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Defence and Peace Economics

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Does Military Spending Crowd Out

Social Welfare Expenditures? Evidence
from a Panel of OECD Countries
a

Eric S. Lin , Hamid E. Ali & Yu-Lung Lu

Department of Economics, National Tsing Hua University, HsinChu, Taiwan

b

Department of Public Policy and Administration, American

University in Cairo, Cairo, Egypt
Published online: 09 Dec 2013.

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To cite this article: Eric S. Lin, Hamid E. Ali & Yu-Lung Lu (2015) Does Military Spending Crowd
Out Social Welfare Expenditures? Evidence from a Panel of OECD Countries, Defence and Peace
Economics, 26:1, 33-48, DOI: 10.1080/10242694.2013.848576
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Defence and Peace Economics, 2015

Vol. 26, No. 1, 3348, http://dx.doi.org/10.1080/10242694.2013.848576

DOES MILITARY SPENDING CROWD OUT SOCIAL

WELFARE EXPENDITURES? EVIDENCE FROM A
PANEL OF OECD COUNTRIES
Downloaded by [University of Sussex Library] at 07:37 15 December 2014

ERIC S. LINa*, HAMID E. ALIb AND YU-LUNG LUa

a

Department of Economics, National Tsing Hua University, Hsin-Chu, Taiwan; bDepartment of Public
Policy and Administration, American University in Cairo, Cairo, Egypt
(Received 15 July 2012; in nal form 12 April 2013)

This article examines the relationship between defense and social welfare expenditures using a panel of 29 OECD
countries from 1988 to 2005. It is quite difcult to take into account the simultaneous channels empirically through
which the eventual allocation of defense and welfare spending is determined for the guns-and-butter argument.
-Taking advantage of our collected panel data-set, the panel generalized method of moments method is adopted to
control the country-specic heterogeneity and to mitigate the potential simultaneity problem. The main nding of
this article suggests a positive trade-off between military spending and two types of social welfare expenditures
(i.e. education and health spending). One of the reasons may be that the OECD countries are more supportive
of the social welfare programs; therefore, when the military spending is increased (e.g. military personnel and
conscripts), the government may raise the health and education spending as well.
Keywords: Crowding-out effect; Military spending; Social welfare
JEL Codes: H51, H52, H53, H54

1. INTRODUCTION
It has been a widespread view to regard military expenditures as public investment while
others view it as social costly enterprise that crowds out investment in social welfare. When
public program demand exceeds available resources, the program competes for budgetary
allocations, and one program wins while others lose. In other words, there is a trade-off
relationship among health, education, and military expenditures, as they are the major government budgetary components. It is no doubt that understanding the trade-off among those
key expenditures for a government is crucial for scal sustainability and ability to operate
over long term while maintaining a higher standard of living for the public. Consequently,
government may therefore reallocate the resources in different sectors where the opportunity
cost is lower.
The issue on the crowding-out effect between military spending and social welfare can
be traced back to the seminal work by Russett (1969). Using the data from the USA,
*Corresponding author: Department of Economics, National Tsing Hua University, Hsin-Chu, Taiwan. E-mail:
slin@mx.nthu.edu.tw

2013 Taylor & Francis

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34

E. S. LIN ET AL.

FIGURE 1 Military spending vs. social welfare expenditures by country

France, and the UK, Russett (1969) concludes that a rise in military spending will reduce
the expenditures on health and education. The reason is intuitive in the sense that in the
presence of dynamic spillovers from a given government budget, an increase in the military
expenditure will crowd out an equivalent amount of all other spending. Thus, education and
health expenditures will be reduced proportionately (Domke et al., 1983; Scheetz, 1992;
Yildirim and Sezgin, 2002). However, according to Keynesian point of view, an increased
military spending is able to promote aggregate demand and in turn stimulate welfare
expenditures indicating a complementarity relationship between military and welfare
expenditures. Due to the lack of a coherent theory to justify the so-called gunsbutter,
previous empirical studies tend to obtain mixed results, which are divergent across
estimation models and data.
As summarized in Yildirim and Sezgin (2002), the causal relationship between military
spending and social welfare expenditures is not clear cut in the literature. Ali (2011) also
argues that the crowding-out of social spending by military spending lacks both theoretical
and empirical justication. Most of the previous studies reveal either the negative trade-off
or non-trade-off relationship, while the positive trade-off is found to be limited. Since there
exist a large amount of channels that simultaneously determine the eventual allocation of
defense and welfare spending, the endogeneity issue should be well taken care of when
conducting the empirical analysis (Deger, 1985). For example, Yildirim and Sezgin (2002)
adopt seemingly unrelated regression (SUR) estimation method to investigate the crowdingout effect in Turkey, and Kollias and Paleologou (2011) utilize the vector autoregressive
regression (VAR) approach to examine the presence of budgetary trade-offs between
defense spending and welfare expenditure in the case of Greece.

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EVIDENCE FROM A PANEL OF OECD COUNTRIES

35

FIGURE 2 Military spending vs. social welfare expenditures

The existing empirical studies in relation to the warfare vs. welfare nexus mainly utilize
the time-series data approach, that is, a single country is typically analyzed at one time.1 A
desirable way to investigate the relationship between defense and welfare spending is to
combine the time-series and cross-section data into a panel data-set by observing a bunch
of countries for a period of time span. The major advantages for using panel data include:
(1) the ability to control for individual heterogeneity (e.g. controlling for country-specic
characteristics such as culture, weather, location, laws, institutions, and so on) to alleviate
omitted variable bias; (2) the increased precision of the regression estimates (using a large
sample size relative to the cross-sectional data); (3) a reduction in identication problems
(identifying individual dynamics); and (4) the ability to model temporal effects without
aggregation bias as in time-series studies. To the best of our knowledge, there are very
limited prior studies employing the panel data method to explore the gunsbutter argument.
This article collects a panel of 29 OECD countries with time spanning from 1988 to
2005 to empirically investigate the gunsbutter trade-off. With such constructed panel dataset, we are able to not only effectively increase the sample size to evaluate the trade-off
relationship, but also resolve the potential simultaneity problem between military spending
and social welfare expenditures. In particular, we adopt the panel generalized method of
moments (panel GMM) to allow for endogenous right-hand-side variables, where the panel
data structure provides an excess of moment conditions available for estimation owing to
an abundance of instruments (i.e. usually based on the lagged variables). It is also worth
noting that previous studies that inspect the trade-off relationship are focused more on lessdeveloped countries (e.g. Deger, 1985; Hess and Mullan, 1988; Apostolakis, 1992). Another
feature of this study is to complement the literature on the gunsbutter argument in terms of
the developed countries.
The remainder of this article is organized as follows. In the next section, we review the
gunsbutter argument and the corresponding empirical ndings. Section 3 describes the data

