What Explains Our Slow Economic Growth ? Causality Analysis between Economic Growth and Defense Spending in Pakistan

Pakistan is faced with budget deficits, high unemployment and slow growth. This study provides a link between defense spending, debt servicing, development expenditures and economic growth for Pakistan. We examine whether there is a causality between defense expenditures and debt servicing on the one hand and economic growth on the other during the period 19882011, using Toda Yamamoto-Modified Standard Granger Causality technique. The unidirectional causality found between economic growth-defense spending and debt servicing economic growth while bidirectional causality is found between development expenditure-economic growth and between current expenditure-economic growth. Research suggested to be selfsufficient in domestic defense industry which leads to curtail in import budget and it will create employment resources and funds will available for developing programs.

proportion of financial resources of these countries.However, spending on defense may have other geopolitical considerations.When a hungry and poor country has to choose between bread and butter or gun which one should it opt for?The former is required for filling up the belly, but the latter is required for survival.If the country opts to allocate more resources to defense, it will have less resources available for civilian consumption.However, it may be argued, that unless you are protected, how can you enjoy the civilian goods and services?For example, if the law and order is bad, can high economic growth become a reality?
The military expenditure is an extremely important part of any country.It shows how much a country feels vulnerable to the outside world.There has an upward trend in the defense expenditure, especially after the World War II and the significant change in the geopolitical scenario.Over the last fifteen years, It is highly observed declining trend followed by development expenditure because of huge defense expenditure in comparison with health, education and other developing expenditure , defense spending stands with higher percentage.In Pakistan , on average GDP growth consists of 5.06 percent, inflation 8.80 percent and saving 15.11 percent.(Economic Survey of Pakistan, 2012Pakistan, , 2013)).Furthermore, defense spending for fiscal year 2014-15 was 11.6 percent and now in fiscal year 2016, it is announced 11 percent. .Although the behaviour of increasing defense expenditure around the world can be tackled by argument of internal and external security, threats and fighting terrorism, the way arms related spending is rising is suspicious .World's Defense spending in 2007 was $1339 billions which is 2.5 percent of the world's GDP (SIPRI, 2008).During 1998 to 2007, defense spending increased by 45 percent in real term because of the second world war and after 9/11 terrorist attack in USA (Agostino and Dunne and Pieroni, 2010).
According to UNDP, Pakistan ranked 145 out of 187 countries in terms of human development index (HDI).Furthermore , multidimensional poverty index (MPI) explored numerous deprivations in education, health and living standard.The UNDP (2011) indicated in a report approximately 50 percent Pakistanis are suffering from multiple deprivations and 11 percent vulnerable to multiple deprivations (Kalim and Hassan).
When there is a very low literacy rate, unavailability of basic necessities, and declining medical facilities, then on average 4.88 percent on defense which is almost 10 times larger as compared to education expenditure and health sectors, which is truly a luxury that costs Pakistan substantially.
The direction of causation between economic growth and defense spending is not predicted theoretically.However, there are two opposing views.First the Keynesian-type argument that changes in aggregate demand brings fluctuations in the level of income, output and employment.Aggregate demand created by increase in defense spending leads to increase in the development of the infrastructure and creates more employment opportunities.There is, therefore, a positive relationship between economic growth and defense spending.The way defense spending leads to higher economic growth (Keynesian notation) is shown in Figure 1.1.Figure 1.2 shows the spin-off effect while Figure 1.3 shows inflation and consumption effects.The second view argues that creation of employment through defense spending is very small because most of LDCs expenditure on defense consists of buying weapons from abroad.The areas of research on defense spending and economic growth can be divided into three parts: 1.
The relationship between defense spending and economic growth.

2.
Causality between defense spending and economic growth.

3.
Political stability/instability's link with defense spending and economic growth The present study deals with causality between defense spending, debt servicing and development expenditures and economic growth in the case of Pakistan.Section 2 reviews the existing literature; Section 3 gives a brief overview of Pakistan's economy with emphasis on defense, development and debt servicing expenditures.Section 4 analyses the data and methodology, while conclusions and policy implications are presented in Section 5.

