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Global Determinants of Defense Reform: Economic
Liberalization
Robert LooneyProfessor, National Security AffairsNaval Postgraduate School
Conference on Global Determinants of Defense Reform at the Naval Postgraduate School
Monterey, California, September 9-10, 2005
Outline Main Issues – Economic Liberalization, and Defense
Expenditures.
Policies of International Financial Institutions -- Neoliberalism in the 1990- period.
Operational Measures of Economic Liberalization.
Economic Liberalization and Defense Expenditures – General Patterns.
Contrasting Environments of Economic Liberalization, Institutions, and Defense Expenditures – Resulting Patterns of Defense Expenditures and Economic Growth.
Implications for Defense Reform.
Main Issues: Effectiveness of Security
Expenditures
Every society must choose between direct productive allocation of its resources and reservation of some of those resources to protection of that production.
From this perspective, resources allocated to defense or to security are themselves no less potentially productive than resources allocated to direct economic activities.
Defending persons and property, however, has its dark side. Powers of enforcement, coercion and punishment are vested in individuals and institutions.
Will these be effective in their task, contributing to growth and development, or will they be corrupt, inefficient and thus detrimental to economic activity?
Main Issues (contd.) A complicating factor has been the post-cold war ascendancy
of neo-liberal free market economic policies and associated expansion in globalization. In theory, both should be conducive to improved growth and development.
However, each has tended to place pressure on “unproductive” expenditures. In many instances this has been translated into declining security budgets, especially in situations where macroeconomic instability exists.
In many cases the resulting reduction in security expenditures has created a vicious circle of increased violence, instability and further macroeconomic instability.
It is becoming increasingly clear that more knowledge is needed to assess the broader impact of security expenditures. Specifically, in which situations are productive aspects of security expenditures likely to prevail over the unproductive? Does economic liberalization tend to increase or decrease the effectiveness of security expenditures?
Trilemmas, Economic Integration, Liberalization and Defense
Expenditures Trilemma of The World Economy
Increased Global
Integration
Nation State
Golden Straitjacket
Democratic Politics
Global Federalism
Bretton Woods
Compromise
Severe Constraints on National
Defense Expenditures
Moderate Constraints on National
Defense Expenditures
Implications for Global
PeacekeepingUnclear
Potential for Improved Economic
Performance but
Vulnerable to Increased Insecurity
and Instability
Potential for Improved
Stability but at the
Expense of Economic
Performance
IMF, The World Bank and the “Washington Consensus”
Adoption of the “Washington Consensus” in the Late 1980s.
Shift from Failed State-Led Development Strategies of the 1960s and 1970s to Market Led Development.
Fiscal Discipline – Limit Budget Deficits.
Macroeconomic Stability Key Objective of Policy
Public Expenditure Priorities – Redirect Expenditure Toward Human Capital and Infrastructure.
Tax Reform – Broaden Tax Base and Cut Marginal Tax Rates.
Washington Consensus (contd.).
Financial Liberalization – Abolish Interest Rate Controls.
Exchange Rates – Introduce Unified and Competitive Exchange Rate.
Trade Liberalization – Replace Quantitative Restrictions by Tariffs then Reduce Tariffs Over Time.
IMF and World Bank Empirical Studies Suggested Defense Expenditures Have Negative Impact on Macroeconomic Stability and Economic Growth.
In this framework defense expenditures viewed as unproductive and a threat to macroeconomic stability. Concern over “excessive” defense expenditures.
Measures of Economic Liberalization – Fraser Institute
Equates Economic Liberalization With Economic Freedom: Personal Choice, Voluntary Exchange, Freedom to Compete and Protection of Person and Property:
Size of Government: Expenditures Taxes and Enterprises.
Legal Structure and Security of Property Rights.
Access to Sound Money.
Freedom to Exchange With Foreigners
Regulation of Credit, Labor and Business.
Measures of Economic Liberalization: Wall Street Journal, Heritage
Foundation
Focus on the Relative Progress Made by Countries in Moving to a Deregulated, Limited Government Free Market Environment:
Trade Policy. Fiscal Burden of Government. Government Intervention in the Economy. Monetary Policy. Banking and Finance.
