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Defence and Peace Economics

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DEFENCE SPENDING AND THE MACROECONOMY: THE CASE OF TURKEY

Onur zsoy a a Department of Economics, Faculty of Political Sciences, Ankara University, Cebeci-Ankara-Turkey 06590 Online Publication Date: 01 June 2008

To cite this Article zsoy, Onur(2008)'DEFENCE SPENDING AND THE MACROECONOMY: THE CASE OF TURKEY',Defence and

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Defence and Peace Economics, 2008, Vol. 19(3), June, pp. 195208

DEFENCE SPENDING AND THE MACROECONOMY: THE CASE OF TURKEY

ONUR ZSOY*
Department of Economics, Faculty of Political Sciences, Ankara University, Cemal Grsel Caddesi, Cebeci-Ankara-Turkey 06590
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GDPE_A_297379.sgm Taylor and Francis

(Received 1 December 2007; in final form 13 January 2008)

This study uses a six-variable vector autoregressive (VAR) model and analyses the relationship between defence spending as a percentage of GNP, government budget as a percentage of GNP, total deficit as a percentage of GNP, the GNP growth rates, inflation rates, and government budget deficit as a percentage of GNP for the case of Turkey from 1933 to 2004. The impulse response functions (IRFs) are also derived and Granger causalities among the variables estimated. The results support the short-run causality between defence spending and economic growth.
ozsoy@politics.ankara.edu.tr OnurOzsoy 000 0 300 19 Taylor 2008 & Francis Original Article 1024-2694 (print)/1476-8267 Defence and Peace Economics 10.1080/10242690801972139(online)

Keywords: Defence expenditure; Macroeconomics; Government budget; VAR; Granger Causality; Impulse Response Functions; Turkey JEL Codes: C22, C32, E10

INTRODUCTION This study attempts to investigate empirically the relationship between defence spending as a percentage of GNP, government budget as a percentage of GNP, total deficit as a percentage of GNP, the GNP growth rates, inflation rates, and government budget deficit as a percentage of GNP for the case of Turkey from 1933 to 2004. The analysis is conducted employing a six-variable vector autoregressive (VAR) model. The VAR model is used to derive impulse response functions (IRFs) to examine the response of one variable to a shock in other variables. Additionally, Granger causalities among the variables are estimated and analysed. Turkey is situated in a high-turmoil region in the world. Many of Turkeys neighbouring countries have long been faced with internal and external economic, social, political, and military problems. For example, Turkeys primary neighbours, Iran and Iraq, were involved in a war resulting from a border dispute between these two countries, which lasted eight years. Not only did this war influence the countries involved in it, but it also affected neighbouring countries, including Turkey. Turkey has also been dealing with terrorist activities since the 1970s. The problems in neighbouring countries, together with internal terrorist activities, have

*Email: ozsoy@politics.ankara.edu.tr

ISSN 1024-2694 print: ISSN 1476-8267 online 2008 Taylor & Francis DOI: 10.1080/10242690801972139

