Recent increases in U.S. defense spending have renewed interest in the defense-growth nexus. The Feder-Ram-based models have traditionally been used in examining this relationship, but Dunn, Smith, and Willenbockel recommend the augmented Solow model because of several weaknesses inherent in the Feder-Ram model (including its static nature, simultaneity bias, and multicollinearity issues). The augmented Solow model addresses these issues, but it has weaknesses too. Thus, by employing both the Feder-Ram and augmented Solow models, the author tests the defense-growth nexus in the United States for 1954 through 2005. The results indicate that defense spending does not significantly affect the U.S. economy.
Defense Spending, Economic Growth, Feder-Ram Based Model, Augmented Solow Model, United States
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The Defense-Growth Nexus in the United States
The annual budget for the U.S. Department of Defense (DOD) in fiscal year (FY) 2006 was approximately $419.3 billion. This was a 4.8 percent boost from the previous year. However, this increase in defense spending in FY 2006 was not an isolated case in the recent past. According to the Office of Management and Budget (OMB), defense spending from 2001 to 2006 increased by 41 percent (OMB 2006; see also Ann Scott Tyson, Washington Post, February 6, 2007). The DOD's base budget for FY 2007 was $439.3 billion. An additional $50 billion was also provided to support the wars in Afghanistan and Iraq (OMB 2007). These increases in defense spending are the largest since the Reagan administration.
According to former Secretary of Defense Donald Rumsfeld, these increases are necessary because "when the Cold War ended, a defense drawdown took place that went too far . . . [and] overshot the mark. Now, through the prism of September 11, we can see that challenge is not simply to fix the underfunding of the past" (New York Times, February 5, 2002). He went further by saying that a "decade of overuse and underfunding" requires catch up to meet all the demands the military is currently facing since "we are a nation at war" (DOD 2005).
During the same period (2001-2006), the average annual economic growth rate was a mere 2.4 percent (Bureau of Economic Analysis's National Economic Accounts; see http://www.bea.gov/National/nipaweb/Index.asp) and the national debt went from $5.8 trillion to $8.6 trillion (Treasury Department n.d.). Coincidentally, the International Monetary Fund (IMF) warned that continuing twin deficits (the budget and trade deficits) along with record-breaking debt increases in the United States threaten the financial stability of both the U.S. and global economies (Elizabeth Becker and Edmund Andrews, New York Times, January 8, 2007). Moreover, slow economic growth is expected in coming months for various reasons (Joanne Morrison, Reuters, November 28, 2007).
Are recent increases in defense spending for the war on terrorism one of the reasons for slower economic growth? Despite the volume of studies on the defense- growth relationship, there is no consensus about the relationship between defense spending and economic growth in the United States. Some scholars argue that defense spending in the United States helps growth (e.g., Atesoglu 2002; Atesoglu and Mueller 1990; Mehay and Solnick 1990; Mueller and Atesoglu 1993), while others contend that the indirect, delayed, negative effects of defense spending on the U.S. economy are greater than the positive ones (e.g., Goldstein 1988; Heo and Eger 2005; Mintz and Huang 1990, 1991; Ward and Davis 1992; Ward, Davis, and Lofdahl 1995).
What are the causes of different empirical findings on the U.S. defense-growth nexus? According to Dunne, Smith, and Willenbockel (2005), the reason previous studies found positive or negative relationships between defense spending and economic growth is because they used various versions of the Feder-Ram-based defense-growth model. …