Abstract
This study investigates the interactions between defense production and the rest of the economy. We develop a two-sector dynamic stochastic general equilibrium model with military and nonmilitary production. Inputs (capital and labor) are distributed between the two sectors. Calibration of the model to key targets of the US economy results in an elasticity of substitution between consumption of goods and services and national defense services of 0.56. The estimated complementarity between consumption goods and defense services results in positive spillovers across military and final goods production sectors, even when the nonmilitary production function is not directly related to military spending. We find that military spending is procyclical and that military spending as a percentage of output is countercyclical. Finally, investment-specific technological shocks to military equipment have a positive impact on nonmilitary output, although they reduce business investment.
Highlights
National defense is a valuable public good, and a fraction of total resources of the economy are expended on military activities for producing defense services
When investment-specific technological change (ISTC) occurs in the business capital assets, we find a positive impact on economic activity, as expected, and in the military sector, as military investment increases
This study investigated the relationship between the military sector and the rest of the economy, using a two-sector DSGE model
Summary
National defense is a valuable public good, and a fraction of total resources of the economy are expended on military activities for producing defense services. With some particular exceptions, devote a fraction of income for military spending, with the aim of providing a sufficient level of national security. According to the Stockholm International Peace Research Institute (SIPRI), military spending as a percentage of GDP in 2018 ranged from 0% in some small countries to 20.7% in Eritrea. Military personnel reached a maximum in North Korea, according to the International Institute for Strategic Studies (IISS), with a military force of 50.5 per 1,000 inhabitants. A major policy determination for governments is the issue of how to allocate resources to maximize social welfare, and the decision on the optimal fraction of resources for military spending. There is no consensus in the literature about the relationship between economic activity and military expenditure, and most recent evidence suggests no relationship between military expenditure and the economy [2]
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