1
Even though there are several papers employing the cross-sectional time-series data, they evaluate the trade-off
relationship for each country in each regression run. For instance, using 12 Asian countries from 1967 to 1982,
Harris and Pranowo (1988) conclude that there are three positive and negative trade-offs as well as six indeterminant relationships.

36

E. S. LIN ET AL.

and econometric methods. Section 4 illustrates and discusses the empirical results. The nal
section concludes this article.

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2. THE GUNS-AND-BUTTER ARGUMENT

There is a long-lasting debate that the government should choose whether to spend its
money on butter (i.e. food or other services) for its citizens or guns which is money
spent by the government for military defense. That is, the gunsand-butter argument reasons that there is a trade-off between military expenditures and other major government
spending. It can be understood that with the limited overall government budget, to increase
military expenditures may result in the crowding-out effect on other components of
government expenditures such as education and health spending.2 From a speech before the
American Society of Newspaper Editors on 16 April 1953, the 34th president of US Dwight
D. Eisenhower addressed a typical guns-and-butter argument:
Every gun that is made, every warship launched, every rocket red signies, in the nal sense, a theft from
those who hunger and are not fed, those who are cold and not clothed. This world in arms is not spending
money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children.
This is not a way of life at all in any true sense. Under the cloud of threatening war, it is humanity hanging
from a cross of iron.

Many empirical studies obtain the negative (or trade-off) relationship between defense
and welfare using different countries and different types of data (Russett, 1969; Peroff,
1976; Dabelko and McCormick, 1977; Peroff and Podolak-Warren, 1979; Deger, 1985;
Apostolakis, 1992). As mentioned in Section 1, Russett (1969) nds a reasonably strong
negative relationship between military spending and government spending on health and
education for the US, France and UK. Dabelko and McCormick (1977) evaluate the impact
of changes in military spending on spending levels for public education and public health
in a number of countries in the period of 19501972. Their major ndings include that: (1)
opportunity costs do exist for education and health across all countries and all years, but
they are weak in magnitude; (2) levels of economic development have little or no impact
upon the opportunity costs for these policy areas; and (3) personalist regimes tend to have
higher opportunity costs of defense than do centrist and polyarchic regimes. Further studies
by Peroff and Podolak-Warren (1979) examine empirically the potential impact of defense
on the private health sector; the results of the analysis give more weight to the hypothesis
of a trade-off. Deger (1985) reports a stylized fact that defense has a high physical-resource
cost as well as the exceptionally high human-resources costs. Thus, developing nations can
and should divert a minute fraction of their massive armament expenditure as a development aid for human capital. Apostolakis (1992), in study of 19 Latin American countries,
conrms a trade-off between military and spending on health, education, social security,
and welfare in the region.
For those studies in support of the guns-and-butter argument, they nd that an increase
in military spending generally inuences welfare expenditures in two ways. First, defense
expenditures may detract from xed investment expenditures, personal consumption, and
state and local government spending, and there will be less public expenditures on human
capital formation, which lowers economic growth and further reduces the welfare spending.
2
The guns-and-butter argument can also be understood through the production possibilities curve, that depicts
the trade-off between any two items produced.

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EVIDENCE FROM A PANEL OF OECD COUNTRIES

37

Second, lower income groups are the main people who carry the burden of defense and the
heavy defense spending hinders the establishment of more welfare programs.
By contrast, some studies argue that military spending may render a positive effect on
investment, economic growth, and welfare (Benoit, 1973, 1978; Lindgren, 1984; Ram,
1995). The defense spending is believed to be helpful to human capital formation in education and health because defense personnel and conscripts are well trained physically and
receive good skills education. Besides, military spending may lead to technological innovations and even spin-offs in defense eld. Therefore, the positive trade-off relationship (i.e.
complementary relationship) has also been found in the literature; e.g. Verner (1983), Harris
and Pranowo (1988), and Kollias and Paleologou (2011). It is noted that the type of welfare
spending may play an important role in the trade-off relationship. Yildirim and Sezgin
(2002) and Ali (2011) suggest that the trade-off is positive between education and defense
spending, while the relationship is negative between health and military expenditures.
Lastly, in addition to the negative or positive gunsbutter argument, no trade-off relationship between military and welfare spending has also been found in the literature as well
(Caputo, 1975; Russett, 1982; Domke et al., 1983; Eichenberg, 1984; Hess and Mullan,
1988; Mintz, 1989; Davis and Chan, 1990; Frederiksen and Looney, 1994). For instance,
Russett (1982) argues that no systematic trade-off between military spending and federal
health and education expenditures is found, nor there is any signicant depressing effect on
health and education expenditures. Domke et al. (1983) utilize three-equation model controlling for the variety of possible determining factors of public resource allocation, and
nds that no patterns of trade-off emerges. Mintz (1989) concludes that, although there may
be years in which R&D or procurement spending increased and welfare spending decreased,
the pattern is not common enough to indicate a trade-off between these spending categories.
Those studies suggest that the budgetary allocation of defense and welfare expenditures
seems to be driven by separate determinants. An increase in defense spending does not necessarily lead to a sacrice in health or education expenditure.
To sum up, numerous studies have attempted to investigate the trade-off relationship
between defense and welfare spending, while there is no consensus on the empirical ndings. As indicated in Section 1, the existing empirical studies are rather limited in terms of
data and econometric methods, that hampered the efforts on empirical discussion of the
validity of gunsbutter argument. This study revisits the warfarewelfare trade-off by taking
advantage of a panel of OECD countries to control for unobserved country-specic effects
and employing the panel GMM method to allow for potential simultaneity issue.
3. DATA AND ECONOMETRIC STRATEGY
3.1. Data Description
To make use of a relatively more complete and reliable data source of military and social
welfare spending, the OECD countries are adopted for our empirical investigation. There
are many previous studies using OECD data to analyze the relationship between military
expenditure and other economic variables (e.g. Smith, 1980; Cappelen et al., 1984; Dunne
and Smith, 1990; Lee and Cheng, 2007). In what follows, we describe the data sources that
are taken in this research.
The data on (annual) military expenditures are adopted from the Stockholm International
Peace Research Institute (SIPRI), which is an independent international institute for research
into problems of peace and conict in Sweden, and is considered a reliable source in the

