Saturday, April 27, 2013

Poor Timing: Military Spending and the Business Cycle

. Saturday, April 27, 2013

First quarter GDP growth figures for the US released yesterday were disappointing, and the Commerce Department pointed to falling military spending as an important contributing factor. This is interesting from a broader perspective. My research on the economic consequences of military buildups indicates that the timing of large changes in military spending bears little relationship to prevailing economic conditions. Military spending rises in response to unexpected foreign military challenges and falls when the threat has diminished. As a consequence, large changes in military spending typically have been pro-cyclical.

Consider the three postwar military buildups since Korea (Vietnam, Carter-Reagan, and War on Terror). In these buildups, defense spending increased by between 25% and 50%, with most of the increase paid for by borrowing, and the deficit-financed buildup persisted for three to four years. The persistent deficits imparted a substantial demand shock, transforming ongoing economic expansions into economic booms.

Similar dynamics might characterize post-conflict demobilizations. Cuts in military spending should weaken macroeconomic activity and there is little reason to expect wars to end just as the economy requires restraining with a counter-cyclical fiscal policy. Military build downs might thus cripple an already limping economy.

We seem to be experiencing just such a pro-cyclical build down currently. Reports yesterday on first quarter growth indicate that reduced military spending--a fall of only 11.5% on an annualized basis--as the US disengages from Afghanistan and Iraq is undermining economic recovery. As the Washington Post reports

That shift in foreign policy is still trickling through the real economy. Compensation for military and civilian employees working in defense have fallen every quarter since 2012. Major contractors such as Lockheed Martin have laid off or bought out hundreds of employees, including top executives, and consolidated facilities in recent years.
Indeed, defense spending cuts (even prior to the impact of sequestration, which kicked in only on March 1) appear to have shaved .6 percent off GDP growth. This appears to be the second consecutive quarter in which large defense cuts have weakened the recovery. The current post-conflict military build down is thus poorly timed from a macroeconomic perspective.

There is a broader point. In the US, the logic of national security overrides the logic of rational macroeconomic management. Variation in US military spending has been driven by the perceived need to respond urgently to foreign challenges regardless of prevailing economic conditions. Because military spending constitutes so large a share of national income, the resulting variation in military spending has substantial macroeconomic consequences. We recognize these consequences at the extremes (e.g., WWII and the end of the Great Depression) and we recognize them when military spending falls. We don't seem to recognize this "military Keynesianism" as a more general phenomenon. We ought to, for national security has been the primary driver of US fiscal policy--and thus a major policy driver of US macroeconomic performance--since 1965. I am puzzled why this is not more broadly recognized.


Ronan said...

You were saying one or two of the chapters might be available online somewhere.....? (or even better, is the book based on this research out soon?) looks like a fascinating argument.

Poor Timing: Military Spending and the Business Cycle




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