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caused many direct and indirect negative impacts on the Turkish economy. The immediate direct negative effects are reduced border security, external military-terrorist treats from neighbouring countries and internal terrorist threats. On the other hand, the indirect negative effects involved the devotion of a large portion of limited resources to defence and securityrelated issues, reduced external inflow of capital and investment, and the availability of fewer resources for other social types of spending, such as education, health, public housing, and public services. Due to these problems Turkey annually devoted approximately 3.4% of its GNP to national defence and security between 1933 and 2004. This figure is quite high compared with other NATO and European Union (EU)1 member countries. Therefore, the examination of the subject matter is crucial and requires special attention. Since the data set employed in this study covers a relatively long time span, the likelihood of drawing a clear picture on the topic is very high. The current study covers a long time period and uses more macroeconomic variables to better investigate and reach more robust results than previous studies conducted to analyse the defence-macroeconomy nexus. The results of this study should help shed new light on defence and security-related issues, both in Turkey and in countries having similar macroeconomic characteristics. The results of the current study should also help policy-makers understand better the subject matter and so design effective and optimal defence-macroeconomics related government policies. This paper is organized as follows. The next section explains the relationship between defence spending and the macroeconomy. The third section contains a brief survey of previous studies conducted on the topic. The fourth section includes an overall Turkish macroeconomic analysis for the period 19332004. The fifth section focuses on model development and presents the estimable form of a VAR system. This section also describes the variables, defines the data sources, computes time series characteristics of the series, and discusses and interprets the empirical results. The final section concludes with main the findings of this study. The Relationship between Defence Spending and the Macroeconomy Military expenditures are expected to positively and negatively influence the macroeconomy in less developed countries (LDCs) as well as in developed countries (DCs) that allocate a significant portion of their limited resources to purchasing or producing defence equipment or related goods, or to developing military industrial technology. These expenditures may affect an economy through several channels, which are categorized into aggregate demand and supply channels. It is argued that defence spending, as part of government expenditure, increases aggregate demand through its stimulating effect on unemployed and unutilized military and non-military industrial capacity, and that this leads to a higher shortrun level of output, causing employment and economic growth to rise (zsoy, 1996; Dunne, 1996, Brauer, 2002, and Dunne et al., 2005). For these reasons, Keynesians widely believe that idle resources always exist in all types of economies and that military expenditures should be used as a tool to increase underutilized capacity and resources, and to expand output. As explicitly indicated by Dunne et al. (2005), aggregate supply channels are considered to be spill-over and crowding-out effects. Spill-over effects occur when one sector of an economic system has an impact on the output of other sectors, and this interdependency is supported by market activities. Spill-over effects can be positive or negative. Examples of
1 Turkey is geo-strategically one of the most important members of NATO. However, Turkey is not a full member of the EU. Negotiations between Turkey and the EU towards full membership started in September of 2005 and hopefully will end around 2015.

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positive spill-over effects include technology spill-over, human capital spill-over, employment spill-over, security spill-over, etc, from the military to the civilian sector. It is believed that military research and development (MIR&D) produce new ideas, new production techniques, and new technologies, which may have direct or indirect civilian applications and use. This situation may reduce the unit costs of production and thus increase productivity and economic growth. Contrary to the positive spill-over effects of MIR&D spending, much MIR&D does not have either civilian applications or civilian use, and defence outlays reduce the available resources for more productive areas and retard economic growth (zsoy, 1996). For example, production of tanks, nuclear missiles, or other armaments is not used to increase civilian productivity or to reduce the unit costs of civilian production. Additionally, imports of military goods reduce the limited amount of foreign exchange that is needed, mainly for imports of intermediate goods, which are necessary for main production. This worsens the balance of payments and retards economic growth in the LDCs. However, it is widely accepted that arms imports by the LDCs from DCs is a way of transferring technology. It should also be realized that DCs transfer technologies to the LDCs and make LDCs technologically dependent on them. In addition to this, military education and personnel training might have spill-over effects on the civilian sector. Military personnel can be employed to increase productivity in the civilian sector after they retire. Military education and training decrease illiteracy and increase modernization of the LDCs. This contributes positively to economic efficiency and growth. Nevertheless, according to some researchers, higher wages in the military sector attract and divert more productive and skilled labour from civilian usage. This may be considered a loss for the national economy as a whole.

