction, education, medical service, and social security investment.

Therefore, defense investment may not be conducive to economic development. However, among the empirical studies on the relationship between defense investment and economic growth, from the pure economic viewpoints, Deger and Sen (1995) argued that national defense expenditure plays the role of army building and security, and is a governmental expenditure without productivity. Therefore, national military investment is expected to have an adverse impact on economic growth.

As mentioned above, the relationship between defense investment and economic growth may be complex. Benoit (1973, 1978) examined the data of 44 underdeveloped countries during the period of 1950 to 1965, and found that that defense investment has a positive incentive to national economic growth. Shieh et a1. (2002a) termed the phenomenon of the positively correlated defense expenditure and economic growth as “Benoit hypothesis”. Scholars in support of the “Benoit hypothesis” include: Deger and Sen (1983, 1992), Stewart (1991), Landau (1993), Mueller and Atesoglu (1993), Macnair et a1.(1995), Brumm (1997), Murdoch et al. (1997). However, some scholars have proposed the negative correlation between defense expenditure and economic growth, such as Deger and Smith (1983), Faini et a1. (1984), Deger (1986), Mintz and Huang (1990), Ward and Davis (1992), Lipow and Antinori (1995), Yakovlev (2007), and Pieroni (2008). In addition, some scholars have argued that the relationship between defense investment and economic growth is debatable, such as Biswas and Ram (1986), Huand and Mintz (1990, 1991), Mintz and Stevenson (1995).

The theoretical studies on the impact of defense investment on economic growth are mainly conducted through the defense investment model. For example, Deger and Sen (1995) summarized the early literature and concluded that defense investment would affect economic growth through a number of channels in the demand and supply dimensions. For the demand dimension, increase in defense investment can enhance the protection of national security and the representative individual utility level, as well as increase the overall demand, thereby increasing the production utility rate of the idle assets and reducing the unemployment rate. For the supply dimension, the military may provide roads, public service airports, communication networks, transportation networks, and other public services to generate positive effects. Therefore, research models relating to defense investment can be summarized in two forms:

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