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38

E. S. LIN ET AL.

defense literature.3 In fact, there are several other sources containing country-wise military
expenditures, including World Development Indicators (WDI), the US Bureau of Arms
Control, Verication and Compliance, the International Institute for Strategic Studies, and
the IMFs World Economic Outlook. It is noted that WDI uses data on military expenditures
and arms transfer from SIPRI so that the military spending based on the two data sources is
quite close according to our checkup.4 Even though there are currently 34 members of the
OECD, we have included 29 countries in our sample. We excluded four countries (i.e.
Chile, Estonia, Israel, and Slovenia) since they had not joined OECD membership until
2010. Iceland has also been dropped because it maintains no standing army. The SIPRI
data-set ranges from 1988 to 2006, where we utilize the military expenditures as % of GDP
as the main explanatory variable.5
We consider health and education expenditures as the two most important components of
the social welfare spending following previous studies, e.g. Yildirim and Sezgin (2002), Ozsoy (2002), and Kollias and Paleologou (2011). The health expenditures data are taken from
WDI and Source OECD databases.6 Note that the health expenditures consist of both public
and private health spending, where the data are mainly from WDI while Source OECD
complements some missing values.
In regard to education expenditures, Source OECD provides a relatively complete data
ranging from 1985 to 2002, where we use the public expenditures on education (including
all levels of education) as % of GDP. The United Nations Educational, Scientic and
Cultural Organization (UNESCO) has been utilized to ll up the data on education
expenditures in the period of 20032005.7 Owing to the data limitation on the primary
variables of interest, the country-level military and education expenditures, we therefore
restrict our sample to the period from 1988 to 2005.
Additionally, we incorporate the following control variables as suggested in the past
studies (e.g. Russett, 1982; Hess and Mullan, 1988; Yildirim and Sezgin, 2002; Kollias and
Paleologou, 2011): tax (total tax revenue of GDP; from Source OECD), GDP (from WDI);8
household consumption (household nal consumption expenditure of GDP; from WDI);
population (total population; from Source OECD) and government expenditure (general
government nal consumption expenditure of GDP; from WDI); and Gini coefcient

The SIPRI military expenditures include all current and capital expenditures on the armed forces, including
peace-keeping forces; defense ministries and other government agencies engaged in defense projects; paramilitary
forces when judged to be trained, equipped and available for military operations; and military space activities. The
SIPRI data can be downloaded in the following website: http://www.sipri.org/databases/milex.
4
The WDI data include the World Bank collection of world-wide development indicators, compiled from ofcially recognized international sources. Please refer to http://data.worldbank.org/data-catalog/world-developmentindicators.
5
We are grateful to an anonymous referee for the discussion on the difference between share of GDP and share
of central government budget. In fact, many empirical studies use shares of GDP (or GNP) to investigate the tradeoff relationship between defense and welfare spending (e.g. Apostolakis, 1992; Ozsoy, 2002). Due to the data limitation, we cannot obtain the all the key variables (e.g. education expenditures) in terms of the share of central government budget. To keep the consistency of the variable measurement, we stick with the share of GDP in regard to
the military and social welfare expenditures. Nevertheless, it is feasible to calculate the correlation between the military expenditure share of GDP and share of central government expenditure, which results in a high sample correlation (0.7533).
6
For Source OECD, please refer to http://miranda.sourceoecd.org/vl=44559650/cl=11/nw=1/rpsv/home.htm.
7
Please refer to http://stats.uis.unesco.org/unesco/TableViewer/document.aspx?ReportId=143&IF_Language=
eng. Even though UNESCO collects the education expenditures from 1975 to 2007, there are many missing values
before 1999 and after 2005.
8
We use the real GDP measuring in billions of US dollars and service year 2000 as the base year.

EVIDENCE FROM A PANEL OF OECD COUNTRIES

39

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TABLE I Description of Variables

Variables

Description

Data sources

GDP
Milex
Edu
Health
Tax
Gini
Pop
Gcon

Gross domestic product (in terms of one billion)

Military spending/GDP
Public and private education expenditures/GDP
Public and private health expenditures/GDP
Total tax revenue/GDP
Income inequality measured by Gini coefcient
Total population (in terms of one million)
General government nal
Consumption expenditure/GDP
Household nal consumption expenditure/GDP

WDI
SIPRI, WDI
Source OECD, UNESCO
Source OECD
Source OECD
WDI, UTIP
Source OECD
WDI

