Economic Growth and Military Expenditure: R&D, Consumption, Capture – What Future for Europe?

Before anything else, I want to start by acknowledging the fact that the focus of this article represents a relatively narrow section of what is an enormously interesting, fertile and relevant field of economics with much to contribute to societal welfare and development. I refer the reader to the section of this website with a list of selected references on economic growth, covering Sollow-growth theory, Ramsey models, overlapping generations, endogenous growth and institutional economic contributions to the field.

Perhaps the topic of this post section can be argued to fit within the endogenous institutional growth theory section. Nevertheless, the role of military-supported R&D in driving technological and by association real economic growth appears to me as being underestimated in the public consciousness and often ignored in supply-side debates of long term economic growth particularly in Europe. It appears to me that this is an unfortunate oversight both for its positive and negative potential. I offer a very short discussion of these issues below by emphasizing the appeal of the implications for economic growth and dangers of government capture and militarism.

In summary, it appears that there are four important factors behind the effect that government military expenditure has on economic growth: Scope, scale and how it is funded. The main strains of literature informing the considerations below stem from Ruttan (2006), Barro and Redlick (2011)Ilzetzki et al (2010) and Acemoglu et al. (2010.b).

Military Expenditure and Economic Growth: The Hypotheses

The argument I want to highlight is basically a repetition of the one outlined by Ruttan (2006) and implicit in Barro (1981)Ramey and Shapiro (1998), Borrus and Stowsky (1997)Edeblberg, Eichenbaum and Fisher (1999)Fisher and Peters (2010)d’Agostino, Dunne and Pieroni (2010)Ramey (2011.a)Ramey (2011.b) and Barro and Redlick (2011). Other more recent contributions include studies such as Alptekin and Levine (2012), Dimitraki and Ali (2013) and Dunne and Tian (2013). Much as is the case with all considerations about the effect of government expenditure on economic growth, the question is whether the effect is negative or positive and in case it is positive whether it is below or above 100%, meaning that a 1% increase in military expenditure would bring about less or more than a 1% increase in GDP. In reviews of the fiscal multiplier literature, Alptekin and Levine (2012) find an overall positive non-linear relationship while Dunne and Tian (2013) find recent evidence of a negative one. So which one is it? My best guess is that it depends on what type of military expenditure is being measured.

Starting with the best case scenario, where military expenditure is directed toward solving a problem at the technological frontier, it makes sense to expect a large positive effect if such exploration is allowed to spillover into the private sector, also known as dual use. The idea, describes a situation where technological growth drives much of the movement in economic growth and thus that whatever drives the first will stimulate the latter. In this specific instance, the emphasis is on the role of military/defence research and development (R&D) in exploring new and unknown paths at the edge of the technological frontier. Because at this cutting edge level fixed and sunk costs are quite large, it is natural to envisage a role for the government to come in and exploit the economies of scale at its disposal. In such a case a 1% increase in government expenditure on military R&D would increase GDP by more than 1%. The USA, where the federal government is able  to galvanise the large tax and financial resources of the whole country, is the perfect case-study. A comparison of the country’s total military expenditure with the following top 9 countries makes this evident. Notice also the decrease in expenditure following the collapse of the USSR and the increase after the Twin-Towers terrorist attack.

Top 10 Military Expenditure by Country_Sipri 2014


Clearly a lot of US military expenditure is operations and infrastructure, but research is not a negligible item.

Defense Spending Composition 1962-2013_Washington Post

In other countries or perhaps in other fields of government expenditure, such an effect might not be felt. Say that all of military expenditure is focused on underwears, bed linen and bullets. In such an environment, military expenditure would at best, depending on the particular scarcity of underwears or bullets, have a positive effect on GDP that is below 100%.

An even worst case is that, in which it is used to pay for an unnecessary number of generals and officers in a country that is not presently nor is it likely in the future to be at war. Then the government and its money is effectively being captured by an interest group, wasted in a way that creates no value added or positive spillover for the economy. This logic was the motivation for Eisenhower’s warning of the military industrial complex in his presidential farewell address. It is also a key driver for countries to keep a small military as discussed by Acemoglu et al (2010.a) in order to avoid military coups (Acemoglu et al. 2010.b). In that case one would be justified in expecting a negative effect.