Literature Review
Al-Jarrah (2005), using the Johansen's cointegration procedure, Standard Granger Causality and VECM reports the presence of cointegration between economic growth and defense spending in the Saudi Arabian economy for the period of 1970-2003, bidirectional causality with real GDP and unidirectional causality with non-oil real GDP.AL-JARRAH recommended reduction in defense expenditure for making more financial resources for education, health and other essential economic and social activities.Indonesia, Thailand and Singapore and bidirectional causality for the panel of five Asian countries.However, there is feedback between defense spending and economic growth in the Philippines at the individual and panel level.Moreover, neither defense spending nor economic growth can be considered as exogenously determined.Furthermore, the long run relationship between economic growth and defense spending exists at the individual level and for the panel.
Dimitraki and Liu ( 2011) for China for the period of 1950-2011used the augmented Dickey-Fuller test, the Breusch-Pagan test, Engle ARCH test and the Breusch-Godfrey LM test.
Empirical results suggested military spending has an overall net positive influence on economic growth.Moreover, the magnitude of the positive impact tends to increase over time.Furthermore, China's military spending is via the Keynesian effect (expansion of aggregate demand) leading to government capital allocation in such a way that enhances employment and profits in the Chinese economy, which in turn leads to increase in investment which has an overall positive impact on economic growth.and granger causality techniques on the variable, namely, defense spending, development expenditure, CPI, GDP and income.Results found long run relationship and bidirectional causality among the variables.Furthermore, long run economic growth is not hurt by defense spending.However, defense expenditure does not significantly explain GDP and inflation dynamics in the short run.Furthermore, long run and short run causality suggested Military Keynesian Hypothesis (MKH) does not hold over the period of the study.
Pradhan's (2010) case study of four Asian countries, namely, Pakistan, India, Nepal and China over the period of 1988-2007 at the individual country level and panel for four Asian nations.The study uses integration and co-integration techniques and Granger causality test.He finds cointegratin between defense spending for the four Asian countries.In the cointegration framework there is a long run relationship between defense spending and economic growth at the individual level and for the panel for the four Asian nations, implying that defense spending of a country can affect the defense spending of other countries.Moreover, there is a bidirectional causality between China and India; unidirectional causality from defense spending to economic growth in China and Nepal, unidirectional causality from economic growth to public debt in Pakistan and unidirectional causality from public debt to defense spending in India.There is short run bidirectional causality between public debt and economic growth at the panel level for the four Asian countries.
Shenggen Fan and Saurkar (2003)  Zaman, Shah, M. Khan, Ahmad, 2012 found external debt is negatively related to economic growth whereas it has a statistically significant positive relationship to military expenditure in the short run.SAARC external debt in the short and longrun have a significant positive relationship to military expenditure.The relationship is elastic in the long-run, but inelastic in the short-run.
Shahbaz, Afza a & Shabbir; 2012 ,corroborated with the view by Abu-Bader and Abu-Qarm (2003) who found that a rise in government non-military spending will stimulate the pace of economic growth and in turn, the government allocates more resources to productive and efficient ventures to sustain the rate of economic growth.The study explored that defense expenditure financed by borrowing and budget deficit will lead to increase in interest rates causing inflation and makes the government non-military spending less efficient and expensive.
Kalim and Hassan, the study revealed military expenditure exerts positive and significant impact on poverty.For example, one unit increase in defense expenditure leads to increase in poverty by 0.44.The inherent justification may be that the defence expenditure in Pakistan may be done at the expense of development expenditure and thus may have a negative impact on economic growth in Pakistan as the studies by Smith (1980) and Dunne (1996) have found a negative relationship between defense spending and economic growth for the case of developing countries.It is evident from the results that poverty lagged by one year accentuates poverty in the current year.It is quite possible that because defense expenditure on social development is hampered, poverty accelerates.
Haseeb, Bakar, Azam, Hassan & Hariyatie, (2014) elaborated that economic growth and the defense expenditure are negatively related, and savings have a positive impact on economic growth.Therefore, one (1) percent increase in defense expenditure causes a 0.57 percent decrease in economic growth and one percent increase in saving causes 0.73 percent increase in economic growth.The Study suggested defense expenditure must be financed by borrowing and increasing the money supply, and at the same time reducing other social and public expenditures.This scenario is the cause of the inflation eroding the savings real worth and eventually leading to a decrease in it, investments are also affected and in turn they further affect economic growth.Tekeoglu (2008) suggested military regimes most dominate with less open trade or in some cases closed economy and tighter controls over markets, whereas democratic governments highlighted with free market features and open trade policies.(Heo, 1998).Spending on defense budget could change as it depends on the country's regime and consequently affecting efficiency and effectiveness.Moreover, Heo (1998) was not able to find any valid and systematic pattern in the relationship between regime type and the economic effects of defense spending on growth.
On the contrary , Na Hou (2009) stated that India's higher and increasing military spending is the cause of Pakistan higher spending on arms and it shows the existence of rivalry and arms race between the two countries.
Agostino , Dunne and Pieroni, 2010, explained the state is mature enough to create an equilibrium between the opportunity cost and security benefits or military spending in order to achieve national interests which achieve the optimal social welfare.
On the opposite side, Keynesian states that the state, in order to improve macroeconomic stability in the economy, uses military spending which increases output, via multiplier effect.It leads to more R&D, increased capacity utilization.However, it has failed to consider the supply side factors.

