Defense Expenditure and Civilian Consumption

Defense Expenditure and Civilian Consumption: The Dynamics of the Interrelationship

Introduction The inter relationship between economic growth and military expenditure has interested researchers recently. One way this inter relationship has been studied is the impact of military expenditure on the economic growth, specially in the case of less developed countries.[Benoit (1973, 1978), Kennedy (1974), Degar (1980), Faine, Annez and Taylor (1980, 1984), Degar and Sen (1983)]. The debate in this line stated with the finding of Benoit (1973) that military spending has source positive impact on economic growth in the less developed countries. Later on his finding has been supported by Kennedy (1974). But other researchers Degar (1974), Degar and Sen (1983), Faine, Annez and Taylor (1980, 1984) have shown that military spending has negative impact on economic growth. Even causality between defense expenditure and economic growth has been studied extensively in case od developing countries [ Dakurah et el, 2001; Deger and Smith, 1983; Kollias et el, 2004; Kusi, 1994 ]. A relation between military expenditure and economic growth is established easily from the basic Kegusian framework. In an economy with excess production capacity, increased aggregate demand from military or any other source will drive up output, capacity utilization and even the rate of profit. Investment may increase in response to higher profits, to put the economy on a faster long-term growth path. But such arguments apply more to developed economies than the less developed countries. In the latter, shortage of crucial inputs such as capital, skilled manpower are likely to affect output in a negative way than its effects on the aggregate demand. But the explanation Benoit (1973) offered for his finding (positive correlation between defence burden and GDP growth) was a productivity shift – newly formed military capital could have supplementary military uses that would contribute to overall economic growth. Again military training impact some skill which will be used in the economy after the completion of military service. This argument through

Defense Expenditure and Civilian Consumption

plausible, can also be reversed. Military spending can easily divert resources from domestic capital formation – resources in the form of foreign exchange, skilled manpower and production capacity in the non traded goods sector and so on. But to the knowledge of the present research the existing literature does not discuss the impact of economic growth on military expenditure. This hypothesis has not been rigorously tested though it has been stated that growth appeared to exert a weak influence on defence expenditure [Benoit (1977, p.276)]. Military spending is done to purchase defence against both external threat and internal instability. Moreover, the concept of insecurity comes more from the perception of the citizens about the surroundings, about the environment. Thus given the stock of arms of neighbouring countries a better perception about the basic insecurity and/ or ease of tension may had to lower demand for defence as a public good and hence lower military expenditure. In the less develop countries we see another problem – and that is problem of initial security. Society often suffers from violence, secessionist movement and the sort of tension which are sometimes the fall out of organizational changes associated with economic growth, like asymmetry in the regional balance within the country, change in the distribution of income and a feeling of deprivation among a section of population. The hypothesis we have here is the following. While economic growth increases the level of civilian consumption, the level of civilian consumption can be taken as an index of economic growth. Now with the increase in the level of civilian consumption, the demand for defence good increases too. This comes from two sources: First, defence is public good and increasing sense of security increases social welfare given the same level of civilian consumption. Again an increase in social consumption increases the sense of insecurity of the citizens also. This happens because of the following: As mentioned earlier a country passes through continuous social change as economic growth occurs. This creates some strains in the society. So the problem of initial security increases Further, with the creation of social capital, a country feels increasing need to protect these valuable things against both internal and external threat. These are the basic of our assumption that the consumption has a fall out in the sense that it increases insecurity too.


Defense Expenditure and Civilian Consumption

OBJECTIVES OF THE PRESENT STUDY : For the present study we propose we explore the relationship between consumption and level of insecurity and through this the relation between economic growth and military expenditure. For this we build up a theoretical model which captures their relationship in an optimizing framework. Then we will test relationship by using suitable economic technique. One aspect of this relation is the impact of military expenditure of the economic growth for the context of the optimizing model we will study empirically the ‘spin off’ of military expenditure on economic growth. Finally, we propose to define and estimate equilibrium demand for military expenditure for a country.

The Model
It is assumed that the social economic welfare is measured by a measured by a strictly concave utility function of current consumption (C) and the state of insecurities (S) which is a stock concept. Such a function follows closely the type of money demand function used in the literature though objection have been raised in recent time. The marginal utilities of consumption is positive but diminishing,. The marginal utility of insecurity is negative and decreasing. The disutility may be due to aesthetic consideration, fear of the citizens about their security from external threat or internal violence.

