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1 Military Expenditure and Economic Growth

Journal of ASEAN Studies, Vol. 1, No. 2 (2013), pp. 106–121© 2013 by CBDS Bina Nusantara University and Indonesian Association for International RelationsISSN 2338-1361 print / ISSN2338-1353 electronic

Relationship between Military Expenditure andEconomic Growth in ASEAN: Evidence fromIndonesia

Tangguh Chairil, Indonesia Defense University, IndonesiaDedy S. Sinaga, Indonesia Defense University, IndonesiaAnnisa I. Febrianti, Indonesia Defense University, Indonesia

AbstractWorld military expenditure in post-Cold War world shows increasing trend especially in ASEANregion; Indonesia is no exception. The trend may have been supported by the argument thatmilitary expenditure has positive multiplier effects on economic growth. Unfortunately, there havebeen not too many studies on the effect of military expenditure on economic growth in theIndonesia context. This paper examines the topic by first reviewing literature on the relationshipbetween military expenditure and economic growth, then by empirically testing the causalrelationship between the two variables by using the Augmented Sollow Growth Model. The resultshows that Indonesia's military expenditure has positive effect on the country's economic growth,which is most possibly caused by development of human capital as effect of military expenditure.

Keywords: military expenditure, economic growth, Indonesia, Augmented SollowGrowth Model

Introduction

In the post-Cold War world, the globalstrategic environment endured changes, inwhich the intensity of inter-state conflictshas been decreasing while internal conflictshave been more emphasized. Along withthe end of Cold War, global militaryexpenditure constantly decreased fromUS$1,613 billion in 1988 to US$1,052 billionin 1996. However, after 1998, global militaryexpenditure had been increasing again. In2012, SIPRI estimated world total military

expenditure at US$1,733 billion, increasing51 percent from US$1,146 billion in 2001.

One of the regions that have beenexperiencing constant increase in militaryexpenditure is the Southeast Asia. Whileglobal military expenditure fell by morethan 40 percent in real terms between 1987and 1997, the military budgets of the fiveoriginal members of ASEAN (Indonesia,Malaysia, the Philippines, Singapore, andThailand) increased by more than 75percent in real terms over that period.

According to Andrew L. Ross (1990),Indonesia military expenditure is

Journal of ASEAN Studies 107

determined by two types of threats: internaland external threats. Indonesia militaryexpenditure was fluctuating between 1988and 2010. Before the 1997-98 economiccrises, the share of military expenditure inthe gross domestic product (GDP) hadalready decreased from 4.2 percent to 1.5percent in the previous 15 years, despiteannual GDP growth averaged to 5.5percent. In 1998, Indonesia militaryexpenditure increased by 38 percent in localcurrency from Rp4.78 trillion in 1997 toRp6.60 trillion in 1998. However, the dropof Indonesia’s currency exchange causedthe military expenditure to decrease in realterms, from US$2.50 billion in 1997 toUS$2.10 billion in 1998.

From 2001 to 2012, Indonesia militaryexpenditure increased by 366 percent fromUS$1.93 billion to US$7.05 billion. Itdecreased in 2005 and 2008, but overall itexperienced an absolute rise. In 2010, thecountry with the biggest relative increase ofmilitary expenditure in Asia is Indonesia by28 percent, followed by Mongolia by 26percent and Philippines by 12 percent(SIPRI, 2010).

This trend seems to be supported by theargument that military expenditure haspositive multiplier effect on economicgrowth. Benoit (1973, 1978) concludes thatmilitary expenditure has positiverelationship with economic growth.Eichenberg (1984), studies Germanymilitary expenditure and finds that it hasthe smallest trade-off compared to otherpublic expenditures. The study shows amore specific factor, i.e. the positiverelationship between the increase ofmilitary expenditure and the urge toincrease tax revenue that can consequentlybe used to fund social spending.

Contrary to that argument, there arealso studies that show negative relationshipbetween military expenditure and economicgrowth, e.g. Hong (1979), Lim (1983), Deger(1983), Smith and Dunne (1994), Heo (2010),

and Dunne (2011). In line with this,Anggoro (2003) states that the relationshipbetween the military expenditure will stillbe a never ending debate among defenseeconomists.