Pakistan's Defense Budget
In fiscal budget 2012-13, the Government of Pakistan allocated additional Rs.50 billion for the defense budget.According to official defense budget documents for fiscal year 2012-13, about 10% or nearly Rs.545 billion (about $5.82) compared with Rs.495 billion in 2011-12 was allocated for defense.Furthermore, actual defense spending for fiscal year 2011-12 was Rs.509.32 billion (about $5.45 billion) or Rs.14.32 billion more than the allocation for 2011-12.The main cause of Pakistan's defense budget deficit is the reduction in US defense aid.Table 1 & Figure 2.1 shows defense expenditure by South Asian countries as a percentage of their GDP during 1988-2010.
Pakistan's economy has passed through many critical challenges such as the sharp rise in food and oil prices combined with natural disasters in 2010 and 2011.Governance and security issues pose the most serious challenges to achieving decent growth rates and investment to GDP which was the lowest for 37 years.In 2011-12, Pakistan's economy grew by 3.7 percent against the targeted growth rate of 4.2 percent.The country faces high public debt and the rate of inflation was double-digit for the last five years.Pakistan's defense and debt servicing expenditures have declined during the last two decades.Debt serving consumed about 39.9 percent of total revenues.During the last fiscal year the country's public debt stood at Rs.856 billion, while debt servicing stood at Rs.1, 024 billion out of which Rs 821 billion was on account of domestic debt servicing.During the Musharraf era, Pakistan's total public debts increased from Rs 3,200 billion to Rs 6,700 billion."The present government has pushed the tally to Rs 12,800 billion.Figure 2.3 shows the trend in debt servicing on external debt as a percent of GDP due to which new development projects could not be initiated .On the one hand, these countries are still facing serious problems such as poverty, unemployment, poor infrastructure and health and illiteracy.But they are spending a large percentage of their GDPs on nonproductive activities.These might be crowding out growth as necessary expenditures and building physical and social infrastructure which can stimulate economic growth are not being made due to the nonavailability of resources.root problem exists against the alternative hypothesis that there is no unit root problem.Standard and Granger causality cannot be used in the presence of co-integration between two variables which has been modified by Toda and Yamamoto.Using this procedure, we can find the causality between integrated variables based on asymptotic theory.One advantage of Toda Yamamoto method is that we need not test for co-integration; the pretest bias can therefore be avoided.
To study the direction of causality between defense spending and GDP growth, we adopted today-Yamamoto version of the Granger causality test.
Other variables for which causality needs to be tested are Total Debt Servicing

