APPENDIX:I Military Expenditure Data
The primary data sources for military expenditures is the Stockholm International Peace Research Institute (SIPRI), supplemented by the US Arms Control and Disarmament Agency (ACDA). The data sources for the other variables are based upon published data by the IMF, the World Bank, the United Nations, the U.S. Central Intelligence Agency, and national accounts.
The SIPRI estimates of military expenditures were chosen because they are probably the most reliable and conform to a consistent definition. For the purposes of this study, two types of modification to the SIPRI data are made. First, the U.S.S.R. and China are among the countries omitted from the SIPRI data set. ACDA estimates for Chinese military expenditures are the only known time series source. In the case of the U.S.S.R., estimates of military expenditures are based on Steinberg (1990). Steinberg’s estimates are provided in local currency, his definition is comprehensive and compatible with SIPRI’s definition, and the latest estimates include an adjustment to account for price differentials within the U.S.S.R. The reader is cautioned that the military expenditure figures of both the U.S.S.R. and China are not as reliable as some of the other figures. However, it seems likely that they provide a credible estimate of the trend.
The SIPRI figures represent total government outlays on the military including military pensions, military interest payments, and paramilitary expenditures; they exclude police. SIPRI follows the NATO convention of including military aid to other nations in the military expenditures of the donating country, and does not include aid receipts from other nations in the military expenditures of the recipient countries,
SIPRI military expenditures -
Ministry of Defense budget
- non-military expenditures of the defense ministry
+ military outlays of other ministries (including military pensions and interest payments)
+ military aid to other nations
- military aid receipts from other nations.
Thus, the SIPRI military expenditures represent the domestic opportunity cost of military appropriations plus military aid to allies, or the total level of resources allocated for military purposes by a country, excluding expenditures funded by aid from foreign governments.
There are a number of potential problems with the SIPRI estimates. First, SIPRI explicitly does not include aid financed military spending. Second, military expenditures are often hidden in the budgets of other ministries. Third, off-budget expenditures financed through other means are often omitted. For instance, expenditures financed through foreign loans, direct earmarked payments to the military of mineral revenues, or funds obtained through asset sales or profits of public enterprises maybe omitted. SIPRI does make some adjustments to account for these factors. For instance, in several countries direct payments to the military of revenue from petroleum or copper sales are added to the military budget. In others, adjustments are made when high imports of military goods are detected without a corresponding change in the Ministry of Defense budget. In a few cases, an in-depth examination of the budget is carried out to reclassify expenditures. However, particularly for the small low profile countries, the budget estimate are used without modification.
The development index and form-of-government variables are constructed variables. The form-of-government variables are interdependent dummy variables constructed from descriptions in Sivard (1991), SIPRI Yearbooks, and the Europa World Yearbook. The benchmark is a multiparty democracy not engaged in internal or external conflict. In a monarchy, power is transferred through heredity. Where there is both multi-party democracy and a monarchy present, these are categorized as democracies. A military government refers to the means by which the authority gained power and the status of the ruler before taking power. A socialist government is one that does not fit into the other categories and where the self-proclaimed ideology of the leadership is consistent with socialist ideology. The category of others refers to states that do not unambiguously fit into one of the above groups, for instance, one-party states and politically unstable states. The number of countries in each category is listed in Table 9; certain countries change status over the time period under review.
The concept for the development index, DI, comes from the United Nations Development Programme (UNDP) human development index. Among the attractive features of the UNDP index is its reliance on purchasing power parity (PPP) rates instead of official exchange rates in cross-country comparisons and the use of other indicators of the quality of life. The development index used herein is constructed in the following manner. The ratio of PPP per capita GDP (1980 real prices) to $7000 is calculated, and a weight of 0.8 is applied. Next, the ratio of life expectancy to 70 years is calculated, and a weight of 0.2 is applied. As with the UNDP index, all countries with a per capita GDP above a certain level ($7000) are assigned a value of unity. Implicit in this formulation is that $7000 is the level at which a country is considered developed. The same is true of the health index.. An expected life span of 70 years is considered an indication of reasonable health standards. This index differs substantially from the UNDP index. The UNDP index is based upon the log of per capita GDP as a ratio to $5000, in 1987 prices; life expectancy as a ratio of 78 years; and the literacy rate. The variables are given equal weight. Since yearly estimates of literacy rates are not widely available for individual countries, this variable could not be used in the present analysis.
