The Peace Dividend: Military Spending Cuts and Economic Growth

Abstract

Empirical results suggest that lower military spending in the late 1980s - plus further cuts in military spending should global peace be secured - could produce a substantial long-term peace dividend in higher capacity output. Conventional wisdom suggests that reducing military spending may improve a country's economic growth, but empirical studies have produced ambiguous results on this point. Extending a standard growth model, Knight, Loayza, and Villanueva exploit both cross-section and time-series dimensions of available data to get consistent estimates of the growth-retarding effects of military spending. Military spending is growth-retarding because of its adverse impact on capital formation and resource allocation. Model simulation results suggest a substantial long-term peace dividend - in the form of higher capacity output per capita - that may result from (1) markedly lower military spending in most regions in the late 1980s and (2) future cuts in military spending if global peace is secured. This paper - a joint product of the Macroeconomics and Growth Division, Policy Research Department, and the International Monetary Fund - is part of a larger effort to understand the link between policies and growth.