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INTRODUCTION

“It is important to remember that every defense dollar spent to over-insure against a remote or diminishing risk … is a dollar not available to take care of our people, reset the force, win the wars we are in, and improve capabilities in areas where we are underinvested and potentially vulnerable. That is a risk I will not take.”
– Defense Secretary Robert Gates

Military spending is the amount of financial resources used for defense purposes for raising and maintaining armed forces. Military spending is part of government direct demand and expenditure, and hence can be used as part of a government’s fiscal policy. It is often a reflection of the economic and military strength of a country. This military budget pays the salaries, training, and health care of defense personnel, maintains arms, equipment and facilities, funds operations, and develops and buys new equipment1 including, but not limited to that of the Army, Navy, Air Force, Marine Corps and Coast Guard. Internal law enforcement such as the police force and disabled veteran rehabilitation (wounded soldiers returning from wars) are usually excluded from this. Understandably, the percentage of GNP of countries devoted to the military budget is large across the board, with global expenditure of 1.63trillion USD. The US is accountable for 711 billion (4.7 % of its GDP in 2011) and China, for 143bn of the sum, 2% of its GDP, but meetings in March 2012 of the National People’s Congress shows the projected plans of the Chinese to increase the ration of military budget to $106.4 billion- 11.2% of its GDP.
In such dire economic situations, why do governments continue to devote huge amounts of money to defense spending? Who finances the defense budget – taxpayers or government borrowing? What are the effects of changes in military spending on productivity and standard of living in an economy? What are the economic benefits and disadvantages? How should the government effectively allocate its resources, and is there a trade-off between defense spending and standard of living? What are acceptable levels of defense spending? Is peacetime military spending necessary, and what impact does it have on growth and government spending on social welfare and infrastructure? These questions pertaining to the expediency of military spending are elaborated upon in this essay.
First, economic theories can be used to explain these questions within the micro and macro economy: Military Keynesianism will be used to examine the multiplier effect of military spending on the economy for consumer spending, increased productivity due to investment in research and development, the effects of increased military spending on the balance of payment and the adverse effects of taxation for the purpose of defense spending. Qualitatively, and logically, increased defense spending leads to higher taxation or reallocation of scarce resources; reducing supply-side advantages and decreasing in purchasing power and standard of living (reduction in workforce). On the other hand, increased military spending leads to increased technological and economic development (increase in military workforce).
Secondly, this paper examines possible economic models that can be analyzed, using variables such as level of unemployment, taxation, public debt, percentage of per capita income spent on defense etc. Using the US as a case study, this paper examines the relationship between US defense spending and US public debt and deficit.
Finally, from the data and literature, this paper will elucidate the hypothesis that increased military sending had a negative effect on economic growth and development, both in the short and long-run.
The Macro-economy To clarify a few economic notions; as stated in the introduction, government funds its projects through spending/borrowing and taxation. Macro-economic policies affect economic growth.
Aggregate Demand = Consumption + Investment + Government spending + Net Exports
Throughout this essay, we will examine how changes in military spending affect each component of aggregate demand. Military Keynesianism
This is basically the belief that war is good for the economy. Governments often claim that giving large sums of money the military fuels economic growth. Increased military spending propagates research and development and technological advance even for civilian purposes such as computers and airplanes, and keeps the industrial sectors linked to defense production running.
However Keynes advocates government spending on peaceful sectors to better the economy; such as on clean energy, education and healthcare which lifts an economy out of recession. During periods of uncertainty, consumer demand for goods and services decreases, as well as business investments. On the demand-side, the government can increase economic activity by direct demand for military goods and services.