Economic Liberalization: Wall Street Journal/Heritage Foundation
(contd.)
Measures of Economic Freedom (contd.):
Capital Flows and Foreign Investment.
Wages and Prices. Property Rights. Regulation. Informal Markets.
World Bank Governance Indicators
Key Dimensions of Governance: Voice and Accountability – Extent to Which
Citizens Able to Participate in the Selection of Governments.
Political Stability and Absence of Violence.
Government Effectiveness – Competence of Civil Servants – Credibility of Government’s Commitment to Policies.
Rule of Law.
Control of Corruption.
Economic Liberalization, Governance and Defense
Expenditures
Environments and The Economic Effectiveness of Defense Expenditures – Main Issues:
Previous Studies Have Found Positive Links Between Defense and the Economy in Resource Unconstrained Environments and Negative Links in Resource Constrained Countries – Do Similar Patterns Apply to the Relative level of Economic Liberalization/Governance Reform?
To What Extent Do Economic Environments Control the Level of Defense Expenditures?
How Do These Environments Influence the Economic Effectiveness of Defense Expenditures?
What types of Economic Liberalization/Governance are Most Significant in This Regard.
Differences: High/Low Defense Expenditure Countries
Key Differences Countries Above/Below Mean for Defense as a Share of GDP: 2000-2003.
Foreign Direct Investment – Much Higher in Low Defense Countries.
Low Defense Countries Better Macroeconomic Aggregates – Lower Government Consumption – Higher Savings Rates, but Similar Investment Rates.
Low Defense Countries Had Higher Rates of Growth – Late 1990s and Early 2000s.
Differences: High/Low Defense Expenditure Countries
(contd.)
Wall Street Journal/Heritage Economic Freedom Index – Low Defense Countries Score Consistently Higher. Only Area High Defense Countries Higher is in Fiscal Burden.
Frasier Index – Low Defense Countries Superior Progresses Except in Access to Sound Money.
Main Areas of Difference are in Governance – Low Defense Countries Score Much Higher in All Categories, Especially in Voice and Accountability – Gap Widened from 1990s.
Regression of Defense Burden on Economic Liberalization – Statistically Significant Variables: Voice and Accountability, Fraser Summary Economic Freedom Index, Fraser Legal Structure Index and World Bank Rule of Law Index – Explain 43% Variance in Defense Burden.
Economic Impact: High/Low Defense Countries -- Model
Model: GDPYPG = F(GFCY, AIDPER, GFDIY, GCNPY, MILXY). + + + - ?
GDPYPG = Growth Per Capita Income.
GFCY = Gross Capital Formation Share of GDP
MILXY = Defense Expenditures Share GDP
GFDIY = Gross Foreign Direct Investment Share of GDP
GCNPY = General Government Consumption Share of GDP.
Economic Impact: High/Low Defense Countries --
Results
Main Results (Statistically Significant):
Total Sample GDPYG = (+)GFCY (–) MILXY (consistent with IMF/World Bank View)
High Military Expenditure Countries GDPYG = (-) MILXY
Low Military Expenditure Countries GDPYG = (+)GFCY
Interpretation of Results
Previous Research Has Shown That Defense Expenditures:
Have Both Positive and Negative Effects on The Economy.
The Environment in Which They Occur Dictates Which Will Predominate.
High Defense Countries Lagged the Low Defense Countries More in Economic Liberalization and Governance Than in Basic Macroeconomic Aggregates.
For the High Defense Countries Positive Linkages Associated With Defense Expenditures May be Suppressed by the Their Relatively Low Levels of Governance and Economic Liberalization.
Economic Liberalization and Defense Expenditures--Linkages
With High and Low Defense Countries Now Defined With Regard to their Position Above and Below A Regression Equation of Defense on Economic Liberalization and Governance Indices -- Hypothesis:
Countries Where Key Economic Liberalization and Governance Indicators Are High Relative to Defense Expenditures Should Have Positive Economic Effects from Increased Military Expenditures.