By consumption we mean civilian consumption.

Defense Expenditure and Civilian Consumption

Formally the conditions on the utility function U are U = U (c, s) Uc > 0, Us < 0, U (c, s) ε R2 Ucc < 0, c > 0 Uss < 0, s > 0 ……….(1) ……….(2)

Ucc Uss – Ucs 2 ≥ 0

Further we assume that an increase in the level of insecurities reduces the marginal utility of consumption, or Ucs < 0 ………(3)

This is economically reasonable, as increasing perception of insecurity reduces satisfaction from the same level of consumption. The following limit conditions are imposed on partial dervatives of U : lim Uc (c, s) = ∞ c→ 0 and lim Us (c, s) = 0 s→ 0 for all C > 0 ………(5) for all S > 0 ………(4)

Condition (4) ensures that no optional policy will lead to a zero level of consumption. This assumption is standard in the optimal growth literature. Condition (5) states that small deviations from a situation of perfect security dose not reduce welfare. This condition is sufficient to ensure that no optimal trajectory moves the economy to the fear of insecurity.

Full employment of the economy is assumed and a fixed level of output (Yo) is produced in each time period. This may be interpreted as output net of replacement investment. This output is allocated to consumption (C) and military expenditure (M) so that Yo=C+M ………(6)

Thus there exists a trade off between Consumption and Utility expenditure. The stock of insecurity increases as a result of the Consumption process. The flow increases at an increasing

Defense Expenditure and Civilian Consumption

rate with respect to consumption. The stock of insecurity is subject to decay at a constant exponential rate θ. Further, in the absence of military expenditure the stock of insecurity evolves over time according to S* = f (c) – θ S Where f (c) ε R2 f (O) = 0 F’ 0, f” 0, c > 0 ………(7)

And also S* indicates rate of change of S with respect to time. [ Henceforth, asterix * after a variable will indicate the rate of change with respect to time] And lim f ' (c) = 0 c→ 0 It is possible for the economy to slow the accumulation of the level of insecurity by increasing military expenditure. The amounts insecurity reduced will be function (g) of the amount military expenditure E. this function satisfy the following condition : g (M) ε R2 , g' (M) > 0, and lim g’ (.) = ∞ M→ 0 Society’s spending on military purposes either reduces the level of insecurity or transform it to some form which can be disposed of at no cost to society other than through M. Thus the society’s net contribution to the flow of insecurity is measured by f (c) – g (M) Form (6) the level of military expenditure can be determined solely by the choice of consumption level. M = Yo – C ……….(9) g (O) = 0 g'' ( M) < 0 , M > 0 ………(8)


Defense Expenditure and Civilian Consumption

The net contribution than is a function of the consumption level and is defined W ' (C) = f (C) – g (Yo – C) The function W ………..(10)

has the following properties as f ' > 0, g ' > o ………..(11)

W’ (c) = f ' ( .) + g ' (.) > 0, And W ' ' (c) = f ' ' – g ' ' > 0

The flow of the insecurity level increases at an increasing rate with respect to consumption. We also see from (8) lim W ' ( C) = lim f ' ( C) + lim g ' (Yo – C) = ∞ …………(12) C→Yo C→Yo C→Yo

Let C0 be the solution of W (C) = 0 Then W ( C) < 0 And W(C) > 0 for C > C0 For C< C0 the economy is reducing the level of insecurity in a net sense. For C > C0, it is increasing the level of insecurity. Thus C0 is the level of consumption which will just maintain a secure position. This is shown in following figure 1.: Figure 1 ______________________________________________________________ + 0 ∅0 Co C for C < C0

______________________________________________________________ W (c) may be thought of as the control function, which controls the level of insecurities.