APPENDIX:II A Public Choice Model of Demand for Military Expenditures
An econometric model designed to test the determinants of military expenditures in a cross-section of countries is developed in this Appendix. The model identifies the political, economic, financial, and geographical factors that are likely to influence government decisions on the level of military expenditures and provides a framework to test the relevant hypotheses. The model does not consider the interaction between military expenditures of allies and rivals. 1/
The model employs a public choice framework that analyzes how the government chooses the level of resources to allocate to the military. The primary assumption is that the leadership selects policies with the goal of maximizing its own welfare, subject to national economic and political constraints. This assumption does not imply that the political leadership is necessarily selfish or uninterested in the welfare of its citizens; any consideration can enter into the welfare calculation of the leadership. To the extent that the leadership is concerned about the welfare of citizens, the welfare function will reflect this concern.
In the model, the leadership of the country has to make two very important budgetary choices: (1) the size of the budget and therefore the ratio of private versus public use of resources in the economy, and (2) the mix of government expenditures between the military and others uses. The variables that enter the welfare function of the leadership are
where W the welfare level of the political leadership,
Ω the welfare function,
U utility derived from private consumption,
D the level of defense derived from military expenditure,
S social welfare derived from social expenditures (approximated by nondefense government expenditures).
The welfare function places relative weights on each of the three variables that determine welfare: private consumption, defense, and social expenditures. In order to keep the model simple and facilitate concentration on allocation of resources to the military, only two types of government expenditures are considered. While the other category includes interest payments, general government expenditures, and expenditures on economic services, for purposes of expositional ease it is referred to as social expenditures. The political variables are treated as state-of-nature factors that affect the environment in which the leadership operates or indicate the ideology of the leadership. Therefore, they determine the weights of the different elements in the welfare function.
The welfare function in its present form is not operational. A more convenient form can be obtained through transformations based on supply-cost relationships. Simple transformations will suffice for U and S since these are not the focus of the study,
where C private consumption,
SE the level of social expenditures.
A more careful consideration is warranted for defense. Defense, or the level of security, is influenced by a number of factors that affect the cost of obtaining security. It is hypothesized that the cost function for defense is
where ME the level of military expenditure,
LA land area,
LB length of land borders,
CB length of coastal borders.
Equation (3) captures the notion that the effectiveness of military expenditure in providing security benefits will vary from country to country. For instance, larger countries are likely to be more costly to defend than small islands and therefore Chile is expected to have a higher defense budget than Mauritius, all other things being equal. The effect of population size is ambiguous. A larger population could be more costly to defend; however, a large population also acts as a deterrent to external attack.
The econometric specification uses a Cobb-Douglas functional form,
In this formulation the state variables, which describe political, demographic, and economic conditions, are assumed to influence the parameters of the equation: α1, α2, and α3; thus they determine the relative priority placed on C, ME, and S. Each parameters is also be assumed to take on a Cobb-Douglas functional form to arrive at equations (2A) and (2B) in the text.
The income constraint in this model is fixed by a number of interrelated equations. The government budget identities are,
where CGE is central government expenditure, T is government revenue, DF Is domestic financing, and FF is foreign financing. Since the government is seen as managing resource allocations within the economy, its budget constraint is determined by the total level of resources available to the economy,
Finally, since tax revenue is both a choice variable and a constraint,
where DI is a development index. Equation (5D) is a behavioral relationship. The level of development is hypothesized to affect the ease with which government can raise revenues; a higher level of development is generally associated with a higher tax base and greater administrative capacity to collect taxes. The form of government is also hypothesized to influence the ability to raise revenues; for instance, a socialist government may be In a better position to collect revenue than a nonsocialist government because a higher proportion of economic assets is gove rnment-owned.
