How Is the Rise in National Defense Spending Affecting the Tenth District Economy?

Article excerpt

In 2007, the United States spent more than $650 billion on national defense. Even after adjusting for inflation, this was the largest annual amount since 1945, surpassing previous post-World War II peaks reached during the Korean, Vietnam, and Cold Wars. Defense spending has risen rapidly this decade, today accounting for nearly 5 percent of overall gross domestic product-about the same share as residential construction.

National defense represents an even larger share of economic activity in the Tenth Federal Reserve District. The region is home to some of the country's largest military installations, a number of private defense contractors, and a disproportionately large number of reservists and National Guardsmen.

Is the buildup in national defense stimulating the economies of the states in the Tenth District? This article finds that, relative to the nation, increased defense spending is likely to help the region more in the long run than the short run. Since 2001, defense spending has risen more moderately in the district than the nation, due primarily to slower growth in the types of defense activities concentrated in the region. Still, the region is poised for an expansion of defense spending in the future. And the region benefits from a less cyclical defense sector than that of the nation.

The article s first section looks at the evolution of defense spending in the United States and reviews research on the effects of defense spending on economic growth. The second section discusses the size and location of defense activities in the Tenth District and then explains how defense spending can benefit state and regional economies. The third section explores how and why the defense buildup has been smaller in the district and how the current buildup compares to past episodes. The fourth section examines why projected defense spending increases may influence the district and national economies differently.

I. NATIONAL DEFENSE IN THE U.S. ECONOMY

Ever since the United States entered World War II, defense spending has played an important role in the nation's economy. This section looks at the size of the defense sector in the U.S. economy and how it helps shape national economic growth.

How sizable is U.S. defense spending?

The scale of military expenditures in the United States has fluctuated considerably over time. In the decade prior to World War II, defense spending accounted for less than 2 percent of GDP (Chart 1). During the war, defense accounted for more than a third of the nation's economic activity-a boost many economists have claimed effectively ended the Great Depression (Tobin). By 1947, military spending had dropped again to about 7 percent of GDP and remained there for several years. Then, the Korean War, the Cold War, and later, the Vietnam War pushed defense's share of national output into or near double digits throughout most of the 1950s and 1960s.

By 1979, military spending had declined again to less than 6 percent of GDP. The Cold War buildup of the Reagan Administration lifted defense spending back above the 7 percent threshold for several years, but by 1986 it began to slow again and by 2000 dipped to a postwar low of 3.8 percent. Since 2001, defense spending has been rising rapidly, last year accounting for 4.8 percent of GDP. Spending on the nations defense is generally expected to climb further in the near term.

Does defense spending boost economic growth?

A good deal of economic research has been conducted on the effects of defense spending on national economic growth. Results of these "guns versus butter" studies have been somewhat mixed since the first empirical analyses were conducted in the early 1970s.1 Indeed, a detailed survey of the literature published in 1995 concluded there was no consistent evidence for either overall positive or negative effects of defense spending on national economic growth (Ram). The findings of individual studies appear to depend partly on the time frame of focus. …