Political Research Quarterly

The Relationship between Defense 63(4) 760­–770

© 2010 University of Utah
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DOI: 10.1177/1065912909334427

in the United States http://prq.sagepub.com

Uk Heo1

Abstract
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.

Keywords
Defense Spending, Economic Growth, Feder-Ram Based Model,   Augmented Solow Model, United States

The Defense–Growth Nexus http://www.bea.gov/National/nipaweb/Index.asp) and the

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. Accord-
ing to the Office of Management and Budget (OMB),
defense spending from 2001 to 2006 increased by 41 per-
cent (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
national debt went from $5.8 trillion to $8.6 trillion (Treasury
Department n.d.). Coincidentally, the International Mone-
tary 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 rela-
tionship 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
1
University of Wisconsin–Milwaukee
Corresponding Author:
Uk Heo, Professor, Department of Political Science, University of
Wisconsin–Milwaukee
Email: heouk@uwm.edu.

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Heo 761
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.
Dunne, Smith, and Willenbockel point out that the Feder-
Ram defense–growth model is not commonly used in the
mainstream growth literature in economics. This body of
literature has found an insignificant relationship between
defense spending and economic growth (e.g., Sala-i-Martin,
Doppelhofer, and Miller 2004). They further argue that the
Feder-Ram–based defense–growth model should not be
used in defense economics research because of simultaneity
bias, multicollinearity between independent variables, and
its static nature stemming from the lack of lagged regressors.
To address these issues, they recommend the augmented
Solow model.
Thus, in this article, I theoretically compare these
two models and empirically test the relationship between
defense spending and economic growth in the United
States for 1954 through 2005, employing both models to
investigate how increases in defense spending affect
the U.S. economy. Considering the recent and scheduled
increases in defense spending, the findings of this study
will further our understanding of the relationship between
defense spending and economic growth and will have
important policy implications for the U.S. government.
Literature Review on the
Relationship between Defense
Spending and Economic Growth
in the United States
Negative Effects
From a purely economic point of view, defense expen-
ditures can be unproductive, although they provide
insurance against war (Cuaresma and Reitschuler 2004).
Goldstein (1988) argues that a 1 percent increase in the
defense share of GNP in the United States reduces eco-
nomic growth by about one-half percent because of the
opportunity cost: a trade-off in the budget and the bottle-
neck effect of defense spending on capital stock (see also
Heo and Eger 2005; Mintz 1989; Mintz and Huang 1990,
1991). The budgetary trade-off occurs because govern-
ment expenditures are generally financed through taxes,
budget deficits, the guns-versus-butter trade-off, or print-
ing new money (Cappelen, Gleditsch, and Bjerkholt 1984;
Chan 1987; DeGrasse 1983). In other words, each incre-
ment of defense spending brings a heavier tax burden; a
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larger government budget deficit; inflation; a decline of
social welfare spending, such as expenditures on public
health or education; or a combination of them (Adams and
Gold 1987; Chan 1987: Mintz 1989; Russett 1982; Ward
and Davis 1992; Ward, Davis, and Lofdahl 1995). All of
these have long-term economic implications.1
The bottleneck effect of defense spending on capital
stocks occurs because defense spending has a dampening
effect on investment through competition for the noncon-
sumption portion of total economic output (DeGrasse 1983;
Heo and Eger 2005; Mintz and Huang 1990, 1991).2
According to Mintz and Huang (1990, 1284), more than
half of total economic output in the United States comes
from private consumption and nonmilitary public expen-
ditures. Since it is politically unappealing, politicians tend
to hesitate to cut off nonmilitary public spending, while
individuals tend to resist cutting back on personal con-
sumption. As a result, defense spending and private invest-
ment vie for the nonconsumption portion of the total
capital available in the economy, which means that more
spending on defense programs is likely to result in the
decline of private investment.
Mintz and Huang (1990, 1991) report that defense
increases in the United States stifle private investment,
although it takes five years for the effect to appear. Heo
and Eger (2005) also find that defense spending has a
dampening effect on private investment but with only a
one-year delay (although both studies report insignificant,
direct effects of defense spending on economic growth).
Lindgren (1984, 376), in his review of more than a dozen
studies of the relationship between defense spending and
investment, also reports that increases in defense expendi-
tures result in the decline of private investment.
