The Color of Money: Defense Resource Allocation and Social Spending Trade-Offs in NATO Countries_Brent M Eastwood

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“The Color of Money:” Defense Resource Allocation and Social

Spending Tradeoffs in NATO Countries, 1980-2003

By Brent M. Eastwood, PhD (2004)

Abstract

This study revitalizes the “Guns and Butter” debate by introducing the

defense acquisition theory “Color of Money.” Three dimensions of

defense expenditures are introduced: Procurement, Research and

Development, and Personnel. Parochialism and regulation over these

three “pots of money” help explain why tradeoffs, which include cutting

defense expenditures and then increasing spending on other social

programs, are so rare. The study also examines the reticence of some

NATO countries to invest in defense. The “free-rider” concept explains

why countries refrain in investing individually in a public good that is

beneficial to other countries. Expenditure patterns are examined in a

logistical regression analysis with all NATO countries from 1980-present.

Comparative analysis controls for political, economic, and foreign policy

factors. Cases showing evidence of trade-offs are selected for further

qualitative study.

Introduction

The dawn of the 21st century has brought enormous challenges to international

security. The global war on terror has incredible costs which would seem to force

governments in NATO countries to closely scrutinize their spending on defense. At the

same time, these countries have pressing needs for social welfare spending, especially as

their populations grow in age. There are greater demands for increased spending on old

age pensions, health care, and unemployment compensation. The existence of tradeoffs

between defense and social spending would then seem intuitively appealing.

However, the main scholarly research concerning comparative governmental

spending on defense and domestic spending is mainly in agreement: there is little trade-

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off between “guns and butter.” The current budget in the United States, with its large

expenditures on defense and homeland security, while at the same time funding a long

list of domestic programs, brings this topic to light. European NATO members feel the

crunch as well. The United Kingdom faces costs from the Iraq invasion. Germany and

France must confront a military that needs transformation to become more mobile and

self-sustaining for missions outside of Europe. Members such as Poland and Turkey find

different viability in the alliance, but it is not clear what effect this has on the trade-offs

of domestic spending. With this background in mind, a new study is in order which

focuses on the “guns and butter” trade-off in NATO countries. This comparative analysis

would be timely and of vital interest to policy-makers and analysts.

The following schools of research on this debate have emerged: Reagan-

Thatcher, US domestic, incrementalism, comparative budgetary theory, and comparative

defense. Research on domestic and defense spending reached heightened interest in the

80’s after the “Reagonomics” budgets. Domke, Eichenberg, and Kelleher (1983)

hypothesized conditions ripe for trade-offs but found no significant patterns of trade-offs

in domestic and military spending. Other factors appear to have been driven “by separate

sets of determinants” (Eichenberg et al. 1983, p. 33). Mintz and Huang (1991) looked for

more indirect trade-offs between higher defense spending which they believed would

crowd out economic growth and welfare spending. The authors’ hypothesized that

military spending would have a negative impact on economic growth and would thus

negatively affect education spending. Mintz and Huang also found no short-term effects

on trade-offs, but they did find some significant linkage to the possibility of long-term

trade-offs. Russett (1982) was also unable to find “regular trade-offs in the data from the

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US Office of the Management of the Budget records for the “last four decades of

American history” (Russett, 1982, p. 775). Russett used OLS regression analysis to

estimate the change in level of Education (DV) and change in military spending

controlling for health, housing, productivity, capacity, GNP, taxes, population under 18,

battle deaths, and Republicans. Even though it could be argued education spending

comes primarily at local levels, it was a robust list of independent variables. But the

analysis yielded no clear-cut patterns.

Most of this literature originates from the US, is narrow in focus, and is relegated

to the cold war. Murray and Viotti’s (1982) comprehensive work is also forged under the

bitter peace of the cold war, but it offers some interesting conclusions. The authors claim

structuralism to be the biggest constraint on policy makers concerning defense spending.

The bipolar cold war structure drove spending decisions and individual actors made

decisions based on these threats and perceptions. Murray and Viotti admit that the rules

and norms of a regime within a security alliance, such as NATO, have more “certainty”

and therefore less a need for arms expenditures.

Wildavsky (1975) attempts a comparative look at budgetary theory and finds

institutional differences can be attributed to differences in budgetary processes. The US

has separation of powers and a strong presidency. The UK has a strong cabinet, but its

members of the House of Commons have little control over spending. Agencies in Japan

must appeal to the Ministry of Finance and to the Liberal Democrats. They also negotiate

in a curious process with an extra-parliamentary party. France has a hybrid President and

Prime Minister system in which, according to Wildavsky, is able to better close off the

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budgetary process to outside pressures. But despite these institutional differences,

Wildavsky still concludes that the budgetary process is based on incrementalism.

Although many schools of thought on the guns and butter debate are evident, I

argue that two underlying theories have been neglected in this literature: the “color of

money” argument, which is a favorite of experts in the field of defense acquisitions (Tack

2000) and the “free rider” concept, which is a tenet of microeconomics. The “color of

money” notion refers to ownership of the total cost of defense spending. Defense

departments or ministries have different “pots” of money which are controlled by

different sectors, for example; procurement, research and development, personnel, or

maintenance and operations (Tack 2000). Since each sector has different accounting

rules and parochial interests which “guard” the pot, it becomes extremely difficult to

chart savings or spending across the whole department. Further, not all these “pots” are

adequately filled to perform the mission of preparing for war in order to keep the peace.

These and other oversight constraints make it difficult to shift funds from one “pot” to

another, which in turn make it more difficult to transfer “saved” funds to increases in

social spending. In other words, institutional constraints (under this construct) make the

guns and butter tradeoff more rare.

