THE DEFENCE-DEBT NEXUS: EVIDENCE FROM THE HIGH-INCOME MEMBERS OF NATO

Abstract

The literature in defence economics has tended to focus on the relationship between defence spending and economic growth. Studies examining the linkage between defence spending and government debt have been relatively rare. Given the recent Global Financial Crisis, originating in the developed economies, and the changed international security picture since 9/11, it is timely to reconsider the defence-debt nexus in the rich economies. This study pays particular attention to developing an empirical strategy which is both soundly based on economic theory concerning the evolution of public debt and which uses econometric methods that are welladapted to the dynamic aspects of the relationship. From the standpoint of economic theory, if a government seeks to minimize the distortionary costs of taxation, then taxation will follow a random walk. Unexpected shocks (war and recession) will cause debt. Other idiosyncratic national-level political considerations that affect the evolution of debt can be factored out by the use of a dynamic panel estimation method. Employing the Arellano–Bond dynamic panel model to the data available from members of the Organization for Economic Co-operation and Development and North Atlantic Treaty Organization over the periods 1988–2009 and 1999–2009, this study finds that the defence burden is a statistically significant and economically important determinant of public debt.