In addition, defense spending dampens human capital,
which in turn has a restraining effect on productivity growth.3
According to Melman (1983), defense industries attract
highly trained workers and engineers and thus have a drain-
ing effect on human resources for private industries. Hong
(1979) shows empirical evidence of a U.S. productivity
decline due to a resource shift from civilian to military use
(see also Gold 1990).4 Ward and Davis (1992) also find that
the factor productivity of the civilian sector in the United
States is higher than that of both the military and the non-
military public sectors. These and other studies show that
defense spending hampers economic growth in the United
States (Ward, Davis, and Lofdahl 1995).
Positive Effects
Mueller and Atesoglu (1993), in their empirical analysis,
find that defense spending stimulates the U.S. economy
(see also Atesoglu 2002; Atesoglu and Mueller 1990).
Cuaresma and Reitschuler (2004) report that the externality
762 Political Research Quarterly 63(4)
effects of U.S. defense spending on economic growth are
also positive. One of the reasons commonly cited for the
positive association between the two variables is job cre-
ation. Since the average salary of the military sector is
generally lower than that of the private sector, defense
spending is economically more efficient in terms of job
creation than other expenditures.
Nincic and Cusack (1979) as well as Blank and
Rothschild (1985) report that defense programs generate
employment in the United States because of the large size of
the U.S. armed forces.5 Former Secretary of Defense Casper
Weinberger (1983, 68) argued in the FY 1984 Report of the
Secretary of Defense that defense cutbacks of $1 billion
would result in the loss of approximately 35,000 jobs in the
United States. DOD economist David Blond also contends
that an average defense spending increase of 10 percent in
the United States may lead to a decline in unemployment
of 0.6 to 2.4 percent.6 He points out that the DOD makes
direct hires for military and support programs. Addition-
ally, defense contracts generate jobs for defense industries
and their subcontractors, thus leading to multiplier effects
on employment.
The positive employment effects of defense spending
also boost aggregate demand in the economy. Those who
earn income through defense programs or DOD contract
awards consume their earnings, which enhances aggregate
demand (Chan 1995). In addition, Adams and Gold (1987)
contend that the defense industry has been a source of sig-
nificant technological innovation in the United States and
has promoted growth through a spin-off effect on the pri-
vate sector (see also Gold 1990; Sandler and Hartley 1995).
In addition, a portion of defense spending is used to
support education, which enhances human capital. As Barro
(1990) notes, the quality of human capital is an import
element in economic growth. Human capital enhance-
ment through supporting/subsidizing education can indi-
rectly and positively affect the civilian sector later.
Finally, defense spending contributes to maintaining
both internal and external security, which is critical for
economic activities. A secure environment may also attract
greater foreign direct investment and international eco-
nomic exchanges, which both contribute to economic
growth (see Sandler and Hartley 1995).
Insignificant Effects
In contrast to the discussion thus far, a group of scholars
finds no statistically significant direct relationship between
defense spending and economic growth in the United
States (Gerace 2002; Heo 2000; Kinsella 1990; Payne and
Ross 1992). Kinsella (1990) as well as Payne and Ross
(1992) conducted vector autoregression analysis to test if
U.S. defense spending and economic growth have a causal
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relationship. The results in both studies indicate no causal
relationship between the two variables.
Gerace (2002) shows that defense spending in the
United States does not have a significant impact on eco-
nomic growth in his spectral analysis. He argues that
defense spending per capita in the United States is simply
not large enough to have a statistically meaningful effect
on economic growth (see Becker 1991 for a similar argu-
ment). Biswas and Ram (1986) also assert that defense
expenditures in general may affect economic growth pos-
itively or negatively, but the effect is unlikely to be con-
sistently significant on the grounds that the nature and the
amount of the spending vary over time.
Heo (2000) conducted an empirical analysis to test the
direct effects of defense spending on economic growth
in the United States for 1948 through 1996 employing
various versions of the Feder-Ram–based defense–growth
models proposed in the literature. Regardless of the model
specifications, he finds a consistently insignificant rela-
tionship between defense spending and economic growth.
Thus, he concludes that data from various sources, rather
than model specifications, are the main cause of inconsis-
tent findings of the relationship between defense spending
and economic growth in the United States.
The Evolution of the Feder-Ram
Defense–Growth Model
As stated earlier, there is a strong tradition of using the
neoclassical production function approach in studying
the defense–growth relationship. This approach employs a
supply-side description of changes in aggregate output,
which assumes that economic growth is a function of
labor and capital. Based on this logic, Ram (1986) devel-
oped a two-sector growth model to examine the relation-
ship between government spending and economic growth.
Her logic for dividing the total economic output into two
(government and private) sectors is that there is a differ-
ence between the public and the private sectors with
respect to productivity.
According to Mintz and Huang (1990, 1991), however,
the effects of defense expenditures on growth may not be
the same as those of nonmilitary government spending.