So far, the increasing trend of Indonesiamilitary expenditure has been caused lessby the argument about the relationshipbetween military expenditure and economicgrowth, and more by the needs to fulfill theMinimum Essential Force (MEF). MEF is “aforce level that can guarantee theattainment of immediate strategic defenseinterests, with the procurement prioritygiven to the improvement of minimumdefense strength and/or the replacement ofoutdated main weapon systems/equipment.” In 2010-2014, Indonesiadefense sector needs approximately Rp279.8trillion, which will be allocated todeveloping the MEF (Sukma, 2012). Inpolitical aspect, Indonesia militaryexpenditure is very changeable compared toother government expenditures.

It is because most stakeholders do notthink that military expenditure will givemuch effect on economic growth. In sometheories, government expenditures haveheterogeneous effect (Pieroni, 2009). Theeffects can be either positive or negative tothe economic growth.

The empirical phenomenon of theconstant rise of Indonesia militaryexpenditure, coupled with the variousarguments about the relationship betweenmilitary expenditure and economic growth,make the topic of the relationship inIndonesia context very interesting. Theprevious studies that discuss this topicspecifically are not widely available andonly in very few number. Therefore, thisstudy aims to revisit the relationshipbetween military expenditure and economicgrowth in Indonesia, given new theoreticaldevelopment and newly available empiricaldata.


Graphic 1 Indonesia military expenditure in constant 2011 USD, 1988-2012

Source: SIPRI Military Expenditure Database

Literature Review

The following literature review seesseveral theoretical and empirical studiesthat discuss the relationship betweenmilitary expenditure and economic growthspecifically and between the defense sectorand the economy generally. The results findthree propositions:1. the relationship between military

expenditure and economic growth issignificant and negative;

2. the relationship between militaryexpenditure and economic growth is notsignificant;

3. the relationship between militaryexpenditure and economic growth issignificant and positive.

The explanation of each proposition isas follows.

First Preposition: Negative RelationshipThe first proposition argues that

military expenditure has negative effects oneconomic growth. This relationship isrelated to the Production PossibilityFrontier model applied to the trade-offbetween the defense sector and the civiliansector, often termed as “guns versusbutter”. In this model, the state must choosebetween two sectors to spend its limitedresources (represented by the GDP): theguns (defense sector) or the butter (civilianproduction). There are various explanationsto this proposition, which have beenclustered as follow.

ProductivityThis explanation argues that the defense

sector can decrease domestic productivity,caused by the trade-off between theproductivity of the defense sector and of thecivilian sector. Hong (1979; cited in Heo,2010), shows empirical evidence of a U.S.productivity decline due to a resource shift


from civilian to military use. Thisexplanation is in line with Ward and Davis(1992) who find that the factor productivityof the civilian sector in the U.S. is higherthan that of both the military and thenonmilitary public sectors. Aizenman andGlick’s study (2003) also tell that the impactof military expenditure on growth is foundto be non-significant or negative.

Grobar and Porter (1989) study severalempirical literatures and uncover thenegative effect of defense spending andeconomic growth, e.g. Kaldor (1976), whosamples 40 least developed countries(LDCs) for 1963-1973 and produces acorrelation coefficient of -0.18 betweenmilitary burden and the rate of growth.There was also Lim (1983), who reexaminesBenoit’s analysis (that military expenditureaffects growth through aggregate demand)for 54LDCsover 1965-1973 period within thecontext of Harold-Domar growth model ofthe form, and concludes that militaryspending is detrimental to growth in LDCs.Nabe (1983) looks at the effects of militaryspending on growth in 26 African countriesover the period of 1967-1976, and finds thatmilitary spending reduces manufacturingGDP through the indirect effects of militaryspending on social and economicdevelopment factors. Faini, Annez, andTaylor (1984) test for the effects of militaryspending on economic performance in thecontext of 69 countries over 1950-1970 withpooled time-series/cross-sectional data andfind the coefficients on defense burden to beconsistently negative except for the group ofdeveloped countries.

Smith (1977, 1978, 1980) finds statisticalevidence for OECD countries that militaryexpenditure has a substantial negative effecton capital formation and consequentlysignificantly reduces growth rates evenwhen "spin-off" effects are allowed for.Melman (1983) states that defense industriesattract highly trained workers andengineers and thus have a draining effect on

human resources for private industries.Deger (1986) similarly argues that militaryexpenditure diverts the limited resourcesaway from the civilian economy. Goldstein(1988) argues that a 1 percent increase in thedefense share of Gross National Product(GNP) in the United States reduceseconomic growth by about 1.5 percentbecause of the opportunity costs, i.e. atrade-off in the budget and the bottleneckeffect of defense spending on capital stock.Cuaresma and Reitschuler (2004) also arguethat defense expenditure can beunproductive, although they provideinsurance against wars. Dunne and Uye(2009) review several empirical literaturesand find results showing negative orinsignificant effects of military spending.Blond (1980) finds that the average 10percent rise in military budget of the UnitedStates can reduce employment by 0.6 to 2.4percent.