PREVIOUS STUDIES Since the influential work of Benoit (1973), there have been many empirical studies conducted to analyse and test the relationship between defence spending and economic growth economic performance of both developed and developing countries. However, the studies have produced different results namely, negative, positive and neutral. The main reasons for these conflicting results are the different methods and different time periods used by different researchers (Dunne et al., 2005). Kinsella (1990) studied and explored the macroeconomic effects of defence spending in the US using time-series data for the period 19391989. Kinsella (1990) indicated that there was no relationship between defence spending and the price level, unemployment rate, or interest rate. He also found that there was no lagged relationship between defence spending and aggregate output. Moreover, Kinsella stated that analysing sub-annual data might attain the causal relationship between defence spending and macroeconomic variables. On the other hand, Baek (1991) extended Kinsellas study by using a structural VAR model. Baek used Kinsellas data and found out that the price level has a considerable impact on defence spending in the post-Second World War period of 19461989 for the USA. Payne and Ross (1992) extended Kinsellas and Baeks works by using quarterly data for the time period 1960:11988:1 for the US. The findings of Payne and Ross paralleled the findings of Kinsella. Using an unrestricted VAR model, Payne and Ross found that there was no relationship between defence spending and economic performance in the case of the US for the time period examined. Atesoglu (2002) used the new macroeconomic theory, proposed by Romer (2000) and Taylor (2000), and cointegration methodology, and investigated the defence spending and aggregate output nexus for the US between 1947:2 and 2000:2. He found that there was a

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positive and statistically significant relationship between defence spending and aggregate output for the US. Halcoglu (2004) adapted Atesoglus (2002) approach and empirically evaluated the relationship between the level of economic growth and defence spending for Turkey for 19502002. She found a positive long-run relationship between aggregate defence spending and aggregate output for Turkey for the sample period. Kollias et al. (2004) analysed the defence spendinggrowth relation for 15 members of the European Union using cointegration and causality tests for the period 19612000. The results of this study did not reveal a uniformity among the sample countries but it showed that growth Granger-caused defence spending. Dakurah et al. (2001) employed the Granger causality test technique to establish a relationship between defence spending and economic growth for 62 developing countries. They found that there existed unidirectional causality for 23 countries from either defence spending to economic growth or vice versa, bidirectional causality for seven countries, no causality for 18 countries, and the data were integrated of different orders for 14 countries. Dritsakis (2004) investigated the relationship between defence spending and economic growth using the Johansen (1988, 1991) cointegration test and vector error correction model for Greece and Turkey for 19602001. He found no cointegrating relationship between defence spending and economic growth. However, he showed that a unidirectional causal relationship existed between defence spending and economic growth for both countries. As the literature review has demonstrated, the relationship between defence spending and various macroeconomic variables has been empirically investigated using different methods and different time periods for different countries. The results of the previous studies found positive, negative and no impact of defence spending on the macroeconomic variables. Thus, there has not been any consensus over the topic among researchers. To the best of the authors knowledge, there have only been a few studies that covered defence spending and more than one macroeconomic variable at the same time for the case of Turkey. Therefore, this study is an attempt to fill this gap by using an unrestricted VAR, IRFs, and Granger causality to empirically investigate the relationship between defence spending as a percentage of GNP, government budget as a percentage of GNP, total deficit as a percentage of GNP, the GNP growth rates, inflation rates, and government budget deficit as a percentage of GNP for Turkey from 1933 to 2004.
g e b [ v r e ]

A BRIEF ANALYSIS OF THE TURKISH ECONOMY After the foundation of the new Turkish state in 1923, Turkey launched new economic policies to overcome its main economic problems, most of which were inherited from the Ottoman Empire. Until 1929, Turkey followed liberal economic policies to strengthen the private sector. However, Turkey was negatively affected by the Great Depression of 1929, and changed its macroeconomic policies. The Turkish economy was then shaped by state-led economic policies until 1980. Throughout the 1960s and 1970s, Turkey followed an import-substitution based economic growth and development policies. During this period, international trade was controlled by the Turkish governments through the implementation of high customs and fixed exchange rate regimes. As a result of these economic policies, during this period, the government played a very important and dominant role in Turkeys overall economic activities. Turkish private sector investment suffered due to a lack of capital stock. Therefore, large-scale investments were made by the Turkish governments. The main purpose of this was to accelerate the formation of capital to boost economic growth. Import substitution economic growth policies were primarily based on importing intermediate goods and raw