Conclusion and Policy Implications
The current research used annual data for Pakistan, we examined the direction of causality between economic growth and expenditure based on Toda Yamamoto (1995).On the basis of empirical results, we conclude that in the case of Pakistan there is a unidirectional causality between GDP and DS.Furthermore, there is a bidirectional causality between development expenditure (DE) and economic growth (GDP), bidirectional causality between the log of current expenditure (CE) and economic growth (GDP).While economic growth (GDP) causes total debt servicing (TDS) but debt servicing does not cause GDP.defense expenditure was funded by taking a route to higher and deepening budget deficit.It is observed, after 9/11, high defense spending is badly needed in the state of Pakistan.However, due to high external debt and slow economic growth, there are hugge obstacles for the defense budget.To maintain a strong armed force in order to control terrorism within a border and across borders.The Massive defense budget is not only due to 9/11, it was inherited in Pakistan's budget since establishment and was strongly recommended after Dhaka's partition.Other research studies discussed the existence of long run negative relationship between defense spending and economic growth in 1972-2009.The study referred to defense expenditure as the real opportunity cost and the country faces a tradeoff between defense spending and the public expenditures.Some argue that high military expenditure is a problem for a country with low income.(Khan ,2004).Pradhan(2010) found the relationship between long run relationship is not only in the case of Pakistan, but exists for all four Asian countries, namely: China, India, Nepal and Pakistan.This is an indication of the causality between spending and economic growth.Moreover, this also points that changes in the defense spending of a country can cause the defense spending of another country.
Empirical finding highly suggested for policy recommendation, Pakistan badly needed to be self-sufficient in domestic defense industry, which can lead to curtail in defense budget, it will create employment resources and funds will be available for developing programs.Although ,because of political and regional instability bound this region to pick guns not butter from guns verses butter dilemma.Although scarcity and inefficiency in productive sectors indicated to choose butter instead of guns.Internal and external terrorism are not allowed to curtail in defense budget, specially in the current situation where India is trying to create another big dispute against Pakistan.Mirza, Jaspal and Malik (2015) suggested Pakistan's defense indusrty needs to be self-sufficient with long-run sustainability by providing essential military equipment to armed force, through this import expenditure will reduce and it can provide support to overall military spending.Furthermore, another policy which needs to be done is to achieve efficiency level or increase efficiency in all economic sectors, by this Pakistan will be able to get rid of IMF's fund, which is the root cause of less developing expenditure.Künü, Hopoğlu and (2016), an empirical finding suggested increase in spending on public sectors and development of domestic defense industry in a way like Iran, Israel and Turkey.This research only checked the direct effects of defense spending on economic growth.It ignored possible indirect effects, such as employment, investment, law and order and political aspects of defense spending.Economic growth can limit the growth of public debt burden and expenses and avoid future debt traps and stronger taxation mechanism.

Figure 1 . 1 :Figure 2 . 1 :Figure 3 . 1 :
Figure 1.1 : Growth in the economy through higher defense spending (Keynesian notation) 2017), Journal of Economics Studies and Research, DOI: 10.5171/2017.280356Hasan (2004) tried to use defense expenditure as a macroeconomic stabilization tool in the case of Pakistan for the period of 1951-2003.The annual time series data analyzed using Johansen's cointegration 2017), Journal of Economics Studies and Research, DOI: 10.5171/2017.280356 2017), Journal of Economics Studies and Research, DOI: 10.5171/2017.280356 2017), Journal of Economics Studies and Research, DOI: 10.5171/2017.280356

Figure 2 . 3 :
Figure 2.3: Debt Servicing on Total External Debt (TDS), current US$ by South Asian Countries as Percentage of Gross Domestic Product (constant 2000 US$) 1990-2011

Source:
Pakistan Economic Survey 2011-12 Data and Methodology Data are taken from various issues of the Pakistan Economic Survey, except the data on GDP which are from World Development Indicators (WDI) (in constant $ 2000 US) for the period 1981-82 to 2010-11.Most of the studies used Granger causality test to determine causality between defense expenditure and growth.This paper uses modified Granger Toda and Yamamoto (1995) test for long run causality.Toda and Yamamoto makes Granger causality test easier because it does not need to test for cointegration or transform VAR into ECM (error correction model) and Toda and Yamamoto procedure avoids Granger causality testing problem with respect to size and power of unit root and co-integration test.By using the methodology, we will try to explore the impact of defense expenditure (DS), development expenditure (DE), and total debt spending (TDS) on GDP growth.

Table 1 :
Defense Expenditure by South Asian Countries as Percentage of GDP 1988-2010 Source: SIPRI

Table 3
presents the result of unit root test.The Tableindicatesthat for all the variables we can not reject the null hypothesis i.e. unit root problem exists in the level form.But by first differencing the variables, the null hypothesis is rejected at the 1%, 5% and 10% significant levels revealing that the unit root problem does not exist.

Table 3 :
Unit root test