Defense Expenditure and Civilian Consumption

By selecting the consumption level the society uniquely determines the amount insecurity it generates in net term. The control function has two components: One is an active control represented by g (M). List us now consider transferring a unit of output from the consumption sector to the military expenditure. In terms of controlling the level of insecurity, economy gain in two ways : First, with increase in military expenditure, level of insecurity reduces. Second, since the consumption level is lower, less flow of insecurity is being generated. With military expenditure, the level of insecurity is governed by the growth function: S* = W ( C ) - θS ………….(13)

The optimizing problem before society is to maximize the discounts flows of utility as follows: ℘ Max ∫ e – ρ t U (C, S) dt σ where ρ is the rate of discount. Subject to, S* = W( C ) – θS, Yo – 0 < U, S<U S(0) = So



This is an optimal control problem with one state variable S and one control variable C. So is historically given initial level of insecurity. Here the improper integral in 14 has a maximum because ∞ ∞ ∫ e –ρt U (c, s) dt ≤ ∫ e–ρt U(Yo,0) dt 0 0 = U(Yo,0)/p which is finite for ρ>0


Defense Expenditure and Civilian Consumption

Using Pontryagin’s Maximum Principle the necessary condition for a solution to the optimizing problem ( 14 ) are deduced as follows The current value Hamiltonian is H = U(c, s) + ψ (W(c) - θS) When ψ is the costate variable. value Lagrangain is Also there exist function γ (t) and q (t) such that the current

L = H + y γ [W(c) – θS] + q (Yo – c) For optimization necessary condition are : δL = 0 < = > Uc (C , S) + ψW’(C ) + γ W’ (C ) – q = 0 δc or (ψ + γ) W’ (C ) = q – Uc (C , S) or ψ + γ = Uc (C, S) +__q______ W’ (C) W’ (C ) dψ = ρψ - ∂L = ρ ψ - Us (c, s) + ψθ + γ θ dt θS or ψ* = (ρ + θ ) ψ - Us (C , S ) + γ θ q ≥ 0, γ ≥ 0, q (Yo – C) = 0 γS=0 γ S* = 0 …………….(16) ……………(17) ……………(18)


A policy of all-out consumption is non-optimal since from (12) and (15) we find that: lim c→Yo

[-Uc ( C,S ) + q ] = 0
=> W’ (c) lim (ψ + γ ) = 0 C →Yo

{as lim W’ (c) = 0 c→Y o


Defense Expenditure and Civilian Consumption

But for C = Yo S* > 0 γ=0 and hence ψ = 0, which can only exist for an instant since ψ * = – Us ( C, S ) > 0 For an interior solution (S > 0, 0 < C < Yo) the necessary condition are ψ = Us (C, S) W ' (c) And ψ * = ( ρ + θ) ψ - Us ( C, S) ……………(20) Now costate variable Ψ has the interpretation of a shadow price of the corresponding state variable if the objective function has the dimension of an economic value [intriligator (ch.11)]. Form 19 see that the shadow price of the insecurity is negative. Again 19 gives the derived demand for consumption as an implicit function of the shadow price and the level of insecurity. We can visualize the system solved as : C = C (ψ , S) (from implicit function theorem this is locally true) Using implicit function rule we can write, _δc = W' δψ - (Ucc + ψW '' ) From Equation (19) we write ψ W ' (c) – Uc (C, S) > 0 ∂c = ______ W’ (c) ∂ψ ψW” – Ucc (C, S)] and δC δS =– Ucs _____ < 0 Ucc + ψ W” (c) as Ucs < 0








Defense Expenditure and Civilian Consumption

The sign of Equation (21A) follows from assumption. [ Ucc < 0, W” (c) < 0, Ucs < 0, and W’(C) > 0 ]. The level of consumption is an increasing function of ψ and a decreasing function of the level of insecurity. Let us now turn to an analysis of the phase diagram in the (S, ψ) plane. First, consider the behaviour of the level of insecurity (stock). We define: Q(ψ, S) = W [C (ψ, S)] - θS = 0 ∂Q ____ = ∂ψ ∂Q ∂S = W’ (c) ∂ C -----------------∂ψ W’ (c) ∂ C ∂S As ∂ C / ∂S >0 …………..(22)






There fore, dψ dS = S*= o ∂Q / ∂S ∂Q / ∂ψ = - W’ (c) ∂c + θ W’ (c) ∂c / ∂ψ >0 …..(25)