The reason is that the military is unique; therefore, defense
programs exist for a number of different reasons and pur-
poses (see Dumas 1986; Heo 1998). Moreover, Alexander
(1990) notes that the nonmilitary government sector can
stimulate positive externality effects on other sectors of the
economy because nonmilitary public expenditures provide
public inputs to improve economic infrastructure while the
military sector may not. Thus, it is theoretically reasonable
to separate the military and nonmilitary government sec-
tors in order to study how various components of public
Heo 763
spending affect economic performance differently. Mintz
and Huang do this and were able to set apart the effects
of military and nonmilitary government spending on
economic growth.7
Mueller and Atesoglu (1993), however, argue that pre-
vious defense–growth models overlooked the importance
of technological progress, although Solow (1970) con-
tends that technology is what tells us how much eco-
nomic output can be produced from the amount of labor
and capital used in production.8 To this end, Mueller and
Atesoglu include technological progress in their two-
sector (defense and nondefense economic sectors) non-
linear defense–growth model to test the defense–growth
relationship in the United States. They assume techno-
logical progress changes at a constant exponential rate
over time, although the progress rates may fluctuate
annually (see also Cuaresma and Reitschuler 2004).
Heo and DeRouen (1998) agree with the Mueller
and Atesoglu (1993) approach of including technologi-
cal progress in the defense–growth model. However, Heo
and DeRouen follow Mintz and Huang’s (1990) logic
that the nonmilitary public sector should be separated
from the private sector of the economy because it is a
public component of the economy (see also Ram 1986
for an argument in favor of separating the public sector
from the private sector). Thus, they augment Mueller and
Atesoglu’s nonlinear defense–growth model by dividing
the nonmilitary sector into the nonmilitary government
and private sectors while still accounting for technologi-
cal progress.
Heo and Eger (2005) further expand Heo and DeRouen’s
(1998) model by separating the nonmilitary sector into
three components—nonmilitary government, export, and
the remainder of the economy—in addition to the military
sector based on Alexander’s (1990) and Feder’s (1983)
arguments. Alexander (1990, 43) contends that the total
economic output needs to be separated into at least four
sectors to accurately measure the defense–growth rela-
tionship.9 Feder (1983, 59) asserts that export-oriented
industries have a higher factor productivity than non-
export-oriented industries; thus, they should enter the
growth model separately.10 Following this logic, Heo and
Eger develop a defense–growth model with four economic
sectors while including technological progress as an ele-
ment of economic input.
As discussed thus far, the empirical models employed
in studying the supply-side defense–growth nexus have
been based on the Feder-Ram defense–growth model. The
Feder-Ram–based defense–growth model has much to
offer thanks to its theoretical nature (Sandler and Hartley
1995, 208). First, the model is developed from macroeco-
nomic theory of growth instead of ad hoc justifications
for their model specification. Based on the neoclassical
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production function approach, the Feder-Ram–based
defense–growth model assumes that labor and capital
along with government expenditures play a key role in
national economic production. By separating defense spend-
ing from government expenditures, the model enables us
to empirically test the defense–growth relationship in the
context of the macroeconomic theory of growth. Further-
more, the model can separately test the economic effects of
defense spending and nonmilitary government spending
on growth.
Second, according to Ward and Davis (1992, 749; see
also Cornes and Sandler 1986), as public expenditures con-
tribute to national productivity, defense spending also has
spillover effects on overall growth, the so-called externality
effects. Most of the Feder-Ram defense–growth models
include both the economic effects of defense spending
and nonmilitary government spending on growth and their
externality effects.11 Thus, the Feder-Ram-based defense-
growth model enables students of defense economics to test
the differential effects of defense and nondefense govern-
ment spending and their externality effects on economic
growth (e.g., DeRouen and Heo 2001; Heo 1998, 2000;
Heo and DeRouen 1998; Heo and Eger 2005; Huang and
Mintz 1991; Mintz and Huang 1990, 1991; Ward and Davis
1992; Ward, Davis, and Lofdahl 1995).
However, Dunne, Smith, and Willenbockel (2005) criti-
cize the Feder-Ram–based defense–growth model because
of a number of issues embedded in it regardless of the num-
ber of economic sectors. To replace the Feder-Ram–based
model, they recommend the augmented Solow model by
addressing the issues embedded in the Feder-Ram–based
defense–growth model. Thus, I discuss the theoretical
strengths and weaknesses of both models and employ them
to empirically test the economic effects of defense spending
on growth in the United States from 1954 to 2005.