Another explanation regardingproductivity topic sees that the defensesector has destructive effect on theproductivity of civilian sector. Murdoch andSandler (2002), in Alptekin (2009),look atcountries experiencing civil war could notrecover easily as their scarce physical andhuman capital has been destroyed, and asthe intensity of civil war increases, the effecton growth is more negative.

Another explanation focuses on therelationship between monetary policybetween the legislatures, armed forces, andthe defense industry base that support it,referred as “military industrial complex”(MIC). Dunne and Skons (2011) reveal thatMICs create inefficiencies in the economyand so can have negative economy effects,particularly as the nature of defenseproduction changed during the cold warand became very different from civilproduction, which can also lead to otherexternality effects through influences on thecivil sector and crowding out.


InvestmentThis explanation argues that the defense

sector can hinder investment. Lim (1983)obtains that there is a negative effect ofmilitary expenditure on growth throughForeign Capital Inflow (FCI) that maycontrol investment and militaryexpenditure together. Faini et. al. (1984) alsoshow that military expenditure caninfluence investment negatively, hencegrowth of output, through absorptivecapacity. Lindgren (1984) reviews a dozenstudies and reports that increase in defenseexpenditures result in the decline of privateinvestment. Mintz and Huang (1990, 1991)report that defense spending and privateinvestment vie for the non-consumptionportion of the total capital available in theeconomy, which means that more spendingon defense programs is likely to result inthe decline of private investment. Heo andEger (2005) also find that defense spendinghas a dampening effect on privateinvestment with one-year delay.

More generally, this explanation alsorelates military expenditure with the peacedividend, i.e. the potential long-term benefitas budgets for defense spending areassumed to be at least partially redirected tosocial programs and/or a decrease intaxation rates. For example, Gleditsch et. al.(1996) use large structural models that tendto show the existence of a ‘peace dividend’as the benefit of reducing military spendingand reallocating it.

FiscalThis explanation argues that the defense

sector can worsen the fiscal condition of acountry. Smith and Dunne (1994) state thatmilitary expenditure would be a very badfiscal regulator because of the lags before itcomes into effect: it takes too long to planand implement to be an effective stabilizer.

SavingThis explanation argues that the scale of

domestic saving will decrease in line withthe increase of tax to fund militaryexpenditure. Deger (1983) estimates therelationship between defense expenditureand economic development using nationalaverage data of 50 LDCs for the period of1965-1973 and finds that military spendinghas a negative coefficient on saving.

Second Preposition: InsignificantRelationship

The second proposition argues thatmilitary expenditure bears no significantrelationship with economic growth. Thisproposition is based on various empiricalresearches that find the regression analysison both variables doesn’t produce astatistically significant coefficient ofcorrelation. Some of those researchesinclude Biswas and Ram (1986) who re-estimate Benoit’s equations for 58 countriesover the periods 1960-1970 and 1970-1977and find that the coefficient on militaryburden for the low-income LDCs isstatistically insignificant. Biswas and Ram(1986) for asserting that defenseexpenditures in general may affecteconomic growth positively or negatively,but the effect is unlikely to be consistentlysignificant on the grounds that the natureand the amount of the spending vary overtime. Joerding (1986) even states thateconomic growth may be causally previousto defense expenditures. Landau (1986), inGrobar and Porter (1989), finds that theestimated impact of the share of militaryexpenditure in GDP on the GDP growthrate is rarely, and never significantly,positive.

Heo (2010) as well as Payne and Ross(1992), conduct vector auto-regressionanalysis to test if U.S. defense spending andeconomic growth have a causalrelationship, and both studies find resultsthat indicate no causal relationship between


the two variables. Heo (2000) conducts anempirical analysis employing variousversions of the Feder-Ram–based defense–growth models to test the direct effects ofdefense spending on economic growth inthe United States for 1948 through 1996 andfinds a consistently insignificantrelationship between both variables. Gerace(2002) and Becker (1991) to argue thatdefense spending per capita in the UnitedStates is simply not large enough to have astatistically meaningful effect on economicgrowth.