Combining the above equations yields the following maximization equation for the government leadership:
Assuming a Cobb-Douglas welfare function, equation (4), the solution is
Equation (7) is a simultaneous equations system that determines the level of central government expenditure in the economy and proportion of the budget allocated to military expenditures. In the first equation, military expenditures are a simple proportion of the government budget, based on the relative priority of defense vis-a-vis social expenditures. In the second equation, central government expenditures have two determinants. In part, a proportion of total national economic resources (GDP + FF) is allocated to CGE based on the relative priority accorded to social expenditures vis-á-vis private expenditure. The other part of the equation indicates that CGE is also a function of ME.
where HE military expenditures in local currency,
GDP GDP in local currency,
GDP$ real GDP in U.S. dollars, 1980 purchasing power parity prices,
CGE central government expenditures in local currency,
FF foreign financing (in US dollars)
DI a development index (see below), and
form of government (mutually exclusive dummy variables, Appendix Table 3):
political variables (mutually exclusive dummy variables):
The formulation separates direct and indirect influences on the level of military expenditures. The indirect influences are transmitted through the central government budget. Among the determinants of the level of central government expenditures are military expenditures, which are expected to have a positive influence, a development index, the form of government variables, and foreign financing. For example, consider a nation that experiences an increase in its development index. Since it is now easier to raise revenues, both its central government spending and its level of military expenditures will rise, even with constant political preferences.
The direct influences on the level of military expenditures reflect the derived demand from the welfare function, which incorporates both the cost function and income constraints. For example, consider two identical countries that differ only in the length of their land borders. The larger country will have a higher value and will have higher demand for ME. Consequently, the larger country will have higher military expenditures and higher central government expenditures, even though the priority attached to defense is identical.
The direct influence of real GDP on ME/GDP is quite complicated and interesting. Military expenditures are often viewed as a pure public good. Therefore, a country with a larger GDP will have more defense for a given proportion of GDP spent on the military due to economies of scale. This implies a negative sign. Conversely, a higher GDP represents more resources available for financing military expenditures and a lower opportunity cost, and this implies a positive sign. Since the two effects have opposite signs, the expected sign is uncertain. Similarly, the coefficient on population could be either positive or negative. A larger population can be more costly to defend, particularly if the military is involved in domestic politics. On the other hand, a large population implies an automatic deterrent.
The financing variables present an interesting specification challenge. In the mechanical delineation of the model above, the level of foreign financing enters the determination of central government expenditures in the manner described in equation (8B). However, this formulation glosses over considerations of the cost of foreign financing and the ease of obtaining foreign financing. To account for this factor, a number of variables have been incorporated into the analysis that act as proxies for the cost of foreign financing. These variables are a dummy variable for the heavily indebted middle-income nations covering 1972-79, HD70; a dummy variable for heavily indebted nations covering 1980-90, HD80; a dummy variable for small low-income economies, SLIE; and the net flow of public and publicly guaranteed foreign financing as a ratio of GDP, PGFF. In order to avoid simultaneity problems, the lagged values of PGFF are used; in addition, since the variable can take on negative as well as positive values, the log transformation could not be applied to the variable. The hypothesized effect of the three dummy variables on the level of central government expenditure is negative while the effect of PGFF Is predicted to be positive. These four variables have also been incorporated into the military expenditures equation to determine whether the financing variables affect the mix of government expenditures. The hypothesis is that easier financing terms will allow governments to engage in the luxury of higher military expenditure, and therefore, HD70, HD80, and SLIE are expected to have negative signs and PGFF is expected to have a positive sign.
As indicated above, the 3SLS method was used to estimate the equations in Table 6. The 2SLS method was used in Tables 7 and 12 with data adjusted for autocorrelation and heteroskedasticity. Furthermore, one equation in Table 8 is based on the fixed effect technique and the other on country means.
The adjustment for autocorrelation and heteroskedasticity follows descriptions in Kmenta (1986) and Kelejian and Oates (1981). For each country an OLS estimate of military expenditures is carried out with the dependent variable ME/GDP and independent variables ln(GDP), ln(GDP) squared, PGFF, and CGE/GDP. If the Durbin-Watson statistic is below 1.57, autocorrelation is found to be present and the standard adjustment is made and the equation is re-estimated. The standard error of the equation for each country is then used to adjust for heteroskedasticity. Then a two staged least squares estimate is made with the adjusted data to derive the estimation results on the first equation. The process is then repeated to arrive at estimates for the second equation. The results produce much higher r-squares. However, since these r-squares are based on the transformed data, they are not subject to the normal interpretation.