The locus of Q (ψ, S) = 0 is upward sloping to the right in the phase diagram with lim ψ = o S→0 s = o lim – Uc (C, S) S→0 W’ (c) C→Co = – Uc (C0 , 0) W’ (C0 ) …..(26)

For fixed level of ψ, So we examine (24).

is a decreasing function of the level of insecurity. This is evident if

Therefore So < 0 to the right of So = 0 and So > 0 to the left. We consider the behaviour of shadow price ψ. We define: N (ψ, S) = ( ρ + θ) ψ - Us[C(ψ, S), S] = 0 Nψ = ( ρ + θ) – Ucs ∂c > 0 ∂ψ ……………(26a) ……………(26b)


Defense Expenditure and Civilian Consumption

Ns = - Uss – Ucs ∂c ∂S


Now dψ / dS ‌

ψ =0


- Uss + Usc ∂c / ∂S (ρ + θ) – Usc ∂c / ∂ψ


Uss + Usc [ - Ucs / Ucc + ψW” ] _____________________________ (ρ +θ) – Usc ∂c / ∂ψ by substituting form 21a - (Ucc Uss – U 2 cs ) - ψ Uss W” _______________________________ - (Ucc + ψ W”) (ρ + θ - Ucs . ∂c / ∂ψ)




The negative sign of (26d) comes from the sign of respective terms. Thus ψ* = 0 is downward sloping to the right with lim ψ S→0 ψ* = 0 = For constant S, ψ* = (ρ + θ) ψ – Us [C(ψ, S), S] Hence ψ* > 0 is true above ψo= 0 is an increasing function of ψ, , [from equation 26b] 0 from (5) lim Us (C, S) / (ρ = θ ) S→0


and ψ* < 0 is below ψo= 0

To determine the stability properties of the equilibrium we consider the Jacobian Matrix of the system


Defense Expenditure and Civilian Consumption

S* = W(c) - θS ψ* = ( ρ +θ)ψ - Us(C,S) Evaluated at the equilibrium (ψ*, S*). The Jacobian will be as follows:

- θ + W ' ∂c / ∂S J = - Uss - Ucs ∂c / ∂S

W ' ∂C / ∂ψ …………(27) (p + θ) – Ucs ∂c /∂ψ

[Chiang, Ch.11] The Phase diagram will look like the following: Figure 2 _________________________________________________________________________ S* 0 I II S S* = 0

ψ* IV III - Uc (C ,0) W’ (C0)

ψ* = 0

Defense Expenditure and Civilian Consumption


Therefore, det J = ( - θ + W ' ∂c) (p+θ - Ucs ∂c) – W ' ∂c ( - Uss – Ucs ∂c ∂S ∂ψ ∂ψ ∂S Since ∂c ∂S = – Ucs Ucc+ψW ''



Substituting the value of ∂c in the term we have ∂S W ΄ ∂c [Uss + Ucs ( – Ucs )] ∂ψ Ucc + ψW ' = W ΄ ∂c [ Uss Ucc + Uss ψW ΄΄ – Ucs2 ] ∂ψ (Ucc + ψW '' ) Therefore the value of the Jacobian will be |J| = (- θ + W’ ∂c ) (p + θ -Ucs ∂c ) ∂S ∂ψ + W ' ∂c /∂ψ [ – Uss Ucc – Ucs2 ) – ψW ΄΄ Uss] (Ucc + ψW '' ) <0 ……….(29)

Since the determinant of J is negative it follows that equilibrium is a saddle point. From the figure we find then equilibrium is unique. Regions I and II are traps in the sense that if any path enters in these regions, it remains forever. We show that the trajectory which lies along the stable branch of the saddle point is the optimal solution to the inter- temporal maximization problem of Equation (14). Path in region I or which enters I can be dismissed immediately as non optimal since S* > 0 and ψ* > 0. Eventually ψ = 0 while ψ* = Us > 0 and ψ becomes positive violating the conditions as in Equation ( 19). To show that the equilibrium path is the optimal path, we proceed as follows.