Third Preposition: Positive RelationshipThe third proposition argues that

military expenditure is directly proportionalwith economic growth. There are variousexplanations to this proposition, whichhave been clustered as follow.

SecurityThis explanation argues that military

expenditure is important to guard nationalsecurity that is vital for supportingeconomic activities. Baran and Sweezy(1966), in Dunne (2011), see militaryspending as important in preventingrealization crises, through absorption ofsurplus without raising wages or capital;other government expenditure could not dothis. In line with the statement, Thompson(1974), in Mylonidis (2006), argues thatgovernment activities, such as the provisionof national defense, which maintainproperty rights, can indirectly supportgrowth by increasing citizens’ incentive toaccumulate capital and to produce. Dunne(1990) also notes that that war would have anegative impact upon the economy, and toprevent a war outbreak, militaryexpenditure to provide defense is required.Sandler and Hartley (1995) point thatdefense spending contributes tomaintaining both internal and externalsecurity, which is critical for economicactivities. Hall and Jones (1999) explains

that military expenditure in the developedcountries is needed to maintain the fragilestructure of the government, which will notbe without any economic cost. In the studyby Aizenman and Glick (2006), as quoted inAlptekin (2009), argue that the non-linearrelationship between growth and militaryexpenditure is associated with the degree ofsecurity and this is related to the level ofthreat. Their model specifies that if there is athreat (resulting insecurity) above athreshold value, then a country benefits byincreasing its military expenditure.

Aggregate DemandBenoit (1973, 1978), as quoted in

Alptekin (2009), is the proponent of the ideathat military expenditure may positivelyaffect growth through aggregate demand. Itis related to the capacity utilization, andalso that when an economy is in a phase ofrecession an increase in militaryexpenditure will boost the economy.Benoit's analysis (1978), quoted in Degerand Smith (1983), finds a significant,positive correlation between defenseexpenditure as a proportion of nationalincome and the growth rate of civilianoutput between 1950 and 1965. Otherstudies that follow Benoit's methodologicalapproach have also derived positive cross-sectional effect of military expenditure ongrowth. Chan (1995), in Heo (2010),similarly explains that the positiveemployment effects of defense spendingalso boost aggregate demand in the UnitedStates economy, in which those who earnincome through defense programs orDepartment of Defense (DOD) contractawards consume their earnings, whichenhances aggregate demand

EmploymentThis explanation argues that military

expenditure leads to employment. Nincicand Cusack (1979) as well as Blank andRothschild (1985) report that defense


programs generate employment in the U.S.because of the large size of the U.S. armedforces. This is in line with Former Secretaryof Defense Casper Weinberger's argument(1983, p.68) that defense cutbacks of $1billion would result in the loss ofapproximately 35,000 jobs in the U.S. alone.Cuaresma and Reitschuler (2004), in Heo(2010), report that the externality effects ofU.S. defense spending on economic growthare positive, with one of the reasonscommonly cited for it being the positiveassociation between the two variables is jobcreation.

TechnologyThis explanation argues that military

expenditure allocated to develop militarytechnology will create spin-off to civiliantechnology. One of the literatures that arguelikewise is Adams and Gold's research(1987) in which they contend that thedefense industry has been a source ofsignificant technological innovation in theU.S. and has promoted growth through aspin-off effect on the private sector. In linewith this explanation, Deger and Sen (1995),in Stroup and Heckelman (2001), note thatvarious studies have considered whethertechnology spin-offs arising from defenseweapons production in countries withcapital intensive military sectors mightenhance growth.

Human CapitalThis argument sees the relationship

between a part of the military expenditureand the development of human capital.Barro (1990), in Heo (2010), notes that aportion of defense spending is used tosupport education, which enhances humancapital. Weede (1983), in Grobar and Porter(1989), argues that military spendingencourages economic growth because "themilitary teaches discipline and creates auseful habit of obeying orders" and "themore capable and disciplined the work

force is, the better the economicperformance should be." Weede estimates95 LDCs using data from the period 1960-1977.

Economic StimulusThis explanation argues that military

expenditure can stimulate the economy.Pivetti (1992) and Cypher (1987) suggestthat military spending is a consciousinstrument of economic policy and has astimulating effect on economy. Mueller andAtesoglu (1993), in their empirical analysisquoted in Heo (2010), also find that defensespending stimulates the U.S. economy.