Issues with Funding

The issue gets further complicated by the channel of funding used to facilitate any military expenditure. Ilzetzki et al (2010) offers a good template of analysis for this, which is also discussed by Barro and Redlick (2011). Say that it is funded by debt issuance in an already debt-ridden, high risk country. The return of the public investment to the rest of the economy is likely to take longer to come into effect than the average maturity of government debt (around 5 to 10yrs, if I am not mistaken). In that case the government would end up incurring large costs that would have to be paid before the return to the investment would be felt. However, the same might not be true of a government who faces low funding costs and has no difficulty rolling over its debt, which is the case for the USA.

Alternatively, the necessity of using tax financing might also create some difficulty in terms of political support due, once again, to the long term nature of such investments. If the support is there, then the effect might depend on the type of tax used to fund it, as Barro and Redlick (2011) argue. Tax, but particularly distortionary taxation like VAT or income tax might create desincentives to work and or to consume, which would inevitably bring GDP down, potentially undermining on the demand side any positive spillovers from supply-side stimulated growth.


Contributions of Defence R&D to Technological Development: Some Examples from the USA

In the USA, this is a cost that is borne by the federal/national government which is responsible for investments in new defence technology via the State Department, the DoD, DARPA, etc. Think about computers (developed for the encryption and decription of communication during WWII), the internet (a post-apocalyptic means of communication for the government, GPS (a missile guidance system). Germany during the second world war is also a good example of this. Then the totalitarian state made great strides in encryption (Enigma), atomic research (Uranverein) and ballistic missiles (V2).  Ruttan (2006) offers a more complete list that also includes nuclear technology, research into the semiconductors necessary for the digital revolution. He concludes that while military expenditure in the past has been a driver of growth, this will no longer be the case and technological progress will be more incremental.

I would generally disagree. I see the efforts of the US military in limb replacement (although this UK company seems amazing), robotics, exoskeletons and quantum computing as the technologies of the future, largely deriving from military and medical needs. Perhaps I am wrong and these views are too influenced by video games, science fiction and confirmation bias, but of course I don’t think so… and I’m in good company… Nevertheless, at the future is always an issue of opinion rather than fact so the point is mute.


Good features of Defence Procurement in the USA

The USA handles its defence procurement quite well in this manner.  It issues calls to tenders to private companies for specific projects that require the development of technological solutions to defence problems. Meanwhile, most of the patents developed in the process can be used, sold and elaborated upon for civilian commercial purposes. Of course the USA is not the only driving force. As Ruttan (2006:6) mentions, the development of the Boeing 707 was sparked by a French military contract. What makes the USA unique is the size of its procurement budget, the fact that it is very open to licensing technology patents to the private sector and its willingness to share resources with non-governmental partners during research. Of course there are limitations on international transfers and exports but the spillovers are enormous. Of the top 10 arms-producing companies in the world in 2008, 6 were from the USA, 1 (the top one) was from the UK (BAE Systems), another from Italy (Finmeccanica), the other from France (Thales) and yet another was a Franco-German consortium (EADS). The top 100 US military contractors includes a much more comprehensive list of companies.


Limitations of the Argument – The Cases of Germany, Japan, Korea and CERN

While the logic that government spending on defence R&D has a lot of appeal, it is clearly limited by the real world experiences of post-WWII Germany and Japan and by post-1980s South Korea. Clearly those are still very innovative countries.

EPO Fillings

However, these cases of civilian R&D do not necessarily undermine the case highlighted above. Instead, they probably complement it. First off, it is impossible on the face of the data available to disentangle any linkages to military research from the figures described above. Ultimately at the technological frontier, what matters is R&D and a matching of the required economic scale. Some projects are cheap enough to be funded privately. In other cases, it is a matter of perfecting existing technologies, which is not ground breaking technological innovation, but rather perfecting existing technology.

In other instances, alternatives to the narrative of R&D leadership by the US military is a regional issue, in line with issues of economic geography. So for example, many technologies have originated in Europe, namely out of CERN, which is a very well-funded international R&D facility for the purposes of this post. The fact that it is located in Europe and that it has staff from all over the world rather than just the USA also plays a role. It was there that the World Wide Web (different from the Internet mentioned before) and of touchscreen technologies were pioneered. Interestingly, the first was not commercialised, while the second was best exploited by an American and a South Korean company.