Defense Expenditure and Civilian Consumption

The path to the equilibrium denoted by (ψ**, C,** S** ) is compared with any other feasible path (ψ, C, ρ )


λ(t) = e –ρt ψ(t) = > λ* = ψ* e

………..(30) – ρ e –ρt ψ


From the concavity condition of the function U(C,S), we have ∞ ∫ e –ρt [U(C**, S** ) – U (C,S)]dt 0 ∞ ≥ ∫ e –ρt {Uc** (C** - C) + Us** (S** -S )} dt ° ∞ = ∫ e –ρt {[ - ψ** W’ (C** _] (C** - C) +[ψ**( α + ρ) -ψ0* ] ( S** - S )}dt 0 ∞ = ∫ [ - ψ** e –ρt ]{W’ (C **) ( C** - C ) – α (S* - S)}dt 0 ∞ + ∫ ( ρ e –ρt ψ* - e –ρt ψ0*) ( S* - S)dt 0 ∞ ∞ –ρt = ∫ [ - ψ** e ] {W ' ( C**) ( C** - C ) – α (S* - S)dt + ∫ λ 0* (S* -S)dt 0 0 Since the equilibrium path is derived from the optimising condition, the equilibrium path is the optimal path. Thus given S (0) , the economy selects that value of ψ(0), which corresponds to the stable branch of the saddle point. The shadow price ψ is then changes over time according to Equation ( 20 ), which ensures convergence to the equilibrium (S**,ψ** ). We see that the equilibrium is a saddle point in the (S, ψ) phase space. This means that if ψ is set at any value other than the one corresponding to the stable branch of the saddle, and then there is change over time according to Equation ( 20) , then the chosen trajectory diverges form optimal trajectory. However there is no reason for the economy to get off the optimal trajectory in such a controlled system is strictly stable subject to the choice of optimal control.

Defense Expenditure and Civilian Consumption

For the initial level of the insecurity lying above the equilibrium solution, the level of insecurity must fall and as it falls over time, resources are released from military expenditure to consumption. For initial level of insecurity below the equilibrium point, the stock of insecurity rises over time. As a result more resources are diverted from civilian to military uses and level of consumption falls over time. Stationary Solution Let us turn to a discussion of the stationary solution. The condition on C and S are: W (C** ) = α S* Uc (C*, S*) = - Us(C**, S** ) W' (C** ) ρ+θ …………(32) …………(33)

Equation (32 ) is the condition that in equilibrium the stock of insecurity is constant. The amount of low insecurity generated W(C** ) is just equal to the amount which reduced as a result of decay θ S*. In equation (33), the left hand side is the marginal utility of consumption. The numerator of the right is the loss in utility caused by an increment in consumption. This utility is lost because additional insecurity has been generated as a result of momentary increase in consumption. If the stock of insecurity does not decay then the loss of utility must be permanent. The present value of this loss is. -Us (C, S) W ' (C) ρ But the state of insecurity decays over time at some positive rate and loss of utility is less. The present value will be lower and this is as follows: Present value = -Us (C, S) W ' (C) ρ +α The present value may be interpreted as the marginal psychic cost of consumption. And equation (33) explains that the marginal utility of consumption equals the marginal psychic cost of consumption.

Defense Expenditure and Civilian Consumption

Variation in Parameters:

Any change of fiscal monetary policies of the government will induce changes in the values of the parameters important in this study like ρ and α . Their changes will
have impact on the values of both civilian and military consumption of the economy. Above we have the stationary value of C and S for given value of the parameters ρ , α and Y(0). We now turn to a consideration of the effects on equilibrium value of C and S of different values of these parameters. Differentiating the system (32), (33) totally we get

W ' dC – α dS = S d α + 0. d ρ + f '. dYo


{ (ρ + α ) Ucc + UsW ' ' + UcsW '} dC + { ((ρ + α ) Ucs +Uss W '} dS = - Uc (d α + d ρ) – Us f ' ' dY0 [ Note : Since W (C) = f (C) – g (Y0 –c), We define the determinant W’ = (ρ + α) Ucc + UsW” + Ucs W’ (ρ + α) Ucs + Uss W’ - α and C = Y0 –M ]

= W’ { (ρ + α) Ucc + Uss W’} + a { (ρ + α) Ucc + UsW” + UcsW’} < 0 as Ucs < 0 Uss < 0 Ucc < 0 W” < 0 by assumption