The various explanations of the threepropositions are summarized in thefollowing table:


Table 1 Explanations of the relationship between military expenditure and economicgrowth

Methodology

The main purpose of this study is to testthe causality relationship between militaryexpenditure and economic growth. Therelationship will be tested by using theAugmented Solow growth model, assuggested by Dunne, Smith, andWillenbockel (2005). Another model oftenused to test the relationship betweenmilitary expenditure and economic growthin the literatures of defense economics is theFeder-Ram model. According to Dumas(1986) and Heo (2010), this model can

distinguish the effects of governmentexpenditures for the military sector andnonmilitary sector (Heo, 2010). The Feder-Ram model also includes the externalityfactors from government expenditure (Heo,2010). Despite that, Dunne, Smith, andWillenbockel (2005) criticize that there is asevere simultaneity problem between thedependent variable and the independentvariables in this model (Heo, 2010).Theyfurther argue that this model hasmulticollinearity between independentvariables (Heo, 2010). Therefore, theyrecommend the use of Augmented Solow

Significant, NegativeRelationship

Insignificant Relationship Significant, PositiveRelationship

Defense sector can decreasedomestic productivity

Regression analysis on bothvariables doesn’t produce astatistically significantcoefficient of correlation

Military expenditure isimportant to guaranteenational security, which isvital to support economicactivities

Defense sector may hinderinvestment

The nature and the amountof defense expenditures varyover time

Military expenditure caninfluence growth throughaggregate demand related tothe capital utilization

Defense sector can worsenfiscal conditions

Defense spending is notlarge enough to have astatistically meaningful effecton economic growth

In recession, rise of militaryexpenditure may encouragethe economy

The scale of domestic savingwill decrease in line with theincrease of tax to fundmilitary expenditure

Military expenditure canlead to employment

Military expenditure todevelop military technologywill create spin off to civiliantechnologyA portion of defensespending is related to thedevelopment of humancapital


growth model commonly used in literaturesabout economic growth.

To see the complete explanation aboutthe specifications of the Augmented Solowgrowth model for defense economics study,

read Dunne, Smith, and Willenbockel(2005). The final model that is tested in thisstudy is:

( ( )) = ( ) + ( ) + ( + + ) + ( ) + ( )Note:

Y : Gross Domestic Product (GDP) at constant pricess : share of investment (formation of gross domestic fixed capital) in GDPM : share of military expenditure in GDPg, n, d : factors determining the steady-state of an economy, in which g represents

technological progress, measured by the share of population working inthe industry sector in the total of workforce; n represents share ofemployment in the total population; d represents share of depreciation inGDP.

Table 2 Data source for variables used in this study

Variables Data SourceY Using data of GDP (constant local currency unit) in the database of World

Development Indicators (WDI) accessed from databank.worldbank.orgS Taken from data of Gross Fixed Capital Formation (constant local currency

unit)from the database of World Development Indicators (WDI) accessed fromdatabank.worldbank.org

M Using data of Military Expenditure taken from SIPRI(Stockholm InternationalPeace Research Institute)Military Expenditure Database.

G Proxy by using share of population working in the industry sector in totalworkforce. The data of the share of employment in the industry sector is takenfrom the database of World Development Indicators (WDI) accessed fromdatabank.worldbank.org

N Taken from data of Total Labor Force and Population from the database of WorldDevelopment Indicators (WDI) accessed from databank.worldbank.org

D Taken from data of depreciation in GDP based on expenditures in the database ofIndonesian Economic and Financial Statistics (SEKI)accessed from www.bi.go.id

In social science, to conclude thatthere is a causal relationship between twovariables, there are at least threerequirements: association, non-spuriousness, and direction of influence(Singleton and Straits, 2010). Association isfulfilled when there is strong association or

correlation between military expenditureand economic growth. Non-spuriousnessrequires this study to eliminate probabilityof association or relationship produced byother external factors. Direction of influencerequires the direction of the causalrelationship to be clear: meaning, this study


shall be capable to limit militaryexpenditure as the cause of economicgrowth. If it appears that economic growthalso in turn plays a causal role for militaryexpenditure, the pattern of causalrelationship between the two variablesbecomes unclear.

Results

Association can be evaluated by seeingthe coefficient of correlation (r) betweenthevariable of military expenditure (ln(M)) andthe variable of economic growth ((d(ln(Y))).The coefficient of correlation between bothvariables is 0.3612 (see attachedStataoutput). This shows that both variableshave positive relationship, despite not toohigh. However, there is a probability thatthe correlation is significant in explainingthe relationship between militaryexpenditure and economic growth.