Po
Price P1 S D0 D1 QtyO Qty1 Quantity THE EFFECTS OF INCREASED GOVERNMENT SPENDING IN AN ECONOMY.
From the diagram above, an increase in government spending leads to an increase in quantity demanded (QtyO to Qty1). Government direct expenditure boosts the economy and starts the spending cycle. It increases the marginal propensity of individuals to consume. This creates a multiplier effect on the circular flow of income in the economy.
However, the military-industrial complex proposed by President Eisenhower of the USA suggests that the growth fuelled by military spending is limited. It proposes that military spending creates a link between politics, legislature and national defense and increases economic development. On one hand, increase in job opportunities and development of heavy industry, on the other hand, during wars there is drainage on available workforce. Also, in order to increase military spending, government would have to increase taxes on workers, while reallocating its resources from expansionary supply-side policies such as education, social security and healthcare. Hence it has an opportunity cost (military/standard of living, through GDP per capita or HDI). Even though increase in defense spending would lead to growth in the defense sector, employment in the defense sector and development of the military industrial base, it neglects other crucial sectors of the economy.
French Political Economist, Frederic Bastiat also rejected the notion that government spending fuels the economy. He proposed the Broken Window Fallacy whereby he measures the opportunity cost of defense spending vs. other supply-side uses. He argues that it is fallacious to think that military spending drives the economy, as the money could be put to better use in sectors such as education and healthcare. This would improve the physical capital of the labor market, leading to improved quality of the workforce. This would lead to greater employment and an increase in the standard of living of individuals. Militarized governments such as the US claim that military spending fuels research and development, which leaks into civilian use, such as airplanes and computers. Increase in technological advance stemming from military expenditure is used to improve the productivity process, making production faster and more efficient. However, with highly modernized militaries, it is futile maintaining large peacetime militaries, as this removes young people from the workforce, causing a brain drain on civilian society.
In a study carried out by the Political Economy Research Institute (PERI) University of Massachusetts-Amherst on THE U.S. EMPLOYMEN T EFFECTS OF MILITARY AND DOMESTIC SPENDING PRIORITIES – (Robert Pollin & Heidi Garrett-Peltier October 2009) focuses on the employment effects of military spending vs. alternative domestic spending priorities where the opportunity cost of spending $1 billion to the military vs. clean energy, health care, and education. They concluded that $1 billion spent on each of the domestic spending priorities will create substantially more jobs within the U.S. economy than would the same $1 billion spent on the military. 2
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From Table 1 above, military spending creates fewer jobs than domestic spending. Total Job creation for the military is 11,600 with $1 billion in spending; expenditure on clean energy creates 17,100 jobs while education creates 29,100jobs: hence military spending creates the least amount of jobs as shown in the figure below.

Taxation
Taxation is the imposition of a financial levy or a sum of money on the income of individuals or firms. There are various forms of tax, but it is income tax that is usually affected by an increase in government spending on the military as part of its fiscal policy. Usually, tax revenues are reallocated by the government into public goods that improve the standard of living of individuals. Certainly, internal defense such as police force is a public good, but reallocating tax revenue for military spending hinders, rather than stimulates economic growth.
When taxes increase, disposable income decreases. This leads to a decrease in consumption and standard of living. It also disincentives people from working, as their taxes increase and their quality of life decreases because the money is going to the military and not development of the economy. Increase in corporate tax also leads to a decrease in investments, leading to various scenarios.
First, the cost-push inflation, where businesses try to shift the burden of tax to their consumers, leading to an increase in prices:

P1
Price level P0 AS1 AD AS0 Real National income RNI1 RNI 0

From the above diagram, we can see the effect of taxation on economic growth. With the imposition of a tax, prices increase from P0 to P1, real national income decreases from RNI0 to RNI1. Consumption decreases, income decreases and the economy fails to grow. Deadweight losses are already a disadvantage of taxation; when this is added to the fact that tax revenue is not re-invested into the economy, but spent on military personnel who end up wounded or dead on battlefields and unable to work to add to the economy, taxation becomes a disadvantage.
Secondly, increased corporate tax leads many businesses to go bankrupt, as their profit margins are either smaller than before taxation or inexistent. They are also unable to pay wages to workers, hence lay them off. This creates a spiral: decreases total consumption due to decreased disposable income, decreased business investments due to high taxes, increased government expenditure on unemployment benefits, workers demanding higher wages due to price increase, all culminating in an economic slump.
So why would governments use tax revenue to finance military spending? It is the only tool on the fiscal policy side, besides its spending it can use; cutting government spending in healthcare or education would cause public outcry.
Governments use the historical argument to support their actions: Regulation during recession. During recession periods, the government can pump money into the economy by purchasing warplanes or military equipment. During this current Eurozone crisis, it seems a better option than austerity measures which limit growth.
Historically, the Second World War is said to have gotten the world economy out of the great depression, and since then, governments have increased their defense budgets. Historians and economists believe that due to it caused accelerated recovery from the Depression, as it drastically reduced unemployment and encouraged trade; more women entered the workforce, as manpower mobilization was at its peak.
The US entry into the war in 1941 finally eliminated the last effects from the Great Depression and brought the U.S. unemployment rate down below 10%.In the U.S., massive war spending doubled economic growth rates4
Guns versus butter model
This is a simple production possibility frontier that shows the relationship between investment in defense and civilian goods. Government chooses between two options when spending scarce resources. It can buy either guns (invest in defense/military) or butter (invest in production of goods), or a combination of both.

