A Study of the Impact of Defense Expenditure on Economic Growth: The Case of Taiwan


Author:Keh -Nan Sun

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Several recent studies have reexamined the relationship between defense expenditure and economic growth, yielding contradictory results. Viewing these studies overall, therefore, it is not certain whether defense expenditure holds back or accelerates the economic growth of a country. It is an interesting phenomenon that in Taiwan a high economic growth rate and heavy defense spending coexist. The important questions of whether defense spending crowds out non-defense expenditure and, if so, how it should be traded off, are examined in this paper. Still more importantly, the question of whether decreases in defense expenditure reduce fiscal deficits while inducing economic growth is also tackled in the present study. In answering these questions, data on defense expenditure in Taiwan is collected. We employ a revised Ram-Biswas (1986) model for estimating the externality effects of government expenditure, which affects private production. This estimation is conducted on the basis of Barro's (1990) endogenous growth model in which government expenditure and the social utility function are included. We then build a theoretical foundation for our empirical estimations. Since in the literature the statistical specifications are somewhat ad hoc and since the channels of influence are ambiguous, it is important to first build a theoretical framework. We also conduct unit root and Granger-causality tests, as well as VAR (vector autoregression) for the time series data used. The empirical results consistently point to an insignificant relationship between defense expenditure and economic growth in Taiwan, although non-defense expenditure is shown to increase the investment ratio. Because defense spending crowds out non-defense expenditure, we suggest that the structure of government expenditure be adjusted and the defense expenditure ratio reduced through the control of fiscal deficits and through reduced defense spending. Keywords:Defense Expenditure; Economic Growth; Endogenous Growth.