Research Design
The Feder-Ram-based
Defense–Growth Model
Regardless of the number of economic output sectors,
all the supply-side defense–growth models based on the
Feder-Ram approach have been derived from the aggre-
gate production function including a marginal factor pro-
ductivity differential across sectors (Sandler and Hartley
1995). For instance, the following is the description of the
aggregate production function of a typical three-sector
defense–growth model.12
M = M(Lm, Km),
N = N(Ln, Kn), and
C = C(Lc, Kc, M, N),
764 Political Research Quarterly 63(4)
where M, N, and C (both capital and lowercase subscript)
represent the military, nonmilitary public, and civilian
sectors, respectively, and L and K (both capital and subscript
in later equations) indicate labor and capital. The reason
that M and N entered the aggregate production function of
the civilian sector is because of their externality effects.
Total economic output and a marginal factor productiv-
ity differential between the military, nonmilitary public,
and civilian sectors can be described as follows:
Y = M + N + C = f(L, K) = ML+ MK + NL+ NK + CL + CK,
ML MK
¼ ¼ 1 þ dm
CL CK
NL NK
¼ ¼ 1 þ dn
CL CK
where Y is national income (gross domestic product), and
δi denotes the productivity differential between the public
(military and nonmilitary) and civilian sectors. According
to Dunne, Smith, and Willenbockel (2005, 454-55), the
interpretation of a productivity differential δi in previous
studies is problematic because scholars interpreted nonzero
δi as one sector becoming more or less efficient than the
other, although nonzero δi occurs when the implicit price
ratio between the military (or nonmilitary public) and
civilian sectors used in the evaluation of GDP deviates
from the marginal rate of the guns-versus-butter trade-
off. They argue that this misinterpretation often leads to
incorrect conclusions.
Turning to the empirical model, taking the total
differential of economic output with respect to time
in the three-sector Feder-Ram–based defense–growth
model leads to the following equation:13
 d reduce the possibility of multicollinearity. The aug-
^ ¼ CL L L^ þ CK I þ
M
Y
m
þ ym M^ þ ym M
^ mented Solow model by Dunne, Smith, and Willenbockel
Y Y 1 þ dm Y is as follows:
 d N
n ^ þ yn N
^ þe
þ þ yn N
1 þ dn Y ∆ln y(t) = β0 + β1ln y(t – 1) + β2ln s + β3ln (g + n + d)
where I is investment, N represents nonmilitary public
expenditures, θ indicates the externality effects of the
military and nonmilitary public sectors, and ^ denotes
growth rates.
According to Dunne, Smith, and Willenbockel (2005),
having the growth rate of defense expenditures on the
right-hand side to test the externality effects of defense
spending may cause a serious simultaneity problem
because economic growth will affect the level of defense
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expenditures (and nonmilitary government spending) if
the defense (nondefense public) spending share of eco-
nomic output is constant. In addition, according to Sandler
and Hartley (1995, 209), there may be a potential interac-
tion between investment and nonmilitary public expendi-
tures because the latter may improve the environment for
private investment. Thus, they recommend the use of a
causality test to identify the relationship between the two
variables.
Multicollinearity may also arise between the last four
terms (defense share of GDP, nondefense share of GDP,
defense spending increase, and nondefense public spend-
ing increase) of the equation because of the similarity of
the variables (Dunne, Smith, and Willenbockel 2005) and
the way nonmilitary government spending is calculated.
Nonmilitary government spending is often constructed by
subtracting defense spending from total government
expenditures. Therefore, there could be a multicollinear-
ity issue on the grounds that the rise of defense spending
is likely to lead to the decline of nonmilitary government
spending unless total government expenditures increase.14
This is why Huang and Mintz (1991) employed ordinary
ridge regression (ORR) in their study (see also Mintz and
Huang 1990, 1991).
The Augmented Solow
Defense–Growth Model
Because of the issues described above, Dunne, Smith,
and Willenbockel (2005, 458) recommend the aug-
mented Solow model. The augmented Solow model
derived by Dunne, Smith, and Willenbockel is dynamic,
unlike the static Feder-Ram–based models, because
it includes a lagged defense spending variable on the
right-hand side of the equation. Furthermore, the aug-
mented Solow model excludes nonmilitary govern-
ment spending as well as the externality effects of defense
expenditures on growth. By doing so, the model can
+ β4ln m(t) + β5ln m(t – 1) + ε,
where ∆ represents difference, y is national income,
s specifies private-sector savings as a share of GDP, g is
the technological progress, n indicates the labor force
growth rate, d shows capital depreciation, and m denotes
the share of defense spending in GDP.