Hcon

WDI

(income inequality measure; from the University of Texas Inequality Project (UTIP)).9 The
description of the variables and original data sources is listed in Table I.
To sum up, our data-set covers a period of 18 years spanning from 1988 to 2005 for 29
OECD countries. The summary statistics are reported in Table II, where the 29 countries
are listed in the rst column of Table II. It is clear to see that on average, Greece has the
highest proportion of military spending in GDP (4.42%) during our sample period 1988
2005, followed by the second and third highest countries, US (4.07%) and Turkey (3.97),
respectively. Nordic countries tend to have relatively higher education expenditures of GDP,
e.g. Denmark (6.20%), Sweden (5.72%), and Norway (5.46%). The US average health
expenditures out of GDP rank the number one in our sample OECD countries.
Figure 1 provides the relationship among health, education, and military expenditures in
all of the 29 OECD countries. It is noted that in terms of the ratio of GDP, we observe that
the military spending tends to have the lowest proportion, heath spending has the largest
ratio, and the education spending is in between these two expenditures for most OECD
countries. Greece is an exception that military spending out of GDP lies above the
education counterpart. The rivalry country of Greece, Turkey, reveals a similar trend
between military and education expenditures before 2003. In most of the countries in our
sample, the health and education spendings keep rising while military spending of the GDP
ratio is relatively stable or declining very slowly. Nevertheless, taking into consideration of
all countries, the correlation between military and health/education expenditures is not clear.
When we turn to aggregate the health, education and military expenditures across countries
for each year, as shown in Figure 2, it seems that the relationship between military expenditures and social welfare is negative an increasing trend of health and education spending
but a down-sizing trend of military expenditures (i.e. in support of the crowding-out
argument). Nevertheless, it should keep in mind that these gures are simply descriptive
since no other explanatory variables are controlled. Thus, the preliminary graphical
inspection cannot be regarded as causal. A further analysis taking into account the potential
factors that are associated with the social welfare expenditures is performed in subsequent
sections.

9
Gini coefcient maintained by UTIP can be found at http://utip.gov.utexas.edu/. Lin and Ali (2009) also adopt
this measure to explore the relationship between military spending and economic inequality.

18
18
18
18
13
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
13
18
18
18
18
18
18

1.88
0.87
1.65
1.51
1.84
1.71
1.47
2.96
1.76
4.42
2.03
0.90
1.98
0.97
2.92
0.76
0.50
1.91
1.40
2.35
2.14
2.23
2.18
1.40
2.10
1.34
3.97
3.10
4.07

SD

0.12
0.10
0.43
0.35
0.22
0.21
0.24
0.40
0.41
0.25
0.66
0.22
0.13
0.02
0.51
0.08
0.07
0.38
0.30
0.46
0.31
0.21
0.66
0.28
0.37
0.31
0.68
0.64
0.88

18
18
17
15
13
18
18
17
12
13
15
18
18
18
12
15
13
15
18
18
11
18
7
18
18
18
8
18
18

3.98
5.05
4.92
5.02
3.56
6.20
5.68
5.24
4.33
3.23
3.72
3.87
4.04
3.57
3.63
3.22
9.93
4.00
5.38
5.46
4.45
4.24
4.89
3.70
5.72
5.18
3.47
4.18
4.64

Edu

SD

0.39
0.57
0.69
0.37
0.74
1.19
0.70
0.54
0.18
0.89
1.56
0.45
0.57
0.15
0.76
0.37
5.34
0.35
0.76
1.17
1.03
1.36
0.74
0.70
1.19
0.54
0.56
0.77
0.65

N
17
18
18
18
16
18
18
16
17
18
14
18
18
17
18
18
16
17
18
18
16
18
9
18
18
18
18
18
18

8.23
8.98
8.41
9.21
6.51
8.52
7.45
9.72
9.95
7.68
7.41
6.74
7.89
7.03
4.66
6.00
5.70
8.29
7.49
8.51
5.82
7.87
5.98
7.22
8.49
9.99
5.12
7.03
13.28

Health
SD
0.70
1.44
0.98
0.51
0.84
0.34
0.66
0.78
0.78
1.67
0.48
0.45
0.46
0.74
0.60
0.93
0.49
0.43
0.67
0.82
0.38
1.37
0.68
0.58
0.40
1.10
1.82
0.70
1.26

N
17
18
18
17
16
18
18
18
18
18
18
17
18
17
18
18
18
18
17
18
16
18
18
18
18
17
18
18
17

18.26
18.83
21.57
21.04
21.69
25.65
22.26
23.09
19.39
15.25
10.90
15.75
19.21
15.53
12.19
15.95
10.49
23.04
18.10
21.38
19.69
18.16
21.65
17.44
27.42
11.51
12.36
19.80
15.67

Gcon
SD
0.47
0.73
0.87
1.83
0.99
0.47
1.46
0.80
0.53
1.36
0.93
1.25
0.81
1.71
0.89
0.51
1.33
0.82
0.73
0.93
2.05
1.89
1.49
0.74
0.88
0.40
1.84
1.08
1.05

Note: N, M, and SD denote the number of observation, mean, and standard error, respectively.

Australia
Austria
Belgium
Canada
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Japan
Korea Rep
Luxembourg
Mexico
Netherlands
New Zealand
Norway
Poland
Portugal
Slovak Republic
Spain
Sweden
Switzerland
Turkey
UK
USA

Milex

TABLE II Summary of Statistics

N
17
18
18
17
16
18
18
18
18
18
18
17
18
17
18
18
18
18
17
18
16
18
18
18
18
17
18
18
17

58.67
56.89
54.31
56.43
51.09
49.80
52.31
56.59
58.33
71.41
66.04
52.49
58.59
55.08
52.63
43.02
68.50
50.10
59.20
47.33
61.13
64.68
53.67
59.62
49.78
59.69
67.29
64.53
68.11

Hcon
SD
1.07
0.75
1.14
1.05
1.67
1.50
1.74
0.67
0.75
2.62
4.35
5.90
0.69
1.94
1.69
2.04
2.12
0.61
1.05
2.92
4.10
1.14
2.46
1.18
1.14
1.09
1.43
1.19
1.47

N
18
18
18
18
9
18
18
18
18
18
18
18
18
18
15
8
18
18
18
18
18
18
8
18
18
18
16
18
18

34.78
26.57
27.84
31.59
24.04
34.42
28.36
29.53
27.84
34.19
27.18
33.36
33.17
30.88
32.94
33.38
51.35
28.47
35.05
30.31
30.89
36.57
34.14
32.10
25.77
32.79
45.18
33.31
43.04

Gini

3.90
2.05
2.48
1.60
3.05
3.14
1.87
2.10
1.82
1.08
2.39
3.17
1.94
2.01
1.05
1.16
2.00
1.33
3.23
2.52
4.08
1.13
2.47
2.78
1.28
1.71
2.18
1.14
2.61

S.D.

