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THERE IS A WIDELY HELD view that political tensions and associated high levels of military spending are likely to detract from a country's long-run economic growth performance. In an insecure region, so the argument goes, each country must devote a disproportionate share of its endowment of scarce economic resources to "unproductive" military spending. In the absence of international cooperation to reduce political tensions, military spending may be ratcheted up throughout a region as each country tries to outspend its neighbors to ensure its own security, resulting in higher levels of military expenditure but no increase -- or even a decrease -- in the security of the region. While political tensions themselves can weaken various aspects of economic performance, there are two direct and interrelated avenues by which higher military spending may adversely affect long-run output growth. First, increases in military spending may reduce the total stock of resources that is available for alternative domestic uses such as investment in productive capital, education, and market-oriented technological innovation. Second, high spending on the military may aggravate distortions that reduce the efficiency of resource allocation, thereby lowering total factor productivity.
If these effects turn out to be empirically significant, then a converse proposition is also likely to be valid: the sustained military spending cuts that would become feasible as a result of improved international security should yield a "peace dividend" in the form of higher long-run levels of capacity output. It would then follow that forms of international cooperation that succeeded in reducing tensions, and thus in lowering military spending, would be to the long-run economic benefit of all countries. Interest in the potential size of this peace dividend has risen considerably in recent years with the improvements in international security that have become evident for both industrial and developing countries with the end of the Cold War and the more recent initiatives aimed at achieving a comprehensive peace in the Middle East.
The view that low levels of military spending are associated with strong growth performance is usually argued by recourse to casual empiricism. For example, the post-World War II experiences of the Federal Republic of Germany and Japan lend support to the notion that there are substantial economic benefits from sustaining low rates of military expenditure...