According to Dunne, Smith, and Willenbockel (2005),
the theoretical advantage of the augmented Solow model
to the Feder-Ram–based model is threefold. First, the
Heo 765
augmented Solow model is dynamic rather than static
because it includes a lag of defense expenditures.
Thus, the current and delayed (although limited to one
time unit, which is a year in this case) effects of defense
spending on economic growth can be tested with this
model. In contrast, the Feder-Ram model cannot test
the lagged relationship between defense spending and
economic growth because of its static nature. Second,
there is a lower likelihood of multicollinearity in
the augmented Solow model due to the exclusion of
nonmilitary government (state) spending and exter-
nality effects from the equation. Third and finally,
labor input is theoretically better specified by includ-
ing capital depreciation and technological progress
(total factor productivity) instead of a simple growth
rate of employed labor.
However, the advantages of the augmented Solow model
are achieved by losing some benefits of the Feder-Ram–
based model. First, exclusion of nonmilitary public expen-
ditures and the externality effect terms of military and
nonmilitary public expenditures to reduce the possibility of
multicollinearity makes it impossible to test the externality
effects of public expenditures and the impact of nonmili-
tary government spending on economic growth. Second,
while the inclusion of both current and lagged defense
spending in the model may make the model dynamic and
allow it to test for delayed effects, it increases the possibil-
ity of multicollinearity between the two terms, as defense
spending tends to have a trend over time. Thus, the aug-
mented Solow model may ease some concerns embedded
in the Feder-Ram–based defense–growth model, but it
also has some weaknesses. I deal with these issues empir-
ically by employing both models in testing the defense–
growth nexus in the United States.
Data and Method
Data
Data for GDP, private-sector savings, employed labor,
capital depreciation, and defense spending are from the
National Income and Product Account Tables in the Bureau
of Economic Analysis’s National Economic Accounts,
available online.15 I converted all the current currency val-
ues (billions of dollars) to constant values (2,000 = 100)
using the implicit price deflator for GDP provided in the
same source. Data for employed labor are total full-time
and part-time employees (thousands), and capital deprecia-
tion is the percentage change in consumption of fixed capi-
tal from the preceding year, provided in the same source.
I used the private business sector’s multifactor ­productivity
index (2,000 = 100) provided by the Bureau of Labor Sta-
tistics as a proxy for technological progress.
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Method
To test the augmented Solow model and a typical three-
sector Feder-Ram–based defense–growth model, I employ
ordinary least squares. Considering the data set is a time
series, there are two methodological concerns: stationar-
ity of the variables and autocorrelation. As Dunne, Smith,
and Willenbockel (2005) and Sandler and Hartley (1995)
note, there is also a potential simultaneity problem between
economic growth and the growth rates of defense spend-
ing and between investment and nonmilitary government
spending in the Feder-Ram model. I address each of these
in this section.
According to Granger and Newbold (1974), if any
variable in a regression equation is not stationary, the
results of the time-series analysis may be spurious. Since
the log changes are used for the analysis of the augmented
Solow model, the variables are stationary. Thus, I tested
each variable of the Feder-Ram model only for the pres-
ence of a unit root, employing the augmented Dickey-
Fuller test. The results of the augmented Dickey-Fuller
test revealed the presence of a unit root only for invest-
ment –YI . Therefore, I use the first difference of investment
share of GDP to address the issue.
Turning to the potential autocorrelation problem in
both models, I tested for autocorrelation using the Durbin-
Watson (D-W) statistic. The D-W statistic indicates that
there is an autocorrelation problem for the augmented
Solow model but not for the Feder-Ram–based defense–
growth model (D-W  = 1.16 and 1.66, respectively). To
address this issue, I employed the Prais-Winsten method
for the augmented Solow model.
For the potential simultaneity problem between eco-
nomic growth and defense spending growth and between
investment and nonmilitary government spending in the
Feder-Ram model, I employed a Granger causal analysis to
test for exogeneity. The Granger causal analysis reveals that
there is no simultaneity bias. There is no statistically signifi-
cant causal effect in either direction in both relationships.16
For the statistical analysis, Intercooled STATA 9.2 is
used. Empirical measures employed for the augmented
Solow model are as follows:
∆ln y(t): growth in gross domestic product—the
log of gross domestic product less the log of
gross domestic product in the previous year;
ln y(t – 1): the log of gross domestic product in the
previous year;
ln s: private-sector savings ratio—the log of the
proportion of gross domestic investment to
gross domestic product;
ln (g + n + d): the log of the sum of the employed
labor growth rate, capital depreciation rate, and
766 Political Research Quarterly 63(4)
the changes in private business sector’s multifac-
tor productivity index;17
ln m(t): the log of the share of defense spending in
GDP; and
ln m(t – 1): the log of the share of defense spend-
ing in GDP in the previous year.