N
18
18
18
18
16
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
16
18
18
18
18
18
18
18
18

357.77
175.51
212.45
634.41
55.57
144.67
108.49
1218.77
1749.38
107.20
44.42
76.25
1023.72
4452.94
434.49
16.94
504.04
341.35
48.74
147.92
151.09
99.26
19.53
522.62
221.03
231.78
176.73
1313.02
8621.03

GDP
SD
66.85
21.62
23.33
101.35
5.56
17.02
15.16
131.93
171.70
17.24
6.52
28.10
81.81
325.03
123.53
4.10
81.21
46.44
7.97
25.02
29.83
13.67
2.94
86.22
26.63
15.75
33.68
180.31
1421.41

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N
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18
18

18.43
7.93
10.17
29.68
10.29
5.27
5.11
58.30
81.33
10.66
10.23
3.71
57.06
125.77
45.48
0.42
93.28
15.59
3.72
4.40
38.18
10.16
5.35
40.06
8.79
7.05
64.18
58.36
271.10

Pop

1.17
0.18
0.17
1.66
0.06
0.10
0.09
1.42
1.37
0.35
0.14
0.20
0.53
1.62
2.03
0.03
7.38
0.51
0.24
0.13
0.12
0.20
0.05
1.37
0.17
0.25
5.22
0.98
16.68

SD

N
18
18
18
18
13
18
18
18
18
18
15
18
18
18
18
18
18
18
18
18
15
18
8
18
18
18
18
18
18

29.22
42.11
43.88
35.20
36.96
48.46
44.89
43.26
36.20
26.06
39.99
32.06
40.60
27.29
21.02
37.37
17.72
41.13
35.32
41.75
34.71
31.68
33.00
33.30
50.20
28.12
26.40
35.51
27.60

Tax
SD
1.48
1.55
1.27
1.14
1.58
1.25
1.49
1.01
0.84
3.03
3.17
2.17
2.09
1.19
2.90
1.87
0.96
2.85
1.53
1.20
1.80
2.70
1.75
1.15
1.96
1.56
5.58
1.24
1.22

40
E. S. LIN ET AL.

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41

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TABLE III Panel Unit Root Tests for all Variables

LLC

IPS

ADF

PP

Milex

7.2846
(0.0000)

3.1005
(0.0010)

99.3570
(0.0006)

134.270
(0.0000)

Milex

12.4513
(0.0000)

10.5301
(0.0000)

216.611
(0.0000)

305.2020
(0.0000)

Edu

6.8108
(0.0000)

1.5541
(0.0601)

86.2057
(0.0095)

101.7060
(0.0003)

Edu

12.7242
(0.0000)

9.1007
(0.0000)

188.9610
(0.0000)

174.1070
(0.0000)

Health

1.1155
(0.8677)

4.2567
(1.0000)

35.3794
(0.9917)

27.6888
(0.9998)

Health

14.3196
(0.0000)

11.2320
(0.0000)

228.0120
(0.0000)

245.5000
(0.0000)

Tax

4.7038
(0.0000)

1.9022
(0.0286)

75.0352
(0.0656)

70.1935
(0.1309)

Tax

14.8685
(0.0000)

12.7041
(0.0000)

265.4250
(0.0000)

277.2770
(0.0000)

Pop

2.9575
(0.0016)

3.7695
(0.9999)

67.3961
(0.1866)

152.6050
(0.0000)

Pop

3.3622
(0.0004)

3.5996
(0.0002)

130.8460
(0.0000)

88.4242
(0.0062)

Gcon

3.7310
(0.0001)

3.3764
(0.0004)

102.1660
(0.0003)

66.1805
(0.2154)

Gcon

12.2794
(0.0000)

10.9424
(0.0000)

220.0210
(0.0000)

240.6090
(0.0000)

Hcon

4.8137
(0.0000)

3.3393
(0.0004)

107.0130
(0.0001)

117.5900
(0.0000)

Hcon

15.3279
(0.0000)

13.5635
(0.0000)

270.8680
(0.0000)

329.4690
(0.0000)

Gini

9.5494
(0.0000)

6.7573
(0.0000)

158.5390
(0.0000)

171.1570
(0.0000)

Gini

20.2839
(0.0000)

17.5672
(0.0000)

392.2940
(0.0000)

717.9210
(0.0000)

GDP

5.37183
(1.0000)

10.4765
(1.0000)

10.2369
(1.0000)

13.9213
(1.0000)

GDP

5.3865
(0.0000)

5.9892
(0.0000)

136.0130
(0.0000)

154.0430
(0.0000)

Note: LLC, IPS, ADF, and PP represent the Levin et al. (2002), Im et al. (2003), augmented Dickey-Fuller, and Phillips and Perron
panel unit root tests, respectively.
The p-values are in parentheses.
indicates the rst-difference operator.