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materials in order to use them as inputs in producing the most important final goods that the country needed. However, the terms of trade deteriorated due to the oil crises of 1974 and 1979. These oil crises led the share of intermediate goods imported in total imported goods to rise from 48% in the early part of the 1970s to 78% in the late 1970s. As a result, the balance of trade produced huge deficits. In order to overcome these balance of trade deficits, the Turkish government borrowed short-term credits from international financial institutions, including the International Monetary Fund and the World Bank. This situation further worsened the macroeconomic condition of the country. Moreover, the conditions mentioned above had adverse impacts both on the demand and on the supply sides of the economy. As a result, inflation, unemployment, interest rates, and international trade deficit started increasing. The year 1980 was a benchmark for the Turkish economy. To overcome the macroeconomic problems faced in the 1960s and 1970s, the authorities in Turkey in 1980 made radical changes to macroeconomic policies and changed legislations accordingly. Turkey switched its macroeconomic policies from import-substitution economic growth to an export-led economic growth model on 24 January 1980. The main aims of the macroeconomic policies implemented in 1980 can be summarized as follows: to promote free international trade, to reduce balance of trade deficits through stimulating foreign capital inflows, and to give incentives for domestic and foreign entrepreneurs to make investments to enhance the macroeconomic condition of the country. To achieve the targeted economic polices, the Turkish government reduced customs and taxes, paid trade incentives to export companies, and adopted a flexible exchange rate regime to improve the terms of trade. Moreover, during this new era, the Turkish currency was systematically devalued to increase competitiveness and improve the balance of trade. After implementation of the new macroeconomic policies, the overall macroeconomic conditions started improving. The major macroeconomic variables are descriptively analysed below. The descriptive data analysis of macroeconomic variables indicates that GNP growth rates were hardly influenced by changing macroeconomic policies in Turkey. The average GNP growth rate was approximately 4.2% for the period 19702004. Between 1970 and 1980, which was before the radical change in macroeconomic policies, average the GNP growth rate was 4.07%. Between 1981 and 2004, which was after the change in macroeconomic policies, the average GNP growth rate was 4.29%. The rapid increase in government expenditure caused inflation to rise from an average of 32.7% in the 19701980 period to approximately 55.3% in the 19812004 period. This was most likely due to the expansionary monetary and fiscal policies adopted after the 1980s. Unemployment has always been a series problem for Turkey, even during the rapid economic growth periods. The Turkish economy witnessed an average unemployment rate of 8.2% for the 19702004 period. The unemployment rate was 7.2% for the 19701980 period. During the 19812004 period, the unemployment rate remained almost unaffected at 8.9%. Interest rates were determined and controlled by the government before the 1980s. As a result, interest rates did not fluctuate and remained between 9% and 12%. On the other hand, the interest rates were partially determined by the government and by market forces during the 19812004 period. The complete change of macroeconomic policies, the complete or in some cases gradual and partial removal of barriers on international trade and the rise of private income led imports to increase. Export receipts were high enough to remove the impact of high imports on the current account deficit. As a result, the current account deficit decreased from an average deficit of 2.05% in the 19701980 period to 1.3% in the 19812004 period.

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140,00 120,00 100,00 80,00 60,00 40,00 20,00 0,00 -20,00

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FIGURE 1 Major macroeconomic indicators, 19702004

As illustrated in Figure 1, almost all macroeconomic variables drift in the same direction. During the import substitution economic growth policy period, which covered the years between 1970 and 1980, movements in macroeconomic variables were smooth. Nevertheless in the post-1980 period, expansionary fiscal and monetary policies, the switching of economic policies from import substitution economic growth models to export-led models, and the deterioration of terms of trade, led the major macroeconomic indicators to increase sharply. In particular, inflation, interest rates, and the share of the government budget in GNP showed a sharp increase. Summary statistics for the major macroeconomic variables are also presented in Table I. When the correlation coefficients matrix is examined, it can be clearly seen that there is a positive correlation between defence expenditure as a percentage of GNP and share of government budget in GNP, inflation, government budget deficit as a percentage in GNP, total debt (internal and external debt) as a percentage of GNP, interest rates, and unemployment rates. However, defence expenditure as a percentage of GNP is negatively correlated with GNP growth rates and the current account deficit as a percentage of GNP (see Table II). The result of preliminary data analysis is consistent with our theoretical expectations, which will be discussed in the next section.
Summary Statistics of Selected Macroeconomic Variables Share of Share of Government Current Defence Ex- Government GNP Budget Total Account penditure in Budget in Growth Deficit/ Debt/ Interest Deficit / GNP GNP Inflation rates GNP GNP Rates Unemployment GNP