Empirical measures employed for the Feder-Ram
defense–growth model are as follows:
Ŷ: growth rate of gross domestic product;
^ : growth rate of employed labor;
L Adjusted R2 0.68
–YI : investment share of GDP;
–M ^
Y M : changes in defense spending share of GDP;
M ^ : growth rate of defense spending;
–YN N^ : changes in nonmilitary government spend-
ing share of GDP; and
N^ :growth rate of non-military government
spending.
Findings
The results of the empirical analyses are reported in
Tables 1 and 2. Both models perform well with the
adjusted R2 of .68 for the augmented Solow model and
.67 for the Feder-Ram–based model, although indepen-
dent variables perform better individually for the former
than for the latter. In terms of the results of the augmented
Solow model, as expected, capital investment and employed
labor (which accounts for capital depreciation and tech-
nological progress with changes in multifactor productiv-
ity of the private business sector) show a highly significant
and positive effect on economic growth.
Turning to the effects of defense spending on eco-
nomic growth, the inclusion of both current and lagged
defense spending in the model leads to a high level of
bivariate correlation between the two variables (r = .98).
However, the effects of both current and lagged defense
spending on economic growth are strong enough to show
a statistically significant impact. The result is that defense
spending shows a contemporary, harmful effect on eco-
nomic growth, but the lagged effect becomes positive and
significant, thus offsetting the negative effects. A 1 per-
cent increase in defense spending as a share of GDP leads
to a 0.127 percent contemporary decline of the economic
growth rate in the United States while boosting economic
growth by 0.146 percent in the following year. According
to this result, as Ward and Davis (1992) found, the imme-
diate effects of defense spending on economic growth in
the United States are negative, although the delayed
effects are positive. This positive effect is similar to the
findings of Atesoglu (2002), Atesoglu and Mueller
(1990), and Mueller and Atesoglu (1993), although they
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Table 1. The Economic Effects of Defense Spending
on Growth in the United States (1954-2005), Augmented
Solow Model
Dependent Variable: Coefficient
Economic Growth Rate, ∆ln y(t) (Standard Error)
GDPt – 1, ln y(t – 1) -0.2026*** (0.0484)
Capital investment, ln s   0.1932*** (0.0385)
Labor, ln (g + n + d)   0.1899*** (0.0383)
Military Spendingt, ln m(t) -0.1271*** (0.0423)
Military Spending t – 1, ln m(t – 1)   0.1463*** (0.0428)
Constant    1.3990** (0.2462)
Durbin-Watson 1.87
*p < .10. **p < .05. ***p < .01 (one-tailed test).
found the immediate positive effects and the magnitude
of the effects was much greater.18 In sum, a 1 percent
increase in the defense spending share of GDP in the
United States is expected to lead to a 0.019 percent increase
in economic growth over two years. This result indicates
that the economic effects of defense spending on growth
in the United States are meaningless because the size of
the effects is virtually zero. See Table 1.
Contrary to Dunne, Smith, and Willenbockel’s (2005)
argument that the statistically significant relationship
between defense spending and economic growth comes
from the use of the variant types of the Feder-Ram
defense–growth model, the augmented Solow model rec-
ommended by them shows the statistically significant
relationship between the two variables. However, as stated,
the significant effects of defense spending on growth
become meaningless over two years because of the offset
by the delayed effects. This confirms the insignificant
relationship proposed by Dunne, Smith, and Willenbockel
and previously shown by Heo (2000).
Turning to the Feder-Ram–based defense–growth
model, the economic effects of capital investment and
the simple growth rates of employed labor both show
positive and significant effects on growth, as macroeco-
nomic theory predicts. However, changes in the defense
spending share of GDP and its externality effects show
an insignificant effect on growth, as found in previous
studies, including Mintz and Huang (1990, 1991), Heo
(2000), and Heo and Eger (2005). As Ward and Davis
(1992) as well as Heo and Eger found, nonmilitary gov-
ernment spending shows a positive and significant effect
on economic growth, yet its externality effects are statis-
tically insignificant.
