Abstract
This paper analyzes the impact of defense spending on income inequality in 14 NATO countries, using SIPRI data for the period 1977–2007. We account for potential endogeneity by employing a novel instrumental variables approach. Specifically, we use the predicted “shift-share” defense as an instrument, in the fashion of Bartik (Who benefits from state and local economic development policies? WE Upjohn Institute for Employment Research, Kalamazoo, 1991). Our identification strategy indicates that defense causes inequality to decrease. The short-run elasticity of inequality with respect to military expenditure is − 0.075. This finding withstands several tests of robustness. Importantly, similar results are obtained when the long-run relationship is scrutinized via the implementation of second-generation panel co-integration and causality techniques, robust to cross-sectional dependence.
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