THE LONG-RUN RELATIONSHIP BETWEEN DEFENCE EXPENDITURES AND GDP IN TAIWAN

Using the Solow-Swan growth model and the time-trend included in the aggregate production function, this study applies the multivariate cointegration approach to re-investigate the long-run and causal relationships between defence expenditures and GDP while controlling for capital and labour input in Taiwan during the 1955-2002 period. It examines the long-run causal relationship using the weak exogeneity test and utilizes general impulse response functions to determine whether a shock to defence expenditures affects economic growth or vice versa. Our findings provide substantive evidence in favour of the existence of a long-run equilibrium cointegrated relationship between defence expenditures, GDP, labour and capital stock. The results of the weak exogeneity test indicate that a bi-directional causal relationship exists in the long-run between defence expenditures and GDP. Thus, the main policy implication that emerges from the long-run results is that increasing defence expenditures in Taiwan is an effective means to boost overall economic performance and, with this improved economy, it should then be able to increase its defence expenditures further. Lastly, from our dynamic vector error correction model estimations, it is found that defence expenditures are a major means of adjusting for disequilibria that occur within the system.