Dunne, Smith, and Willenbockel (2005) raised a con-
cern about the possibility of multicollinearity between
public expenditures (both defense and nonmilitary gov-
ernment spending) and their externality effect terms
Heo 767
Table 2. The Economic Effects of Defense Spending
on Growth in the United States (1954-2005), Feder-
Ram-based Model
Dependent Variable: Economic Coefficient
Growth Rate (Ŷ) (Standard Error)
Capital investment ( –YI ) 0.0438* (0.0322)
Employed labor growth (L^) 1.0029*** (0.1062)
Military Spendingt ( –M ^ -1.6825 (1.6808)
Y M )
^ )
Military spending externality (M 0.1054 (0.1282)
Nonmilitary public 2.2877*** (0.7336)
  spending ( –YN N^ )
Nonmilitary public spending -0.0044** (0.0021)
  externality (N^ )
Constant -0.0020 (0.0066)
Adjusted R2 0.67
Durbin-Watson 1.73
*p < .10. **p < .05. ***p < .01 (one-tailed test).
because of their similarity. I tested the bivariate correlation
among them.19 There is a high level of bivariate correlation
between defense spending and its externality effect (r = .95)
but not for the rest. Thus, I ran two more regressions: one
without externality terms and the other excluding both the
externality terms and nonmilitary government spending. In
both cases, defense spending showed a statistically insig-
nificant relationship with economic growth, confirming
the original results.20 See Table 2.
Conclusion
Sharp increases in U.S. defense spending in the past few
years are likely to continue as the war on terrorism contin-
ues. This trend, coupled with increasing annual budget
deficits, has generated renewed interest in studying the
relationship between defense spending and economic
growth. Previously, the Feder-Ram–based supply-side
models have dominated theoretical frameworks in testing
the economic effects of defense spending on growth. How-
ever, Dunne, Smith, and Willenbockel (2005) argue that
the Feder-Ram–based defense–growth model is not com-
monly used in mainstream growth studies in economics
(e.g., Sala-i-Martin, Doppelhofer, and Miller 2004) and
should not be used in studying the defense–growth nexus
due to statistical problems inherent in the model. Thus,
they recommended the augmented Solow model.
The benefits of the augmented Solow model are
achieved through the loss of the Feder-Ram model’s ben-
efits as far as testing the economic effects of nonmilitary
expenditures compared with those of defense spending
and the externality effects of both public expenditures.
Moreover, the augmented Solow model may also have
multicollinearity issues because of the inclusion of both
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current and lagged defense expenditures. Thus, I employed
both the Feder-Ram and augmented Solow models to test
the economic effects of defense spending on growth in
the United States from 1954 to 2005.
The empirical results of both models show that defense
spending does not significantly affect economic growth
in the United States. For the augmented Solow model,
defense spending appears to contemporaneously harm
economic growth, but the damage is negated by the posi-
tive effects that follow later. For the Feder-Ram defense–
growth model, defense spending showed a statistically
insignificant effect on economic growth, while nonmili-
tary public expenditures hampered economic growth.
The potential simultaneity bias noted by Dunne, Smith,
and Willenbockel (2005) between economic growth and
defense spending or between investment and nonmilitary
public expenditures did not exist in the U.S. case. Multi-
collinearity appeared in both models, although it did not
significantly affect the results of the statistical analyses.
In sum, the augmented Solow model recommended by
Dunne, Smith, and Willenbockel (2005) theoretically may
avoid some potential issues embedded in the Feder-Ram–
based defense–growth model, such as simultaneity bias and
its static nature, but it has a multicollinearity issue and results
in the same conclusions as those found with the Feder-Ram–
based defense–growth model (at least for the U.S. case).
In conclusion, as earlier work by Heo (2000) found,
the relationship between defense spending and economic
growth in the United States is statistically insignificant
regardless of which models are used to examine the rela-
tionship. Considering that defense spending is projected
to continue to rise, this finding has important policy
implications for the U.S. government on the grounds that
increased defense spending is unlikely to have a signifi-
cant, direct effect on the U.S. economy.
The real effects of defense spending on the U.S. econ-
omy, however, may not be direct. As Mintz and Hunag
(1990, 1991) as well as Heo and Eger (2005) note, the
real effects of a defense spending increase on the U.S.
economy may be delayed and through indirect channels,
such as investment, consumption, employment, interna-
tional competitiveness, national debt, and budgetary trade-
offs through cutbacks on public expenditures on health
and education. Moreover, defense budget allocations are
directed toward a small number of states. Thus, further
studies at the state level are also required to get a better
picture of the relationship between defense spending and
economic growth in the United States.
Author’s Note
I would like to thank John Bohte and Terence Roehrig for their
helpful comments and suggestions. Of course, I take the full
responsibility for all the remaining errors.