Spurious relationship is usuallyproduced by non-stationary data that is notco-integrated in long term. Therefore, to testwhether the data used in this study havethe probability to produce spuriousregression, this study conducts the Dickey–Fuller test (DF Test) for unit root, to test thedata stationarity. The result is that allindependent variables are non-stationary inlevel 0, but are stationary in level 1.Therefore, the regression model is furthermodified into:

( ( )) = ( ( )) + ( ( ))+ ( ( + + ))+ ( ( )) + ( ( )))To test the pattern and direction of the

relationship between the variables, thisstudy conducts the Granger causality test.The result is that the variable of economicgrowth has simultaneous causality withmilitary expenditure, meaning that not onlyeconomic growth is affected by military

expenditure, but military expenditure isalso affected by economic growth. To findthe parameter that can estimate thesimultaneous relationship between thevariables, this study conducts a regressionusing the Three-Stage Least Squares(3SLS)model, which follows the followingequations:

( ( )) = ( ( )) + ( ( ))+ ( ( + + ))+ ( ( )) + ( ( ))( ( )) = ( ( )) + ( ( ))+ ( ( ))

This study suspects that other than theindependent variables in the system, thereis also a linkage between the disturbancefactor from both equations in the systemthat also explains the relationship betweenmilitary expenditure and economic growth.To summarize it, the disturbance factor ineach equation is suspected to affect themilitary expenditure and economic growth.Therefore, this study also conducts 3SLSmodel regression using the seeminglyunrelated regression (SUR).

Prior to discussing the regression result,the descriptive statistics for each variablewill be presented as follows.


Journal of ASEAN Studies, Vol. 1, No. 2 (2013), pp. 106–121© 2013 by CBDS Bina Nusantara University and Indonesian Association for International RelationsISSN 2338-1361 print / ISSN2338-1353 electronic

Table 3 Descriptive statistics of variables used in this studyVariable Mean Std.

DeviationMedian Unit

Gross Domestic Product atconstant prices (Y)

1,460 420 1,440 trillion rupiah

Share of investment (formation ofgross domestic fixed capital) inGDP (s)

22.73 2.48 22.47 percentage

Share of military expenditure inGDP (M)

1.06 0.16 1.06 percentage

Share of employment in the totalpopulation (n)

62.58 0.93 63.00 percentage

Share of population working inthe industry sector in the total ofworkforce (g)

17.09 2.75 18.00 percentage

Share of depreciation in GDP (d) 4.90 1.76 5.00 percentageobservations: 1988-2010 (23 units)

In the above table, the median and meanof each variable is relatively the same, thusbias due to extreme lower or upper valueneeds not to be concerned. The share ofinvestment in Indonesia is relatively small,only 22.73 percent of GDP. It is rather lowcompared to the number of other countriesin the region: China’s 35.76 percent, SouthKorea’s 32.03 percent, Thailand’s 30.55percent, Singapore’s 29.51 percent,Malaysia’s 28.95 percent, and Japan’s 25.87percent (databank.worldbank.org). In aneconomy, investment encourages currentGDP and develops productive capitals thatthe economy runs on: both physicalinfrastructures such as buildings, roads, andmachines, and also soft infrastructures suchas software and patents. The higher theshare of investment, the higher the capacityof an economy to increase its productivity;thus increasing its economic growth.

The portion of military expenditure inIndonesia’s GDP is relatively small.Indonesia’s 1.06 percent is lower than theaverage 2.61 percent of 164 countries,especially to other countries in the region:Singapore’s 4.51 percent, South Korea’s 3.05percent, Malaysia’s 2.31 percent, China’s

2.05 percent, Thailand’s 1.90 percent, andthe Philippines’ 1.75 percent (SIPRI MilitaryExpenditure Database). Only Japan’s 0.94percent figure is lower than Indonesia’ssince because of the Article 9 of itsConstitution, which limits its defensespending to 1 percent of its GDP. With thesmall share of military expenditure inIndonesia’s GDP, hence it is expected thatthe burden it may cause to the economy isalso relatively small.

