Military industry bubbles: are they crowding out utility investments?

Abstract

The rapid growth in defence expenditure in China raises the concern that investments in the defence sector crowd out investments in social sectors, i.e., the ‘guns for butter’ argument. This article resorts to the bubble testing method to study the trade-off between defence and utilities sectors in the Chinese capital market. Based upon the generalized sup Augmented Dickey-Fuller (GSADF) test, this paper captures and date stampings explosive behaviors in defence and utilities industries using stock indexes. Empirical results reveal bubbles for defence and utilities sectors in similar time periods, thus indicating that the factors driving explosive movements are alike for both sectors. However, bubbles in a certain sector do not necessarily crowd out investments in the other sector. Through testing bubbles in the ratio of stock indexes of two sectors, we find that the explosive episodes vanish. The results indicate that the crowding-out effect between defence and utilities sectors does not exist in the Chinese capital market. Increases in the military expenditure in China are necessary to safeguard the national security because of frequent geopolitical conflicts and terrorism. However, the defence to utilities ratio is increasing rapidly, implying the possibility that excessive growth in military expenditure may generate the ‘guns for butter’ problem, which can be detrimental to economic growth.