42

E. S. LIN ET AL.

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3.2. Panel GMM

As noted in Section 1, evaluating the trade-off relationship between the military spending
and welfare spending using the typical OLS or SUR regression may suffer from the endogeneity problem, e.g. Deger (1985). Therefore, this study applies the panel data to get rid of
the country-specic effect to alleviate the omitted variable bias. We further consider to
resolve the potential simultaneity problem (e.g. it could be a bi-directional crowding-out
effect between military spending and welfare expenditures) by adopting the panel
generalized method of moments, which is designed to allow for endogenous right-hand-side
variables. The panel GMM takes advantage of the panel data structure by providing an
excess of moment conditions available for estimation based on an abundance of instruments
(lagged variables) without seeking for external instrumental variables (IV). Since the
welfare expenditures studies in this article consist of health and education expenditures, we
consider two separate panel data models to explore whether the military spending will
crowd out the health and education spending. The health and education equations are therefore dened as follows:
Healthit ao a1 Milexit a2 Eduit Wit0 g di mit

(1)

Eduit bo b1 Milexit b2 Healthit Wit0 c li eit

(2)

where Healthit, Eduit, and Milexit denote the health, education, and military expenditures of
GDP for country i (i = 1,...,N) at time t (t = 1, , T), respectively. Wit is a vector
including other control variables such as tax of GDP, household consumption of GDP,
government consumption of GDP, population, GDP, and Gini index. i and i represent the
country-specic effects. a, b, g, and c are parameters to be estimated. mit and eit are
idiosyncratic error terms. If we obtain a negative a1 (or b1 ), it may conclude that there is a
(negative) trade-off between military spending and health (or education) spending. While
we yield a positive a1 (or b1 ) , it may indicate that military spending and health (or education) spending are complementary.
It is worth noting that Russett (1982) considers the rate of change in all variables in his
empirical model. Yildirim and Sezgin (2002) further claim to utilize all variables in terms
of the rate of growth in order to prevent the non-stationary problem. We follow these
previous studies by taking the rst difference of the level economic variables to avoid the
spurious regression problem. We then conduct the panel unit root tests to check whether the
differenced variables under consideration are indeed stationary. Several popular panel unit
root tests in the literature are implemented, including LLC test (Levin et al., 2002), IPS (Im
et al., 2003), Fisher-type tests based on the ADF regression (Maddala and Wu, 1999), and
Phillips/Perron-type individual unit root test (Choi, 2001). The four types of panel unit root
tests reported in Table III show that after taking the rst difference, all variables in our
model reject the null hypothesis ensuring all the variables to be stationary. Therefore, we
use the rst-difference variables in our model.
A standard approach to dealing with the simultaneity problems is the IV estimation
method. For cross-sectional data, it is difcult to nd suitable instruments. However, with
panel data under some mild exogeneity assumptions, lagged variables can serve as valid
instruments for panel GMM estimation. Our panel GMM specication in principle can
allow all right-hand-side variables to be endogenous (e.g. the military spending and

EVIDENCE FROM A PANEL OF OECD COUNTRIES

43

TABLE IV Empirical Results for Health Equation

Variables
Milex
Edu
Tax
Pop
Gcon

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Hcon
Gini
GDP
Constant

N
First stage
F statistics
Hansens
J statistics
p-value

POLS

FE
**

RE

GMM 1
***

GMM 2
***

GMM 3
***

GMM 4
***

0.687
0.151
0.004
(0.020)
0.018
(0.024)

GMM 5
***

0.875
(0.210)
0.175***
(0.061)
0.017
(0.034)
0.245***
(0.054)

GMM 6
1.055***
(0.287)
0.141***
(0.023)
0.060***
(0.023)
0.181***
(0.028)
0.210***
(0.034)

0.143
(0.118)
0.004
(0.013)
0.016
(0.013)
0.142***
(0.030)
0.250***
(0.037)
0.044**
(0.017)
0.005
(0.005)
0.001 ***
(0.000)
0.111***
(0.015)

0.196
(0.097)
0.005
(0.015)
0.015
(0.012)
0.064
(0.122)
0.248***
(0.023)
0.042***
(0.013)
0.005
(0.005)
0.002 ***
(0.000)
0.145***
(0.037)

0.153
(0.095)
0.004
(0.015)
0.016
(0.012)
0.147***
(0.034)
0.249***
(0.023)
0.044***
(0.012)
0.005
(0.005)
0.001 ***
(0.000)
0.113***
(0.017)

0.920
(0.245)
0.052
(0.130)
0.084*
(0.049)
0.221***
(0.055)
0.087
(0.097)
0.138***
(0.032)
0.001
(0.009)
0.002 ***
(0.001)
0.167***
(0.020)

0.534
(0.135)
0.061**
(0.024)
0.006
(0.012)
0.143***
(0.027)
0.047
(0.050)
0.144***
(0.016)
0.011*
(0.006)
0.001 ***
(0.000)
0.140***
(0.012)

0.441
(0.122)
0.056**
(0.023)

0.136***
(0.034)
0.143***
(0.055)
0.110***
(0.021)
0.014**
(0.006)
0.001 ***
(0.000)
0.136***
(0.012)

0.097*
(0.051)
0.110***
(0.019)
0.012*
(0.006)
0.000
(0.000)
0.154***
(0.014)

0.005
(0.026)
0.01
(0.010)
0.002 ***
(0.001)
0.122***
(0.023)

0.016**
(0.008)
0.002 ***
(0.000)
0.137***
(0.017)

389

389

389

334

306

306

306

306

306

66.760

78.230

49.980

27.780

52.640

47.320

7.303

21.748

21.552

15.438

17.587

19.088

0.504

0.152

0.088

0.349

0.226

0.162

Notes: Standard errors are in parentheses.

