Global Determinants of Defense Reform: Economic Liberalization

1
Global Determinants of Defense Reform Economic
Liberalization

• Robert Looney
• Professor, National Security Affairs
• Naval Postgraduate School
• Conference on Global Determinants of Defense
  Reform at the Naval Postgraduate School
• Monterey, California, September 9-10, 2005

2
Outline

• Main Issues Economic Liberalization, and
  Defense Expenditures.
• Policies of International Financial Institutions
  -- Neoliberalism in the 1990- period.
• Operational Measures of Economic Liberalization.
• Economic Liberalization and Defense Expenditures
  General Patterns.
• Contrasting Environments of Economic
  Liberalization, Institutions, and Defense
  Expenditures Resulting Patterns of Defense
  Expenditures and Economic Growth.
• Implications for Defense Reform.

3
Main Issues Effectiveness of Security
Expenditures

• Every society must choose between direct
  productive allocation of its resources and
  reservation of some of those resources to
  protection of that production.
• From this perspective, resources allocated to
  defense or to security are themselves no less
  potentially productive than resources allocated
  to direct economic activities.
• Defending persons and property, however, has its
  dark side. Powers of enforcement, coercion and
  punishment are vested in individuals and
  institutions.
• Will these be effective in their task,
  contributing to growth and development, or will
  they be corrupt, inefficient and thus detrimental
  to economic activity?

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Main Issues (contd.)

• A complicating factor has been the post-cold war
  ascendancy of neo-liberal free market economic
  policies and associated expansion in
  globalization. In theory, both should be
  conducive to improved growth and development.
• However, each has tended to place pressure on
  unproductive expenditures. In many instances
  this has been translated into declining security
  budgets, especially in situations where
  macroeconomic instability exists.
• In many cases the resulting reduction in security
  expenditures has created a vicious circle of
  increased violence, instability and further
  macroeconomic instability.
• It is becoming increasingly clear that more
  knowledge is needed to assess the broader impact
  of security expenditures. Specifically, in which
  situations are productive aspects of security
  expenditures likely to prevail over the
  unproductive? Does economic liberalization tend
  to increase or decrease the effectiveness of
  security expenditures?

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Trilemmas, Economic Integration, Liberalization
and Defense Expenditures
6
IMF, The World Bank and the Washington
Consensus

• Adoption of the Washington Consensus in the
  Late 1980s.
• Shift from Failed State-Led Development
  Strategies of the 1960s and 1970s to Market Led
  Development.
• Fiscal Discipline Limit Budget Deficits.
• Macroeconomic Stability Key Objective of Policy
• Public Expenditure Priorities Redirect
  Expenditure Toward Human Capital and
  Infrastructure.
• Tax Reform Broaden Tax Base and Cut Marginal
  Tax Rates.

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Washington Consensus (contd.).

• Financial Liberalization Abolish Interest Rate
  Controls.
• Exchange Rates Introduce Unified and
  Competitive Exchange Rate.
• Trade Liberalization Replace Quantitative
  Restrictions by Tariffs then Reduce Tariffs Over
  Time.
• IMF and World Bank Empirical Studies Suggested
  Defense Expenditures Have Negative Impact on
  Macroeconomic Stability and Economic Growth.
• In this framework defense expenditures viewed as
  unproductive and a threat to macroeconomic
  stability. Concern over excessive defense
  expenditures.

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Measures of Economic Liberalization Fraser
Institute

• Equates Economic Liberalization With Economic
  Freedom Personal Choice, Voluntary Exchange,
  Freedom to Compete and Protection of Person and
  Property
• Size of Government Expenditures Taxes and
  Enterprises.
• Legal Structure and Security of Property Rights.
• Access to Sound Money.
• Freedom to Exchange With Foreigners
• Regulation of Credit, Labor and Business.

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Measures of Economic Liberalization Wall
Street Journal, Heritage Foundation

• Focus on the Relative Progress Made by Countries
  in Moving to a Deregulated, Limited Government
  Free Market Environment
• Trade Policy.
• Fiscal Burden of Government.
• Government Intervention in the Economy.
• Monetary Policy.
• Banking and Finance.

10
Economic Liberalization Wall Street
Journal/Heritage Foundation (contd.)

• Measures of Economic Freedom (contd.)
• Capital Flows and Foreign Investment.
• Wages and Prices.
• Property Rights.
• Regulation.
• Informal Markets.

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World Bank Governance Indicators

• Key Dimensions of Governance
• Voice and Accountability Extent to Which
  Citizens Able to Participate in the Selection of
  Governments.
• Political Stability and Absence of Violence.
• Government Effectiveness Competence of Civil
  Servants Credibility of Governments Commitment
  to Policies.
• Rule of Law.
• Control of Corruption.

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Economic Liberalization, Governance and Defense
Expenditures

• Environments and The Economic Effectiveness of
  Defense Expenditures Main Issues
• Previous Studies Have Found Positive Links
  Between Defense and the Economy in Resource
  Unconstrained Environments and Negative Links in
  Resource Constrained Countries Do Similar
  Patterns Apply to the Relative level of Economic
  Liberalization/Governance Reform?
• To What Extent Do Economic Environments Control
  the Level of Defense Expenditures?
• How Do These Environments Influence the Economic
  Effectiveness of Defense Expenditures?
• What types of Economic Liberalization/Governance
  are Most Significant in This Regard.