Those Countries Who Have High Defense Expenditures Relative to Economic and Governance Reforms Should Have Negative or Neutral Linkages Between Military Expenditures and the Economy.
Country Groupings:Main Differences
Defense Burden (Defense Share of GDP): Old -- 5.49%(H) vs. 1.49%(L) New – 3.19%(H) vs. 1.67%(L)
Growth in Per Capita GDP Old –2.32%(L) vs. 1.88%(H) New 1.94%(H) vs. 1.76%(L).
Economic Liberalization/Governance Old -- Low Consistently Better New – Nearly Balanced With Each Group Superior
in Some Areas.
New Country Groupings
Trends in Defense Burdens
1988 1990 1992 1994 1996 1998 2000 20021
2
3
4
5
6
7
8
Mil
ita
ry E
xp
en
dit
ure
% G
DP
LegendTotal SampleRelatively Low Defense CountriesRelatively High Defense Countries
New Country Groupings:Patterns of Growth
1988 1990 1992 1994 1996 1998 2000 2002-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3A
ve
rag
e A
nn
ua
l %
Gro
wth
in
GD
P
LegendTotal SampleRelatively Low Military GroupRelatively High Military Group
New Country Groupings:Comparisons of Capital Formation
1988 1990 1992 1994 1996 1998 2000 200220
20.5
21
21.5
22
22.5
23
23.5
24G
ross
Cap
ital
Fo
rmat
ion
(%
GD
P)
LegendTotal SampleRelatively Low Military GroupRelatively High Military Group
Economic Impact: New Groupings High/Low Defense Countries --
Results
Main Results (Statistically Significant):
Relatively High Military Expenditure Countries
GDPYG = (+) GCFY
Relatively Low Military Expenditure Countries
GDPYG = (+)GFCY (+) MILXY
Summary: Economic Liberalization, Governance and Defense Impact
Analysis of Defense
Expenditures
Regression of Governance/
Economic Liberalization on Share of
Defense Expenditures
in GDP
Governance - Defense
Environment
Defense/GDP Function of:Voice and
Accountability, Fraser
Summary,Fraser Legal Structure
Rule of Law
New Country
Groupings
Defense Higher than Predicted
Defense Lower than Predicted
Defense - Growth
Defense -- No
Statistically Significant Impact on Per Capita
GDP Growth
Defense --Statistically
Positive Impact on Per Capita
GDP Growth
Group Profiles
Relatively High Growth With Better Levels of: Openness, Fiscal Burden,
Voice Accountability,
Political Stability
Relatively High Savings, Investment With Better:
Monetary Policy,
Property Rights,
Government Effectiveness Rule of Law, Control of Corruption,Economic
Liberalization
Implications For Defense Reform
World Bank, IMF View Of Defense Expenditures Implicitly Assumes Negative Links With Economy--Biased Towards Arbitrary Budgetary Cuts in Defense Often Neglecting Security Considerations.
The Trilemma Between Institutions, Nation State and Globalization May Not be As Binding as Commonly Believed. There May Be a Variety of Alternative Approaches to Economic Growth and Globalization Consistent with Good Economic Performance and Productive Defense Expenditures.
Results Here Suggest A Constructive Approach is Possible -- Letting Countries Define Their Security Needs While The IMF/World Bank Can Push for Complementary Economic/Governance Reforms.
Implications For Defense Reform (contd.)
Specifically:
Rather Than Considering Defense Expenditures as Excessive or Not Based on Their Absolute Amounts or Share of GDP, Defense Expenditures Should be Assessed in their Economic and Institutional Settings.
Within this Context Economic Strategies Should be Designed in Conjunction Improvements in Key Areas of Governance and Economic Reform To Reinforce the Positive Linkages of Defense Expenditures With the Economy.
Selective Economic Liberalization and Improved Governance in Key Areas Rather Than Across the Board Efforts May Be Sufficient for This Purpose.
The Key is to Coordinate Economic Liberalization and Governance Reforms in the Civilian Sector With the Requirements of Improved Security in the Defense Sector.
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