*
denote statistical signicance at the 10% level.
**
denote statistical signicance at the 5% level.
***
denote statistical signicance at the 1% level.
The F-statistics are obtained by regressing the endogenous regressor (Milex) on the instruments.

education expenditures in the health equation), indicating that endogeneity issue can be well
treated to obtain consistent estimates (see Cameron and Trivedi (2005) for more details). To
describe our panel GMM approach, we rst introduce the generalized method of moment
estimator by Hansen and Singleton (1982) in the context of linear panel data model:
Yi X i h u i ;
where Yi and ui are T  1 vectors, Xi is a T  K matrix with tth row x0it , and K is the dimension of explanatory variables. We use the exogenous variables in the previous period(s) other
than the current period as an instrument (Zi ), and Zi is a T  r matrix, where r  K is the
number of instruments. This is in the spirit of Anderson and Hsiao (1982) and Arrelano and
Bond (1991) methods. The resulting unconditional r moment conditions are:
EZi0 ui  0:
The GMM estimator based on these moment conditions minimizes the associated quadratic
form:

44

E. S. LIN ET AL.

TABLE V Empirical Results for Education Equation

Variables
Milex
Health
Tax
Pop

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Gcon
Hcon
Gini
GDP
Constant

POLS

FE

RE

GMM 1

GMM 2

0.200
(0.145)
0.046
(0.170)
0.027
(0.037)
0.103
(0.261)
0.090
(0.055)
0.001
(0.027)
0.010
(0.017)
0.001
(0.002)
0.141***
(0.043)

0.244
(0.335)
0.056
(0.183)
0.024
(0.041)
0.917**
(0.418)
0.073
(0.092)
0.008
(0.045)
0.008
(0.018)
0.001
(0.001)
0.094
(0.130)

0.200
(0.315)
0.046
(0.169)
0.027
(0.038)
0.103
(0.106)
0.090
(0.086)
0.001
(0.041)
0.010
(0.017)
0.001
(0.001)
0.141***
(0.051)

0.951***
(0.360)
0.980**
(0.443)
0.142**
(0.068)
0.205***
(0.072)
0.361 **
(0.163)
0.143*
(0.083)
0.028
(0.021)
0.002**
(0.001)
0.264***
(0.065)

1.192***
(0.169)
0.661***
(0.209)
0.104***
(0.022)
0.106***
(0.037)
0.398 ***
(0.115)
0.018
(0.022)
0.036**
(0.016)
0.001**
(0.000)
0.234***
(0.032)

0.060*
(0.031)
0.478 ***
(0.111)
0.049**
(0.020)
0.036***
(0.010)
0.000
(0.000)
0.184***
(0.034)

0.366 ***
(0.123)
0.025
(0.035)
0.029**
(0.014)
0.000
(0.000)
0.189***
(0.037)

0.085***
(0.024)
0.044***
(0.013)
0.001***
(0.000)
0.151***
(0.030)

0.030**
(0.013)
0.001**
(0.000)
0.158***
(0.035)

389

389

389

344

321

321

321

321

321

50.430

691.930

54.850

23.100

94.340

191.940

8.084

12.592

10.644

8.926

10.620

13.169

0.425

0.702

0.714

0.716

0.716

0.513

First stage F
statistics
Hansens J
statistics
p-value

GMM 3

GMM 4

GMM 5

0.891***
(0.316)
0.285*
(0.152)

1.063***
(0.250)
0.364*
(0.211)
0.085***
0.030

0.791***
(0.275)
0.077
(0.166)
0.060**
(0.024)
0.066***
(0.019)

GMM 6
0.577**
(0.270)
0.231
(0.251)
0.023
(0.029)
0.073**
(0.035)
0.177
(0.123)

Notes: Standard errors are in parentheses.

*
denote statistical signicance at 10% level.
**
denote statistical signicance at the 5% level.
***
denote statistical signicance at the 1% level.
The F-statistics are obtained by regressing the endogenous regressor (Milex) on the instruments.

"
QN b

N
X
i1

#0
Zi0 ui WN

"

N
X

#
Zi0 ui ;

i1

where WN denotes an r  r weighting matrix. The panel GMM estimator can be obtained
as follows:
b^PGMM argb QN b:

Since we are considering a linear panel data model, our panel GMM estimator is thus given
by the following closed-form solution:

EVIDENCE FROM A PANEL OF OECD COUNTRIES

"
b^PGMM

N
X

!
Xi0 Zi

i1

WN

N
X
i1

!#1
Zi0 Xi

N
X

!
Xi0 Zi

WN

i1

45
N
X

!
Zi0 Yi

i1

It is convenient to express the panel GMM estimator in matrix from:

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1
b^PGMM X 0 ZWN Z 0 X X 0 ZWN Z 0 Y ;

where X 0 X10 . . .XN0 , Z 0 Z10 . . .ZN0 , and Y 0 Y10 . . .YN0 :

The panel data structure allows us to make use of the lagged variables to serve as the
instruments, which usually results in an over-identied model. To test the correct model
specication, the over-identifying restriction tests are performed to test whether the instruments are valid. Moreover, to avoid the weak instruments problems, we adopt the partial FStatistics to check if the instruments are strong or not. Other estimation methods, such as
pooled OLS (POLS), random effect (RE), and xed effect (FE) estimators, will also be
implemented for comparison purposes.
4. EMPIRICAL RESULTS
Tables IV and V report the estimation results of the health and education Equations in (1)
and (2), respectively. The POLS estimators indicate that military spending is nothing to do
with both health and education expenditures. FE and RE specications lead to a no
trade-off result, where we control the country-specic heterogeneity to mitigate the
omitted variable bias problem. On one hand, it is observed that the coefcient estimates
using POLS, FE, and RE methods generally give rise to the same signs as those in terms of
various panel GMM estimations. On the other hand, the POLS, FE, and RE may obtain
many insignicant parameter estimates (e.g. see Table V). Because POLS, FE, and RE do
not treat the right-hand-side variables as endogenous, the estimation results are hence not
reliable. In the following discussion, we will concentrate on the results of the consistent
parameter estimation using panel GMM method.
As pointed out in Cameron and Trivedi (2005), the panel GMM method can be conducted by choosing different lagged variables as instruments. We rst consider to include
lag one-period (e.g. Milexit1 andWit1 in Equations (1) and (2)) and two-period (e.g.
Milexit2 andWit2 in equations (1) and (2)) variables as the IV (see GMM1 model in Tables
IV and V).10 The lagged variables up to the three periods are also performed in our analysis, indexed by models GMM2GMM6 in both tables. Overall, instruments based on lagged
variables up to two (model GMM1) and three (model GMM2) periods lead to very similar
results.
When inspecting Table IV, it is clear to see that military spending has a positive impact
on the health expenditure (see the results of models GMM1 and GMM2). The positive
crowding-out effect implies that an increase in military spending also promotes the health