TABLE I

Mean Median Standard Deviation Variance

19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04
Year Share of Defense Expenditure in GNP Inflation Government Budget Deficit/ GNP Interest Rates Current Account Deficit/GNP Share of Goverment Budget in GNP GNP Growth rates Total Debt/GNP Unemployment

FIGURE 1

Major macroeconomic indicators, 19702004

3.67 3.5 0.70 0.49

23.42 20.9 8.13 66.19

48.25 48.54 26.13 682.97

4.19 4.90 4.71 22.23

4.73 3.9 4.43 19.68

61.55 63.4 28.58

46.32 46.7 29.98

8.14 8 1.18 1.41

1.54 1.48 2.05 4.20

817.22 898.94

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TABLE II Correlation Matrix of Selected Macroeconomic Variables

Share of Defence Expenditure in GNP Share of Government Budget in GNP Interest Rates

Government GNP Growth Budget Deficit/ Total Debt/ Inflation rates GNP GNP

Unemployment

Current Account Deficit/GNP

DEFENCE AND THE MACROECONOMY

Share of Defence Expenditure in GNP Share of Government Budget in GNP Inflation GNP Growth rates Government Budget Deficit/GNP Total Debt/GNP Interest Rates Unemployment Current Account Deficit/GNP 1 0.1308 0.281 0.8979 0.7117 0.1951 0.3621 0.042 1 0.4 0.285 0.251 0.776 0.067 0.303 1 0.259 0.123 0.103 0.102 0.385 1 0.7928 0.3911 0.3914 0.0495 1 0.5212 0.3347 0.171

1 0.885 0.046 0.132 0.727 0.474 0.04 0.258 0.26

1 0.03 0.3954

1 0.215

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DATA AND EMPIRICAL MODEL Data The study uses annual time series data for the period 19702004. The data sources and the variables are outlined and described below. SDGNP: Defence expenditure as a percentage of GNP, obtained from the Stockholm International Peace Research Institute Yearbooks (SIPRI). SGBGNP: Share of government budget as a percentage of GNP, taken from the Turkish Statistics Organization (TSO). TDGNP: Total deficit as a percentage of GNP, obtained from the TSO. GNPGR: Annual growth rate of GNP, gathered from the TSO. INF: Inflation series collected from the TSO. GBDGNP: Share of government budget deficit as a percentage of GNP, taken from the TSO.
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The procedure starts with the test of determining the order of integration of each of the series covered in this study employing the Augmented DickeyFuller (ADF) (Dickey and Fuller, 1979) unit root test. The unit root test is crucial in determining the existence of stationarity of time-series data, because if the stationarity of the time-series is violated, this could lead to a spurious regression (Granger and Newbold, 1974) and thus the estimated regressors could be invalid for interpretations. In general, a non-stationary time series is said to be integrated of order d, if it becomes stationary after differencing d times, and it is denoted as I(d). The following ADF unit root test is performed to determine the order of integration for each of the series. Xt = 1 Xt 1 +

X
i i =1

t i

+ t

(1)