Defense Expenditure and Civilian Consumption

We now solve (34) for the desired partial derivation using Cramer’s rule. First consider variation in ρ and other two parameters are unchanged as dY0 = 0 = da

Then system (34) reduces to W’ dc – α dS = 0 {( ρ + α ) Ucc + Us W '' + Ucs W '}dc + {{( ρ + α ) Ucs + UssW '}dp = - Uc d ρ

Therefore ∂C = - Uc α ∂ρ Δ and ∂S ∂ρ = >0 as Δ < 0, ………….(35)

- UcW '



Thus both consumption and level of insecurity move in the same direction as the discount rate. Let us suppose that preference for the present time increases (or discount rate is higher ). Now given the level of insecurity, the economy will consume more. Let us now investigate the effect of change in the decay rate α . we find that __∂C ∂α = 1 {S {( ρ + α ) Ucs + W’ Uss] – α Uc} > 0 Δ Ucs < 0, Uss < 0 , Δ < 0., and ………..(38) ………..(37)

Because we have

∂S/ ∂c = 1 {- W’ Uc – S [{( ρ + α ) Ucc + Us W ' ' + Ucs W ' ]} ≥ 0 Δ <


Defense Expenditure and Civilian Consumption

As W ' > 0, Uc > 0, Ucc < 0, W '' < 0 Thus level of consumption moves in the same direction as decay rate. But the level of insecurity may or may not move in the same direction as decay rate. One thing is important. If for some reasons, tension reduces so that decay rate of insecurity become higher, society as a whole benefited by higher level of consumption.

Let us now consider variation in full employment output Y (0). This may be caused by economic growth caused by an increase in capital stock or the incidence of technological progress. Form (34 ) we have

∂C / ∂Y0

= 1 [ {f ' ( ρ + α )Ucs + UssW ' } – α Uss f ' ] > 0 Δ as W’ > 0, Uc > 0, Ucc < 0, W” < 0

……… (39)


∂S / ∂Y0

= 1 {- Us f '' W ' – f ' [( ρ + α) Ucc + Us W '' + Ucs W ']} ≥ 0 Δ < as Us < 0 …………(40)

Thus when economic growth occurs, in equilibrium the society has a higher level of consumption. But from Equation (40) we find that there may or may not be any relation in between economic growth and the level of insecurity. Conclusion We can summaries the major points of the optimal control model. First the steady state equilibrium is stable. Thus the society can achieve efficient allocation of resources in between civilian consumption and military expenditure. Secondly, an increase in the decay rate of the stock of insecurity (resulting from ease of tension) will increase the equilibrium of consumption. Thus the society is benefited. Thirdly, we have a desired demand for military expenditure deduced from optimizing framework. Fourthly, the relationship between economic growth and military expenditure is not so simple as suggested in the literature. We are to make empirical investigation to see whether it can throw some light on this.

Defense Expenditure and Civilian Consumption

References Benoit, E., Defense and Economic Growth in Developing Countries, Lexington Books, Lexington, 1973. __________, Growth and Defense in Developing Countries, Economic Development and Cultural Change, 26, 271 – 280 , 1978 Dakurah, A.H., S. P. Davis and R.K. Sampath, Defense Spending and Economic Growth in Developing Countries: a Causality Analysis, Journal of policy Modeling, 23, 651 – 658 , 2001. Deger, S., Military Expenditure in Third World Countries: The Economic Effects, London, Routledge, 1986. Deger, S. and S. Sen, Military Expenditure , Spin-off and Economic Development, Journal of Development Economics, 13, 1983. Deger ,S. and R. Smith, Military Expenditure and Growth in Developing Countries, Journal of Conflict Resolution, 27, 335 – 353 , 1983. Faine, R., P. Arnez, and L. Taylor, Defense Spending, Economic Structure and Growth: Evidence among Countries and Over Time, Economic Development and Cultural Change. 1984. Kennedy, G., The Military in the Third world, London, 1974. Kollias, C., G. Monolas, and S. Paleologou, Defense Expenditure and Economic in the European Union: A Causality analysis, Journal of Policy Modeling, 26, 553 – 569 , 2004. Kusi, N.K., Economic Growth and Defense Spending in Developing Countries: A Causal Analysis, Journal of Conflict Resolution, 38, 152 – 159 , 1994.


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