The red curve represents all possible choices of production for the economy. With two possible choices of outputs, every choice has an opportunity cost; the curve is the limit to the production - produce outside the curve unless there is an increase in productivity.5
Economic model analysis
In the course of my research, previous analyses on the impact of defense spending on the economy have shown conflicting results. For example, the Feder-Ram Model, a supply-side model measuring the productivity of one sector of the economy i.e. the military, the Neoclassical Growth Model the Augmented Dicky-Fuller (ADF) and Philips-Perron (PP) tests. In the future, I would like to carry out a multiple regression, time-series analysis of the positive relationship between increased taxes and increased military expenditure, military spending and standard of living or employment vs. percentage of per capita income spent on military expenditure.
First, the various components of government expenditure can be regressed to see how each affects endogenous economic growth. (Education, defense, health, and agriculture are components that can be analyzed as variables) Gross domestic product (GDP) is a dependent variable while the others are independent variables. Since these values are non-stationary (the process evolves through time) unit roots6 test is carried out first5to find a difference that is stationary), so as to prevent errors due to changes over time.7
There is a correlation between military spending and economic growth, productivity, taxation or standard of living but it is difficult to say whether increased military spending has a negative effect on these. It is even possible for a reverse causality, whereby economic growth leads to increased military spending eg China announced it will increase its military spending by 11.2%.

The US example The US accounts for almost half (49%) of the world’s total defense spending. Foreign policy objectives, power politics, real or perceived threats and the availability of economic resources affect a country’s level of defense spending. The US has the world’s largest military, with over 6,000 bases on US soil, and numerous bases in 60 other countries. It is facing increased pressure from taxpayers to reduce the size of the fiscal deficit and the national debt, which have increased due to increased military spending. While military Keynesianism is one way out of a recession, it is not the most effective, and the opportunity cost is high.

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From the diagram above, US military spending has doubled since 2001. 9
From the Table above showing US spending in 2012, the highest proportion of US expenditure is on the defense at 902.2 billion. Spending on welfare, protection and education are low relative to defense spending at 451bn, 65bn and 153bn respectively.
US taxation and government deficit
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From the diagram above, US government expenses always exceeded tax revenue, except from 1998-2001. This can be explained by the 1980’s recession in the US, where tax revenues were low and there was high unemployment, hence, there was a greater government expenditure than revenue. Due to the contractionary monetary policy (increase in interest rates to incentive savings and reduce money supply), the 1973 oil crisis and the energy crisis in 1979, recession hit the US. Despite this fact, military spending was still relatively high, reaching over 500bn USD in 1985.

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The US was still suffering from the outcome of the Vietnam War in 1975, holding up the Cold War with Russia while building up their nuclear capabilities and trying to settle the US-Iran conflict; hence the increase in military spending. From the graph above, we can see that defense spending decreased during the early 90’s, which could be due to conflict resolution. Government spending in general, including military spending decreased during this time, which could be as a result of economic growth after the recession, apparently fuelled by increased military spending. After the September 11 attacks, however, military spending has increased exponentially, with adverse effects on the economy.
US Tax System
Progressive taxation is applied in the US system whereby, the higher the income, the higher the marginal tax rate. Hence the rich finance government expenditure. However, The expenses-revenue line above also shows that the US government always spent more than it received, hence a huge budget deficit and the calls for deficit reduction in the US.