In the equation, is the first difference operator, Xt is the variable to be tested for unit root in time t, is the stationary random error, t is time, and n is the lag length. The null hypothesis of the existence of a unit root, in variable Xt, H0 :1 =0 is tested against the alternative hypothesis of the non-existence of a unit root, Ha :1 <0. The optimal lag length is determined the by Schwarz information criterion (SC). The unit root test results are presented in Table III. The results for ADF unit root tests for the levels and the first differences of all variables are illustrated in Table III. The null hypothesis of the existence of a unit root, in variable Xt, H0 :1 = 0 is being tested against the alternative hypothesis of the non-existence of the unit root, Ha :1 < 0. The null hypothesis of stationarity is rejected at the 5% level of significance for all variables. On the other hand, first differenced series, which were stationary at their levels,
TABLE III Variable SDGNP SGBGNP TDGNP GNPGR INF GBDGNP The Results of ADF Tests for Stationarity Level 0.51(0) 0.47(0) 1.02(0) 1.80(0) 2.13(0) 0.90(0) First difference 8.25(2)* 9.78(2)* 7.39(2)* 8.82(2)* 8.53(2)* 8.75(2)

Note: (*) indicates significance at 1% level. The values in parentheses are the lags. Asymptotic critical values reference: Davidson and MacKinnon (1993) 3.96, 3.41, 3.13 for 1%, 5%, 10% significant levels respectively.

DEFENCE AND THE MACROECONOMY TABLE IV Trace Test H0 r=0 r1 r2 r3 r4 r5 Ha r=1 r=2 r=3 r=4 r=5 r=6 TS 24.74 17.91 13.57 8.78 2.82 0.07 CV (5%) 83.93 60.06 40.17 24.27 12.32 4.12 Prob.** 0.40 0.55 0.63 0.73 0.85 0.82 H0 r=0 r1 r2 r3 r4 r5 Ha r>1 r>2 r>3 r>4 r>5 r>6 Johansen Tests for the Rank of Cointegration Maximal Eigenvalue Test MES 24.74 17.91 13.57 8.78 2.82 0.07 CV (5%) 36.63 30.43 24.15 17.79 11.22 4.12

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Prob.** 0.58 0.70 0.64 0.61 0.81 0.82

Note: r is the number of cointegrating vectors. Trace test indicates no cointegration at the 0.05 level. ** denotes MacKinnon-HaugMichelis (1999) p-values. t-statistics are in parentheses. TS: Trace statistic; MES: Maximal eigenvalue statistic; CV: Critical value.

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were found to be non-stationary. These results indicate that all the series included in this study are integrated in the first order. Estimation of VAR models with differenced data may be misleading if the cointegrating relations among the variables are disregarded (Engle and Granger, 1987). As a result, before the estimation of the proposed VAR model, cointegration among the variables needs to be checked. For this reason, Johansens (1988) cointegration tests were conducted. The results indicate no cointegration between any of the series at the 5% significance level (see Table IV). Since the series are integrated of order one and there is no cointegrating relationship among them, an appropriate vector autoregressive (VAR) model can be developed to be estimated. This study makes use of a six-equation VAR model to test and analyse the relationship between defence spending, government budget, total deficits, gross national product, inflation, and government budget deficits for Turkey between 1933 and 2004. Empirical Model The unrestricted VAR model can be described in the matrix form as follows:
X a Xt - g  X  a  X t - g X = a + X g ! ! !t - ! M M M M Xn a n Xnt - g n

g ! g " g ! g " g !! g !" g n! g n "

g n e t g n e t g !n + e !t M M g nn e nt

where 1,t are mutually independent error terms. The X variables are fixed and integrated of same order, I(1). The estimable form of the VAR system includes six equations. They are defined in a matrix form as follows:
SDGNP a SDGNP - g  t t SGBGNPt a  SGBGNPt - g TDGNP a ! TDGNP - g ! t t = + GNPGRt a " GNPGRt - g " INF a INF g t t - # # GBDGNP a $ GBDGNP - g $ t t

g ! g " g # g $ g % g & g ' g  g !g " g !! g !" g "! g "" g #! g #" g $! g $"

e t g # g $ g % g & g ' g  e t g !# g !$ g !% g !& g !' g ! e !t + g "# g "$ g "% g "& g "' g " e " t g ## g #$ g #% g #& g #' g # e #t g $# g $$ g $% g $& g $' g $ e $ t

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The equations defined in the above matrix represent a standard VAR model. The VAR model is used to derive impulse response functions. Impulse response functions show the predictable response of each variable in the system to a shock to one of the variables included in the system.

