Growth and Defense: Pooled Estimates for the NATO Alliance, 1951-1988

Abstract

In two provocative and influential contributions, Emile Benoit [4; 5] uncovered a net positive association between defense spending and economic growth for 44 less-developed countries (LDCs) during the 1950-65 period. Apparently, a larger defense burden, as measured by the share of national income devoted to defense, may have promoted growth for these countries. This finding was controversial and generated an extensive literature that either found fault with Benoit's methodology,' or else investigated the relationship between growth and defense with alternative methodologies. One such methodology relied on an aggregate production function to derive an equation for the sources of growth owing to technological change, labor growth, investment, productivity differences among sectors, and externalities. This supply-side approach was associated with Feder [13] and Ram [22]. When a Feder-Ram model was used, researchers typically discovered either a small positive effect or else no impact of defense on growth. Except for Alexander [1], the Feder-Ram approach has been applied to large cross-sections of LDCs, to cross-sections of LDCs and developed countries, or to individual countries over time. The purpose of this paper is fivefold. First, we extend the three-sector Feder-Ram model to allow for the influence of defense spillin externalities as the defense expenditures of a nation's allies affect the nation's own defense and civilian sectors in either a positive or negative fashion. Spillin externalities can stem from input complementarity or substitutability, procurement practices, joint ventures, or operational considerations. Second, we check the data for unit roots and, when appropriate, cointegration. These tests help us to avoid a dynamic misspecification. Third, we estimate a three-sector Feder-Ram growth equation for each of ten NATO allies for the 1951-