The 62.58 percent share of employmentin the total population shows that morepeople works than the dependents.However, the 17.09 percent share ofpopulation working in the industry sector ismedium-to-small. In 2010, 19.30 percent oftotal Indonesian employment was workingin the industry sector, slightly above half ofCzech Republic’s 38 percent as the countrywith highest percentage of employment inindustry. Among East Asian countries,China's 28.70 percent was top of the tableand 15th among 93 countries with availabledata of share of employment in the totalpopulation from databank.worldbank.org,followed by 20th-place Malaysia's 27.60percent, and 26th-place Japan's 25.30


percent, while Indonesia was ranked 61th

out of 93. Theoretically, the higher thenumber, the higher the technologicalprogress of the economy.

The 4.90 percent share of depreciationshows degree of capital need to be replaced.Logically the higher the number, the higherthe investment or technologicaladvancement needed to produce economicgrowth.

Table 4 The results of the 3SLS regressions3SLS 3SLS, SUR

Dependent Variable:Economic Growth, d(ln(Yt))

Economic growth of previous year, d(ln(Yt-1)) 0.1613. 0.1496 .Capital investment, d(ln(st)) 0.3032*** 0.3147***Growth of steady state factors (labor), d(ln(gt+nt+dt)) 1.3155*** 1.2741***Growth of military expenditure, d(ln(Mt)) 0.1786 ** 0.0652 **Previous growth of military expenditure, d(ln(Mt-1)) 0.0020. 0.0188 .

“R-square” 0.6933. 0.8461 .Chi-square 89.85. 116.71 .Prob (Chi-sq) 0.0000. 0.0000 .

Dependent Variable:Growth of Military Expenditure, d(ln(Mt))

Economic growth, d(ln(Yt)) .1996 . .7138 .Previous growth of military expenditure, d(ln(Mt-1)) .1647 . .1641 .Growth of government expenditure, d(ln(Govt)) -.0222 . -.0305 .

“R-square” 0.0471 . 0.0617 .Chi-square 89.85 . 1.73 .Prob (Chi-sq) 0.8763 . 0.6310 .

*** significant at α= 1%** significant at α= 5%* significant at α= 10%

Standard Solow growth model conceivethat main engines of growth, are investmentand steady state factor in which labor orhuman capital investment is the dominantelement. Table 4 shows that the steady statefactor has greater positive impacts (1.3155or 1.2741) than investment (0.3032 or0.3147). It can be interpreted that forIndonesian economy, in order to boostgrowth, investment in human capital andother factors affecting the steady state level

postulated by Solow is needed more thanadditional physical capital or gross fixedcapital formation. Therefore, it is expectedthat allocation of resources to this factor willresult in a higher economic growth than theone allocated to physical capital.

From the regression results, it can beseen that military expenditure has positiveeffects on economic growth in Indonesia.The positive relationship between militaryexpenditure and economic growth is most


probably caused by the development ofhuman capital as a portion of defensespending. In military expenditure,personnel expenditure can contribute indeveloping the human capital throughmeans of training and communityinvolvement conducted by militarypersonnel in the forms of MilitaryOperations Other Than War (MOOTW).Theshare of personnel expenditure is thehighest compared to other types ofspending in military expenditure: capitaland goods expenditures. Personnelexpenditure makes up to 48 percent of thetotal military expenditure in 2011, whilecapital spending only makes up to 31percent and goods spending up to 21percent.

Graphic 2 Indonesia military expenditureby types

Source: Appendix 1 of the PresidentialDecree No. 26 Year 2010

A look at Gyimah-Brempong (1989)’sstudy can help to elaborate more discussionon the results. Using cross-national data for39 Sub-Saharan African countries duringthe 1973 to 1983 period, Gyimah-Brempongalso arrives at a relatively similar conclusion

to his study regarding labor factor. He usesa four-equation simultaneous model and3SLS estimation procedure to investigatethe relationship between defense spendingand economic growth in Sub-SaharanAfrica, and withdraws the followingconclusions from his econometric analysis:

1. the total effects of defense spending oneconomic growth are negative andstatistically significant,

2. defense spending affects economicgrowth through increased supply ofskilled labor and decreased investment,

3. defense spending does not havesignificant effect on economic growthwhile it has positive effects on labor’sskill formation.

Having found that African countries'defense spending contributes to thedevelopment of human capital in the formof skilled labors, Gyimah-Brempong (1989,p.88) then suggests that defense policy shallfocus on labor-intensive armed forces. Thiswill result in increasing stock of skilledpersonnel while attending to the defenseneeds of the country. “Emphasis onweapons acquisition at the expense of skillformation is also likely to slow economicgrowth in foreign exchange scarceeconomies” (p.88).