Diagnostic Tests on Residuals Before going further, diagnostic tests should be conducted to ensure that the model is free from problems and is estimable. Results of diagnostic tests indicate that the model does not have problems of serial correlation and heteroscedasticity (see Table V). Although residual test results confirm that the normality assumption is violated mainly due to the kurtosis problem, Gonzalo (1994) suggests that violation of normality in a VAR model is not a crucial problem. The inverse roots graph proves the stability of the system (see Figure 2). Therefore, the system is free from problems and can be used to draw conclusions.
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TABLE V Hypothesis

Diagnostic Tests Results Test statistics (p values) LM Stat Chi. Sq Jarque-Bera Jarque-Bera 31.55 (0.68) 524.82 (0.25) 2.024 (0.36) 4.95 (0.084)

H0: No Var Residual Serial Correlation H0: No Var Residual Heteroscedasticity H0: Residuals are Multivariate Normal [Cholesky-(Lutkepohl)] H0: Residuals are Multivariate Normal (Urzua)

Pairwise Granger Causality results are shown in Table VI. The results indicate that there is no Granger causality either from SDGNP to SGBGNP, TDGNP, INF, and GBDGNP, or from SGBGNP, TDGNP, INF, and GBDGNP to SDGNP. However, there is a unidirectional Granger causality between SDGNP and GNPGR but not vice versa. These findings are in line with the results of Kinsella (1990), Atesoglu (2002), Dakurah et al. (2001), and Dritsakis (2004) studies. On the other hand, the results of this study contradicts the findings of Baek (1991), Payne and Ross (1992), and Halcoglu (2004). In impulse response analysis, the ordering of the variables is important to analyse the effect of the shocks. The residual correlation matrix (see Table VII) suggests the correct ordering based on the magnitude of the correlation matrix; however, low correlation in our estimation results indicate that the different ordering of the variable would not produce significantly different results. The share of defence expenditures as a percentage of GNP continuously decreases for about ten periods as a result of a shock to SDGNP. SDGNP initially decreases for about two and a quarter periods as a response to a shock to the share of the government budget as a percentage of GNP. The response of SDGNP to a shock to total deficit as a percentage of GNP is ignorable for about two and a quarter periods. However, this impact becomes negative thereafter. SDGNP increases for about four periods, then decreases for about two periods and then reaches its equilibrium due to a shock to GNPGR. A shock to INF has no impact on SDGNP for three and a quarter periods; thereafter, a negative impact is present. SDGNP remains constant for two periods as a result of a shock to the government budget deficit as a percentage of GNP and then becomes negative for about three periods; after the fifth period this effect dies out.
FIGURE 2 Impulse Response Functions g] [e b e v r

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Response to Cholesky One S.D. Innovations 2 S.E.