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Public debt is deficit collected over a period of years. A budget deficit occurs when expenditure is greater than revenue, as has been the case for the US for decades. The diagram above shows CBO’s projections for US government income and expenditure.
The U.S. federal government has run annual deficits in 36 of the past 40 fiscal years, with surpluses from 1998-2001. Tax revenues averaged approximately 18% GDP from 1971–2010, with expenditures around 21% GDP, resulting in an average annual deficit of around 3% GDP. For example, in 2010 revenues were $2.16 trillion and outlays were $3.46 trillion, resulting in a deficit of $1.3 trillion or 9.4% GDP.13
The situation after 2001 can be explained through increased military spending on the Afghanistan and Iraq wars. To restore a healthy budget situation, the US government has a choice: austerity measures vs. supply-side spending. Since the 2008 financial crisis, austerity measures have not worked, both in the US and in Greece. Neither have huge government bailouts. Hence, the government should let the free market work, while influencing it through expansionary fiscal policy on the supply side.

Conclusion: In the world today, the military is essential. Some view military spending as a problem of misguided priorities, others see it as a vital sector of the economy and as a tool for power politics. Hence, it is necessary to strike a balance between defense, welfare and the economy; else the cycle of militarism, nationalism and futile spending will continue. The guns and butter choice, military expansion or civilian spending is a difficult one. Government spending boosts the economy, is extravagant military spending worth it, when millions of people live below the poverty line? After the Second World War, military production may have provided some benefits by giving a boost to purchasing power when government spending was low and credit tight, and by giving a push to some high technology industries. Nowadays, there are other ways to stimulate the economy. Military spending may have played a crucial role in relieving the world of the Great Depression and relieving the US of the 1980’s recession, but today it no longer does. With high military spending and a shrinking US economy, it is advisable to search for other options.
Military spending strangles the supply-side of the economy, increasing both voluntary and involuntary unemployment and reducing the rate of growth. After British economist Ron Smith analyzed the US situation, he concluded that countries with large military investments have low economic growth as (due to the military-industrial complex) military spending pushes civilian investment aside. This leads to a one-sided economy, with labor and capital channeled solely towards the production of military goods. They are also less efficient than civilian investments, as they know that the government would step in if there was increased cost.
In terms of Research and Development, military spending has aided technological advance which has increased productivity. However, rather than waiting for the military to develop capital for civilian use, which may or may not happen, it is more efficient and more productive to switch funds to civilian research and development.
Military spending is not the best way to have economic growth, neither is persistent government spending. Governments should influence other components of aggregate demand; such as cutting taxes to increase consumption and investment, and indirectly, net exports. Though arms exports contributed slightly to US economic growth, increased military spending far depleted this. Hence, governments should learn from the adverse impacts of military spending on the economy; power politics due to military prowess should be downplayed and economic stability should take its place.

BIBLIOGRAPHY http://ideas.repec.org/p/wbk/wbrwps/1138.html http://costsofwar.org/article/macroeconomic-impact-military-spending http://data.worldbank.org/indicator/MS.MIL.XPND.GD.ZS http://www.globalissues.org/article/75/world-military-spending#Increasedspendingbeforeandevenduringglobaleconomiccrisis http://www.theatlantic.com/national/archive/2012/01/will-cutting-the-defense-budget-leave-america-at-risk/252010/ http://battleland.blogs.time.com/2011/09/21/study-federal-spending-on-defense-doesnt-create-as-many-jobs-as-education-spending/

http://battleland.blogs.time.com/2011/09/21/study-federal-spending-on-defense-doesnt-create-as-many-jobs-as-education-spending/#ixzz1uMAXACYP

http://groundviews.org/2011/02/27/lanka-63-the-%E2%80%98military-business-model%E2%80%99-of-post-war-economic-development/ http://www.nytimes.com/2012/02/14/us/politics/obama-budget-raises-taxes-on-the-rich-to-spend-on-jobs.html http://www.globalissues.org/article/768/global-financial-crisis http://www.iedm.org/uploaded/pdf/robertjbarro.pdf http://www.jstor.org/stable/174205?seq=5