We also consider to use only the lag one-period variables as the IV. However, the rst-stage F-statistic is smaller than the rule of thumb cut-off value 10 (Staiger and Stock, 1997), indicating a weak instrument problem. Therefore, we do not report the set of estimation results.
10

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46

E. S. LIN ET AL.

spending as % of GDP, suggesting a complementary relationship between the two types of

government spending. As for the education equation in Table V, we nd that military
spending also has a signicantly positive impact on education expenditures once again
conrming a positive crowding-out effect of milex vs. welfare spending relationship. This
phenomena has been found in previous studies such as Verner (1983), Harris and Pranowo
(1988), Frederiksen and Looney (1994), and Kollias and Paleologou (2011). According to
Frederiksen and Looney (1994), government is willing to cut from the infrastructure
programs instead of curtailing the social welfare expenditures in response to an increase of
military spending. In addition, the defense spending can be benecial to human capital formation since defense personnel and soldiers are appropriately taken care (in terms of health
spending) and well trained physically, and receive good skills (in terms of education spending). This is particularly the case since we focus on the well-developed OECD countries.
Moreover, even though the military expenditures are mainly paid for new weapons rather
than military personnel, the education training programs must be offered for army personnel. Our empirical results are robust across different model specications in terms of
GMM3GMM6 in Tables IV and V.
It is worth noting that our nding that military spending and two social welfare
expenditures (i.e. health and education) are complementary is slightly different from those
of Yildirim and Sezgin (2002) and Ali (2011) using the data in Turkey and Egypt, respectively. Their nding that the trade-off is positive between education and defense spending is
consistent with our result, while the negative crowding-out effect between health and military expenditures is opposite to our crowding-in effect.
The relationship between health and education expenditures in both health and education
equations is distinct. In Table IV, education spending has a positive impact on health spending even though this relationship is not always signicant (e.g. models GMM1 and
GMM4). However, health expenditures tend to shrink the size of education expenditures as
indicated in Table V. Once again, it is not signicant in each model specication (e.g. models GMM5 and GMM6). The asymmetric nding between the two social spendings may be
due to that the health spending seems to constantly account for a higher rate as % of GDP
than education (see Figure 2 and Table II). However, it needs more work to gure out the
detailed link between the two variables in the future research.
In regard to other control variables, the effect of population on education and health
expenditure is signicantly positive in both equations. The evidence may imply that the
social welfare expenditures depend on the number of welfare recipients. The positive impact
of the tax revenue on education expenditure suggests that the increasing tax revenues can
be utilized to nance more social welfare expenditures. The effect of household consumption and government consumption is positive and signicant in both equations. However,
GDP has a negative effect on the social welfare expenditures, which might indicate that
other components (e.g. gross investment and net export) in GDP increase with a faster rate
than government spending.
To test whether our model specication is right, the Hansens over-identifying restriction tests are performed across GMM1GMM6 in both Tables IV and V. It shows that
the p-values are all large enough to support the over-identifying restriction. The weak
instrument problem is an issue in an over-identied model. To address this problem, we
apply the F-statistic criterion by Staiger and Stock (1997) from the rst-stage regression.
Tables IV and V show that the panel robust F-statistics (treating military spending as
endogenous) are sufciently large enough to avoid the weak instrument problem in all
cases.

EVIDENCE FROM A PANEL OF OECD COUNTRIES

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5. CONCLUSION
In this article, we aim to empirically evaluate the guns-and-butter argument using a panel
data of OECD countries from 1988 to 2005, which provides much more complete and accurate data sources. Earlier empirical studies on the relationship between defense and social
welfare expenditures tend to use single-equation models or cross-section data analysis,
ignoring the potential endogeneity problem. This study adopts the panel GMM method to
control for unknown country-specic heterogeneity, to overcome the simultaneity problem,
and thus to reach a more reliable empirical result.
Our empirical nding suggests that there is a positive crowding-out effect between
defense spending and the two types of social welfare expenditures, namely, health and education expenditures, in terms of the panel GMM estimator. This result is along the line of
several previous studies (e.g. Benoit, 1973, 1978; Lindgren, 1984; Harris and Pranowo,
1988; Ram, 1995; Kollias and Paleologou, 2011), even though we employ a different dataset and different empirical method. The positive effect (or complementary effect) in our
study may be due to the fact that the developed OECD countries are more supportive of the
social welfare programs. Government is willing to cut from the infrastructure programs
rather than sacricing the social welfare expenditures in response to an increase of military
spending. Additionally, the defense spending can be benecial to human capital formation
because defense personnel and soldiers are appropriately taken care and well trained physically, and receive good skills. Therefore, if the government increases military spending, the
health and education spending may be raised as well.
Since this study focuses on merely OECD countries, it is still unclear whether there is a
signicantly positive crowding-out effect in non-OECD countries or other regions in the
world. It is likely that the guns-and-butter argument holds in a panel of the developing or
less-developed countries. However, it is out of the scope of the current article. We leave this
direction to our future research.
ACKNOWLEDGMENT
We wish to acknowledge very useful and constructive comments from two anonymous
referees and the participants at the 15th Annual Conference of the African Econometric
Society, American University in Cairo, Egypt for many useful comments and suggestions
on earlier drafts of this article. Financial support from the Monsoon Asia and Multi-Cultures
Program, Research Center for Humanities and Social Sciences at National Tsing Hua
University is gratefully acknowledged. Any remaining errors are our own.
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