Response of SDGNP to SDGNP
1.2 0.8 0.4 0.0 0.4 0.8 1.2 0.8 0.4 0.0 0.4 0.8

Response of SDGNP to SGBGNP

10

10

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Response of SDGNP to TDGNP

1.2 0.8 0.4 0.0 0.4 0.8 1.2 0.8 0.4 0.0 0.4 0.8

Response of SDGNP to GNPGR

10

10

Response of SDGNP to INF

1.2 0.8 0.4 0.0 0.4 0.8 1.2 0.8 0.4 0.0 0.4 0.8

Response of SDGNP to GBDGNP

10

10

FIGURE 2

Impulse Response Functions

206 TABLE VI Pairwise Granger Causality Tests

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Sample: 19332004 Lags: 2 Null Hypothesis: SGBGNP does not Granger Cause SDGNP SDGNP does not Granger Cause SGBGNP TDGNP does not Granger Cause SDGNP SDGNP does not Granger Cause TDGNP GNPGR does not Granger Cause SDGNP SDGNP does not Granger Cause GNPGR INF does not Granger Cause SDGNP SDGNP does not Granger Cause INF GBDGNP does not Granger Cause SDGNP SDGNP does not Granger Cause GBDGNP TDGNP does not Granger Cause SGBGNP SGBGNP does not Granger Cause TDGNP GNPGR does not Granger Cause SGBGNP SGBGNP does not Granger Cause GNPGR INF does not Granger Cause SGBGNP SGBGNP does not Granger Cause INF GBDGNP does not Granger Cause SGBGNP SGBGNP does not Granger Cause GBDGNP GNPGR does not Granger Cause TDGNP TDGNP does not Granger Cause GNPGR INF does not Granger Cause TDGNP TDGNP does not Granger Cause INF GBDGNP does not Granger Cause TDGNP TDGNP does not Granger Cause GBDGNP INF does not Granger Cause GNPGR GNPGR does not Granger Cause INF GBDGNP does not Granger Cause GNPGR GNPGR does not Granger Cause GBDGNP GBDGNP does not Granger Cause INF INF does not Granger Cause GBDGNP Obs 72 70 72 72 72 70 72 72 72 70 70 70 72 72 72 F-Statistic 0.38372 2.10387 0.08543 0.91644 0.61715 9.72951 0.37124 2.17584 0.09131 0.16351 0.10203 2.47827 1.48931 0.89791 1.26410 4.20732 1.56567 2.13394 0.38380 0.05355 3.20617 3.06582 3.84807 4.07816 3.45114 0.53516 0.45132 0.16294 0.39905 4.03937 Probability 0.68281 0.12997 0.91822 0.40504 0.54252 0.00020 0.69129 0.12147 0.91285 0.84949 0.90315 0.09178 0.23290 0.41227 0.28914 0.01900 0.21650 0.12635 0.68280 0.94790 0.04700 0.05341 0.02634 0.02145 0.03745 0.58806 0.63871 0.84998 0.67254 0.02206

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TABLE VII

Residual Correlation Matrix SDGNP SGBGNP 0.353422 1.000000 0.419157 0.339429 0.124186 0.708427 TDGNP 0.130031 0.419157 1.000000 0.423422 0.263503 0.253333 GNPGR 0.007971 0.339429 0.423422 1.000000 0.359672 0.352892 INF 0.008328 0.124186 0.263503 0.359672 1.000000 0.208615 GBDGNP 0.318264 0.708427 0.253333 0.352892 0.208615 1.000000

SDGNP SGBGNP TDGNP GNPGR INF GBDGNP

1.000000 0.353422 0.130031 0.007971 0.008328 0.318264

DEFENCE AND THE MACROECONOMY

207

CONCLUSIONS This study used a six-variate VAR model and examined the relationship between share of defence spending in GNP, share of government budget in GNP, total deficit in GNP, GNP growth rate, inflation and government budget deficit in GNP for Turkey from 1933 to 1924. IRF results are derived from the VAR model and examined. The results indicated that there is a unidirectional Granger causality between SDGNP and GNPGR and not vice versa. However, there is no causal relationship between SDGNP and all the other series included in this study. Moreover, IRF results show that a shock to GNP has no impact on SDGNP for about two periods, it increases SDGNP for about two periods and then reaches equilibrium after the sixth period. SDGDP decreases for about two periods as a result of a shock to SDGNP and then gradually increases until the eighth period and eventually returns to equilibrium. SDGNP remains constant for two periods, decreases for two and a half periods, increases for four periods and comes to the equilibrium due to a shock to TDGNP. The response of SDGNP to a shock to INF is unnoticeable for about three and a quarter periods, decreases for one and a half periods and then increases and returns to equilibrium. Furthermore, a shock to GBDGNP has no impact on SDGNP for about two and a quarter periods; it negatively affects SDGNP for about one and a half periods and then reaches equilibrium at about the fifth period. The major conclusions to be derived from this study are that defence expenditure Grangercauses economic growth and a shock to GNPGR leads SDGNP to increase. References
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