768 Political Research Quarterly 63(4)
Notes
  1. According to Kennedy (1987), high levels of U.S. defense
spending during the Cold War led the country to become
the world’s largest debtor because it was financed through
high levels of government debt. The Reagan military build-
up in the 1980s at the cost of a large government budget
deficit is another example of this problem (see Adams and
Gold 1987; Gold 1990; Mintz 1989).
  2. In contrast, Boulding (1973) argues that defense spending
has little impact on investment. He compared U.S. invest-
ment in 1929 and 1969 and found that increased defense
spending had very little impact on investment.
  3. The military sector in the United States also owns a large
portion of the capital equipment, structures, and inventories,
which could be used for other purposes (see also Lumsden
1980). In the 1971 Economic Report of the President (p. 115),
Arthur Burns, chairman of the Council of Economic Advisors
under President Eisenhower, asserted that “the real cost of
the defense sector consists, therefore, not only of the civilian
goods and services that are currently foregone on its account;
it includes also an element of growth that could have been
achieved through larger investments in human or business
capital” (cited in Ward, Davis, and Lofdahl 1995, 28).
  4. According to Denison (1985), however, slowdowns in U.S.
productivity are not because of increased defense spending
but because of cyclical phenomena.
  5. According to Sandler and Hartley (1995, 201), defense
spending can boost employment during a period of unem-
ployment, but this effect does not last once the economy
recovers to near full employment.
  6. Office of the Secretary of Defense, Symposium on the
Impact of Higher Levels of Defense Expenditures on the
United States Economy in the 1980s, October 26-29, 1980,
Arlington, VA. Also cited in Adams and Gold (1987, 33).
See also Dunne and Smith (1990).
  7. Ward and Davis (1992) also developed a two-sector defense–
growth model based on the Feder-Ram model, but they sep-
arate the state sector into two components: military spend-
ing and nonmilitary state spending.
  8. Solow (1970, 35) writes that “labor augmenting form of
technological progress is necessary for steady-state growth
to be possible.”
  9. Alexander (1990) developed a four-sector defense–growth
model without technology spillover.
10. Relatedly, Levine and Renelt (1992) find a consistently
positive relationship between trade and economic growth
in their sensitivity analysis with cross-national data.
11. Ward and Davis (1992) specify the externality effects
as the defense spending share of the total government
expenditures.
12. Despite the common usage of entering multiple economic
sectors and externality effects into the model, Sandler and
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Hartley (1995, 209) contend that “the pattern of externali-
ties among sectors is difficult to fix at the outset.”
13. Dunne, Smith, and Willenbockel (2005) did not include
nonmilitary government expenditures and the externality
effects of defense and nondefense public spending in their
description of the Feder-Ram defense–growth model,
although they are typically included (e.g., Heo 1998; Heo
and DeRouen 1998; Heo and Eger 2005; Huang and Mintz,
1991; Mintz and Huang 1990, 1991; Ward and Davis 1992).
Thus, I describe the Feder-Ram defense–growth model dif-
ferently than Dunne, Smith, and Willenbockel by including
them in the model.
14. This problem may not be severe in some cases because
changes in defense and nondefense spending share of GDP
are used instead of simple percentage of defense and non-
defense government spending to GDP.
15. See http://www.bea.gov/National/nipaweb/Index.asp.
16. The results of the Granger causal analysis are:
Defense spending growth → Economic growth,
c2 = 0.3352 (probability > c2 = 0.846)
Economic growth → Defense spending growth,
c2 = 2.0375 (probability > c2 = 0.361)
Investment → Nonmilitary public expenditures,
c2 = 3.22 (probability > c2 = 0.199)
Nonmilitary public expenditures → Investment,
c2 = 3.84 (probability > c2 = 0.146)
17. Dunne, Smith, and Willenbockel (2005) described the labor
variable as ln (g + n + d), and I imported their description of
the augmented Solow model for this study. However, since
the data for capital depreciation has absolute value of capi-
tal depreciation percentage, I subtract (instead of add) that
in my calculation of the ln (g + n + d) variable despite that
it is described as ln (g + n + d).
18. Mueller and Atesoglu (1993) reported that a 1 percent
increase of defense spending leads to 0.046 percent of eco-
nomic growth in the United States. Cuaresma and Reitschul-
er (2004) also found a contemporaneous negative effect of
defense spending on growth in the United States, but the
externality effects of defense spending showed positive ef-
fects on growth.
19. The bivariate correlation matrix is as follows:
Military M externality Nonmilitary Nonexternality
Military —
M externality   .95 —
Nonmilitary –.03 –.07 —
Non- –.06 –.10 .39 —
externality
M externality, military spending externality.
20. The results are available from the author upon request.
Heo 769
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