Public Investment and Defense Spending

ABSTRACT

The conventional way of public investment has been the target of criticism in recent years. Also, there is a significant possibility that the multiplier effect, often the subject of discussion when planning economic measures, may have diminished in comparison with earlier times. Furthermore, there are certainly a lot of issues to be addressed, such as rigid budget allocation, etc. However, it is a fact that even the conventional, civil engineering-focussed public investment has contributed to private sector productivity through the formation of social infrastructure.

If spending on this kind of public investment were to be reduced following 1970s, and these funds diverted to defense expenditure, the formation of social capital would be slowed. As a result, there is every possibility that productivity growth would stagnate, causing a slowdown in the economic growth. This effect is not noticeable in the short term, but would become markedly noticeable over a longer term of 20 to 30 years.

An estimate of the productivity effect of social capital shows that between 1970 and 1997, on average, 'an increase of 1% in the social capital leads to an increase of 0.2% in the productivity of private capital.' Based on the assumption that approximately 60% of public investment contributes to the formation of new social capital, we estimated what would be the effect on real GDP if a certain portion of public investment were to be diverted to defense spending.

If we were to hypothesise that, since 1970, Japan's defense spending has been 2% of GDP, rather than 1%, then the social capital for 1997 would be 58 trillion yen (15%) less than the actual figure, and real GDP would be lowered by between 3.1 and 5.5%. It has to be acknowledged that the 'peace dividend' has been substantial.

China's current military spending is estimated to be around 5% of GDP. If this were reduced by even 1%, and that portion diverted to the provision of social infrastructure, potentially substantial long term benefits can be imagined. Such a reduction in military spending would surely be beneficial to China's own economic development.