So clearly there is something about the economic environment that must support R&D. At the extreme, any technological innovations brought about by Soviet military research during the cold war would have had a very difficult time entering the real economy because it operated a command economy with no price mechanism or property to facilitate investment and returns. Of course, such an example does not exist in Europen anymore, but it might speak to the concerns that the US economy is more flexible than its neighbour on the other side of the Atlantic. Nevertheless, the case of CERN, in this context does echo the concern voiced by Neil Degrass Tyson about the technological decadence of the USA, even if his fears might be exaggerated.

European Limitations To Defence R&D

The issue of scale could however be a huge problem due to the relatively small size of European economies.

Nominal GDP 1980-2013

No single European country can individually match the monopsonistic purchasing power of the USA because none possesses, and will never again be able to possess, individually the necessary scale to do so in these days of globalised supply chains and expensive R&D. Individually the best of us are too small, but together we are one of the largest. Presuming that there can be large positive spillovers from military R&D expenditure, as described earlier, then the call for a European army might not be exclusively justified by recent fears of Russia. There clearly is at least another, deeper desirable economic, outcome that may be derived from it, although it will be difficult to control capture from the military establishment and from the military industrial complex.

European military integration is in all dimensions a logical thing to do assuming that preferences are aligned within the member states as it limit duplication efforts and take advantage of economies of scale.

For now, the EU has established military cooperation and the Lisbon Treaty created a framework for unanimous delegation of defence policy to the EU as well as a for partial integration between a smaller number of member states through enhanced cooperation. There is a Common Foreign and Security Policy, with a European Defence Agency, a EU Military Staff, a EU Battlegroup, a European Rapid Operation Force, a European Corps, among many others, but none of this constitutes an army upon which large scale operations, much less R&D could be jointly conducted. However, seeds have been planted for the future, first among which I would highlight the EDA’s Code of Conduct on Defence Procurement and Electronic Bulletin Board, and the September 2012 letter of recommendations by EU foreign ministers, including France, Germany, Spain, Italy and Poland and the Benelux, but any true integration is still very far.

Political Capture, Militarism and Crowding Out

Clearly, the issue of capture mentioned above is the main danger that looms behind the creation of any army for it may disrupt the Another pitfall of the economic argument in favour of further military European integration is the effect that an increased military role in R&D might have on private sector R&D. It is not impossible that specialisation in specific types of R&D that may be prevalent for military projects may not be relevant for other private sector issues and may thus lead to a crowding out of investment in other fields. It is possible that there are investment horizon differences between the two, even if I have neither heard nor imagined them so far. An interesting and particularly extreme instance of this might be the economic role that the Egyptian army has (discussion here, here and here). This is a somewhat different argument to the one of capture, in that it already presumes military capture. Instead, this is about the manner in which military capture would manifest itself once it is established, and this is not pretty.


Conclusion – The Looming Memory of Militarism

I think that the argument laid out above in favour of military innovation as a driver of very long term economic growth is extremely compelling. My concern is not that its impact is exaggerated but rather that its secondary effects in the form of military capture are very difficult to control. Thus, while I must admit I began writing this post with an extremely strong conviction that this is the way to go, my enthusiasm has at the very least been tempered by the insights I gained along the way regarding military capture. To be fully convinced of the viability of a European Army, one of two things must happen. Either necessity must make it inevitable, a fact which in my view Russia is endeavouring to make a reality, or enough checks and balances must be imposed upon it.

A European army must be fully transparent and accountable and subject to civilian oversight for its activities in order to avoid capture. Moreover, belligerence must be absolutely internalized so that it is a last resource rather than just another option. I would go as far as suggesting a small professional and elite army for UN sanctioned foreign intervention but that any escalation from this small set force would bring about an automatic increase in taxation and military conscription in order to ensure that the population was included, informed and internalized the financial and human cost of foreign military intervention. In this context, and in line with Acemoglu et al (2010.a), concern about the stability of the political system may also warrant strong considerations about inequality (Solt 2011), as a source of support for authoritarianism and military coups. The shadow of militarism looms too dark over the memory of the continent to allow for anything else.

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