Conventional wisdom suggests that reduced levels of military spending are associated with a “Peace Dividend” in the form of stronger economic growth performance. Yet available empirical studies have yielded only partial support for this view.
To unravel the ambiguous empirical findings, this paper estimates an extension of a standard growth model using a panel-data procedure that delivers robust estimates of the effect of military spending on economic growth. The model assumes that high levels of military spending detract from growth both by reducing productive capital formation and by acting more generally to distort resource allocation. In contrast with earlier empirical work, the current panel-data estimates of these adverse effects are statistically significant and sizable.
The recent, marked trend toward lower levels of military spending in many regions of the world augurs well for a future Peace Dividend in terms of a higher growth path of capacity output. The likely quantitative impact of these effects for different geographic regions is simulated. The study finds that the military spending cuts that occurred in most regions in the late 1980s will eventually lead to substantial gains in per capita capacity output, particularly for developing countries in Asia, North Africa, and the Middle East, where military spending ratios were reduced markedly. By contrast, in Eastern Europe and sub-Saharan Africa, where military spending ratios rose in the late 1980s, the output path will eventually be lower than it would have been if military expenditures had remained steady.
The results of a second set of simulations undertaken in this paper suggest that economic growth would be enhanced substantially by deeper cuts in military spending that could become feasible if a generalized international peace were achieved in the future. Furthermore, these Peace Dividend effects, while sizable, may understate the potential gains in economic growth, since a generalized peace would almost certainly result in improvements in other economic determinants of growth. For example, a generalized peace would permit fuller liberalization of trade regimes in a number of developing countries as well as higher expenditures on infrastructure, education, and health.
The major policy implication of this study is that reductions in military spending are potentially attractive elements of macroeconomic adjustment and structural reform programs designed to achieve strong and durable increases in per capita capacity output.