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Differences High/Low Defense Expenditure
Countries

• Key Differences Countries Above/Below Mean for
  Defense as a Share of GDP 2000-2003.
• Foreign Direct Investment Much Higher in Low
  Defense Countries.
• Low Defense Countries Better Macroeconomic
  Aggregates Lower Government Consumption
  Higher Savings Rates, but Similar Investment
  Rates.
• Low Defense Countries Had Higher Rates of Growth
  Late 1990s and Early 2000s.

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Differences High/Low Defense Expenditure
Countries (contd.)

• Wall Street Journal/Heritage Economic Freedom
  Index Low Defense Countries Score Consistently
  Higher. Only Area High Defense Countries Higher
  is in Fiscal Burden.
• Frasier Index Low Defense Countries Superior
  Progresses Except in Access to Sound Money.
• Main Areas of Difference are in Governance Low
  Defense Countries Score Much Higher in All
  Categories, Especially in Voice and
  Accountability Gap Widened from 1990s.
• Regression of Defense Burden on Economic
  Liberalization Statistically Significant
  Variables Voice and Accountability, Fraser
  Summary Economic Freedom Index, Fraser Legal
  Structure Index and World Bank Rule of Law Index
  Explain 43 Variance in Defense Burden.

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Economic Impact High/Low Defense Countries --
Model

• Model
• GDPYPG F(GFCY, AIDPER, GFDIY, GCNPY, MILXY).
• 
  - ?
• GDPYPG Growth Per Capita Income.
• GFCY Gross Capital Formation Share of GDP
• MILXY Defense Expenditures Share GDP
• GFDIY Gross Foreign Direct Investment Share of
  GDP
• GCNPY General Government Consumption Share of
  GDP.

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Economic Impact High/Low Defense Countries --
Results

• Main Results (Statistically Significant)
• Total Sample
• GDPYG ()GFCY () MILXY
• (consistent with IMF/World Bank View)
• High Military Expenditure Countries
• GDPYG (-) MILXY
• Low Military Expenditure Countries
• GDPYG ()GFCY

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Interpretation of Results

• Previous Research Has Shown That Defense
  Expenditures
• Have Both Positive and Negative Effects on The
  Economy.
• The Environment in Which They Occur Dictates
  Which Will Predominate.
• High Defense Countries Lagged the Low Defense
  Countries More in Economic Liberalization and
  Governance Than in Basic Macroeconomic
  Aggregates.
• For the High Defense Countries Positive Linkages
  Associated With Defense Expenditures May be
  Suppressed by the Their Relatively Low Levels of
  Governance and Economic Liberalization.

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Economic Liberalization and Defense
Expenditures--Linkages

• With High and Low Defense Countries Now Defined
  With Regard to their Position Above and Below A
  Regression Equation of Defense on Economic
  Liberalization and Governance Indices --
  Hypothesis
• Countries Where Key Economic Liberalization and
  Governance Indicators Are High Relative to
  Defense Expenditures Should Have Positive
  Economic Effects from Increased Military
  Expenditures.
• Those Countries Who Have High Defense
  Expenditures Relative to Economic and Governance
  Reforms Should Have Negative or Neutral Linkages
  Between Military Expenditures and the Economy.

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Country GroupingsMain Differences

• Defense Burden (Defense Share of GDP)
• Old -- 5.49(H) vs. 1.49(L)
• New 3.19(H) vs. 1.67(L)
• Growth in Per Capita GDP
• Old 2.32(L) vs. 1.88(H)
• New 1.94(H) vs. 1.76(L).
• Economic Liberalization/Governance
• Old -- Low Consistently Better
• New Nearly Balanced With Each Group Superior in
  Some Areas.

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New Country GroupingsTrends in Defense Burdens
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New Country GroupingsPatterns of Growth
22
New Country GroupingsComparisons of Capital
Formation
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Economic Impact New Groupings High/Low Defense
Countries -- Results

• Main Results (Statistically Significant)
• Relatively High Military Expenditure Countries
• GDPYG () GCFY
• Relatively Low Military Expenditure Countries
• GDPYG ()GFCY () MILXY

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Summary Economic Liberalization, Governance and
Defense Impact
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Implications For Defense Reform

• World Bank, IMF View Of Defense Expenditures
  Implicitly Assumes Negative Links With
  Economy--Biased Towards Arbitrary Budgetary Cuts
  in Defense Often Neglecting Security
  Considerations.
• The Trilemma Between Institutions, Nation State
  and Globalization May Not be As Binding as
  Commonly Believed. There May Be a Variety of
  Alternative Approaches to Economic Growth and
  Globalization Consistent with Good Economic
  Performance and Productive Defense Expenditures.
• Results Here Suggest A Constructive Approach is
  Possible -- Letting Countries Define Their
  Security Needs While The IMF/World Bank Can Push
  for Complementary Economic/Governance Reforms.

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Implications For Defense Reform (contd.)

• Specifically
• Rather Than Considering Defense Expenditures as
  Excessive or Not Based on Their Absolute Amounts
  or Share of GDP, Defense Expenditures Should be
  Assessed in their Economic and Institutional
  Settings.
• Within this Context Economic Strategies Should be
  Designed in Conjunction Improvements in Key Areas
  of Governance and Economic Reform To Reinforce
  the Positive Linkages of Defense Expenditures
  With the Economy.
• Selective Economic Liberalization and Improved
  Governance in Key Areas Rather Than Across the
  Board Efforts May Be Sufficient for This Purpose.
• The Key is to Coordinate Economic Liberalization
  and Governance Reforms in the Civilian Sector
  With the Requirements of Improved Security in the
  Defense Sector.