Conclusion

Military expenditure is a publicspending by governments that has influencebeyond the resources it takes up, andconsequently beyond the defense sectoritself; Indonesia is no exception. Whetherthe influence is positive, negative, orinsignificant does not in Indonesia's case,since Indonesia must inevitably increase itsmilitary expenditure gradually to meet itsMEF requirements. As the Director-Generalof Defense Potential (Pothan) of the

Personnel

Expenditure48%Material

Expenditure21%

CapitalExpenditure31%


Indonesian Ministry of Defense, Dr. Ir. PosM. Hutabarat, explained, the MEF would befulfilled approximately in 2024 with anominal approximately Rp300 trillion. Headded that the ideal budget to fulfilldefense requirements, especially indeveloped countries, was around 2 to 3percent of the GDP, while Indonesiamilitary expenditure had merely beenunder 1 percent. To null this gap, Indonesiamilitary expenditure has been increasedgradually each year, notwithstanding theeffect it may cast upon economic growth.

However, it is best for Indonesia’sinterests to know the nature of therelationship between its militaryexpenditure and economic growth, so thatthe future policy regarding defensespending can be based upon thisunderstanding. This study concludes thatthe relationship between militaryexpenditure and economic growth inIndonesia is positive. This is because mostof Indonesia military expenditure is usedfor personnel expenditure, whichconsequently increases the human capitaland eventually affects the economypositively. The findings tell us thatIndonesia needs not to worry about thedamaging trade-off between defense andother government spending on civiliangoods, because the former also reinforcesthe latter, in the form of the development ofhuman capital as a portion of militaryexpenditure. This may be the case inIndonesia, where the National ArmedForces (TNI) holds the doctrine of“Manunggal TNI dengan Rakyat” (UnifiedArmed Forces with the People) andconducts many community developmentactivities, one of which is humanitarianassistance disaster relief operations. Thetask is the implementation of Law No. 34 of2004 on the Indonesian Armed Forces,Article 7, Paragraph 2, Item 12.

Other sectors in which militaryexpenditure may have influence show no

other significant effect from Indonesiamilitary expenditure. In developedcountries, military spending tends to havean impact on growth through its effects ontechnology. The findings tell us thatIndonesia defense industry still cannotcontribute to the advancement oftechnology in Indonesia. This is whereIndonesia military expenditure should behighlighted. By the enactment of Law No.16 of 2012 on Defense Industry, Indonesianeeds to put more emphasis on the militarytechnologies that can also affect growthpositively.

Another interesting find in this study isthat the augmented Solow growth modelrecommended by Dunne, Smith, andWillenbockel (2005) still has simultaneityproblems for the Indonesia study case,requiring the model to be further modifiedin order to obtain more robust results.

About Authors

Tangguh Chairil earned his bachelor'sdegree in International Relations fromUniversitas Indonesia in 2011 and master'sdegree in Defense Economics at the IndonesiaDefense University in 2013. His thesis is titled"Determining Factors of Proportion of MilitaryExpenditure as Percent of Gross DomesticProduct of Countries: Cross-Country StatisticalAnalysis". Currently, he is acting as SpecialAssistant to the Director of Maritime SecurityStudies Program at the Indonesia DefenseUniversity. He can be contacted [email protected].

Dedy S. Sinaga received his bachelor's degree inEconomics from Universitas Indonesia in 2009.He then received scholarship from the Ministryof Defense of Republic of Indonesia in 2011, topursue postgraduate study in DefenseEconomics at the Indonesia Defense University.His thesis is titled "The Impacts of DefenseSpending Increase on Economic Growth,Inflation, and Employment in Indonesia:Simulations Using Computable General


Equilibrium". Currently, he is working at theIndonesian central bank.

Annisa I. Febrianti received her bachelor'sdegree in International Relations in 2011 fromUniversitas Paramadina. She earned the bestInternational Relations graduate student in the5th Judicium of Universitas Paramadina. Shereceived scholarship to continue postgraduatestudy at the Indonesia Defense University. Sheearned her master's degree in DefenseEconomics in 2013. She focused her study in thedefense industry. Her thesis is titled "The Impactof Defense Offset Towards the IndonesianDefense Industry: Case Study of PT. Pindad".She has also conducted research about UnitedNation Peacekeeping Operation in Nepal.

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