Mintz (1988) recognized the problems of the “color of money” concept in his

work on resource allocation and the US Department of Defense. He also divided total

defense spending into procurement, R&D, personnel, and maintenance. Mintz (1988)

used each dimension as a separate dependent variable and compared them to economic,

political, and foreign policy “shocks.” He found that certain domestic pressures such as

elections, public opinion, and party control of the White House had strong influence over

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spending changes in military personnel and procurement. The presence of war had the

strongest influence. Although Mintz’s work was groundbreaking in the “color of money”

aspect, it still did not address social spending tradeoffs.

Free-riding has to do with getting a good or service without paying for it. In the

case of NATO, member countries have no incentive for increasing defense spending

individually, especially in areas like procurement or research and development, if they

feel it will benefit other countries (Vlachos-Denglar 2002). Free-riding can help explain

the large difference in defense spending between the United States and NATO countries

(Russett 1970). It also helps explain some NATO countries’ reluctance to conduct

peacekeeping operations with “teeth” (Lepgold 1998), although some scholars recognize

the willingness for certain countries such as England and France to take a more active

role in European security without the United States, i.e. Bosnia (Kramer 2002). In this

respect, the free-rider concept could negate the guns and butter argument. If countries are

already spending less on defense, policy-makers have to make fewer “tradeoff” decisions.

The “color of money” and “free-rider” premises help better explicate the guns and butter

debate by modernizing the framework of the argument. Since most of the original guns

and butter literature occurred during or immediately after the cold war, it is time to

update theory and confirm new hypotheses.

Purpose

I am replicating parts of the Domke (1983) et al study and including the “color of

money” and “free rider” notions within their original models. I want to expand the

number of countries analyzed (to full NATO membership) and expand the time-frame to

account for the last 20+ years. I choose this timeframe because the Reagan-Thatcher era

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was a watershed in defense policy, it includes the end of the cold war and the beginning

of the “peace dividend” era, and it includes the beginning of the global war on terror.

I will not only analyze individual countries, but also the NATO-Europe bloc as a whole

(16-countries), the four-largest military spenders in NATO-Europe (UK, France,

Germany, Italy), and the four-smallest military spenders in NATO-Europe (Luxembourg,

Portugal, Greece, Belgium).

I hypothesize that a fragmented trade-off pattern (null hypothesis) will present

itself as most NATO countries will show very little change in social spending as defense

spending increases. Cases in which trade-offs actually occur, that is when defense

spending increases and social spending decreases (alternative hypothesis), will be

selected as cases for further qualitative study. The purpose of this regression analysis is

to test the theoretical presence of defense and welfare spending trade-offs in NATO

nations from 1980 until present.

Other theories tested include the defense acquisition concept of “color of money”

and the microeconomic “free-rider” concept. The first comparative analysis compares

changes in total defense expenditures (DV) to the changes in total welfare expenditure

(Explanatory IV) controlling for total overall expenditures, chief executive political

orientation, legislature political orientation, presence of an election year, war deaths,

international tension index, inflation, and unemployment. Welfare expenditures are

defined by “Total Social Welfare Outlays” from OECD countries as used by Swank

(2002). Controlling for domestic political pressures, economic pressures, and foreign

policy pressures will show the importance of competing interests for the budget dollars of

various policy makers within the sample. However, I keep in mind the constraints of

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incrementalism (Wildavsky 2004) and how certain facets of these relationships depend

on how much each country spends on defense in the first place. Due to the free-rider

concept, I hypothesize certain tradeoffs occurring among the “Big Four” European

NATO countries (UK, France, Germany, Italy), but few if any tradeoffs occurring with

the “low-spenders” such as Belgium, Luxembourg, Greece, and Portugal.

I set up a second group of equations to factor in consideration of the “color of

money” theory. Defense expenditure is broken down into three dimensions:

procurement, research and development, and personnel. This separate model centers on

three separate equations which compare total welfare spending to the changes in spending

on procurement, R&D, and personnel. These equations also control for total overall

expenditure plus the same domestic, economic, and foreign policy variables as in the first

equations.

Literature

The “guns and butter” literature can be broken down into five main categories:

The Reagan-Thatcher defense build-up, US domestic, Incrementalism, Comparative, and

the Post-Cold War/“peace dividend” school of thought. Kamlet, Mowery, and Su (1988)

devised simulations based on federal budgetary outcomes during the Reagan

administration to judge fiscal impact from 1982-86. The authors hypothesized that

presidents following Reagan’s term still would have spent runaway amounts on defense

even without the tax cuts. They found that the tax cuts were the major contributor to the

deficit. This type of deficit spending is an important economic argument against

tradeoffs. The Keynesian dynamic of deficit spending during times of recession allows

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for governments to keep spending on social programs, even in times of increased defense

spending.

Other researchers search for tradeoffs in US spending on social programs and

defense expenditures. Beck (1983) examined various tools of analysis for estimating

time series models in US budgetary policy and identified spending shifts before or after

politically important times such as elections or administration changes. Kamlet and

Mowery (1987) looked at more specific macroeconomic and political factors which may

affect budget priorities between the US executive branch and Congress. They found

defense budgets to have more expenditure interdependence with economic factors such as

inflation and unemployment. These factors of interdependence were more pronounced in

the executive branch than in Congress.

Mintz and Huang (1991) looked at the indirect spending effects of military

spending on education spending in the US from 1953-1987. They found no short-term

effects, but significant negative long-term effects. Peroff and Podolak Warren (1979)

tested four different tradeoffs concerning defense and health spending in the US from

1929-1974. These tests were based on time, size of defense share of spending, the stage

of the budgetary process, and type of financing. They found evidence of health and

defense spending tradeoffs during the Vietnam War, but found no overall tradeoffs occur

during aggregate times of war and peace. Russet (1970) found the aftereffects of war to

be significant in post-war spending habits. He called this phenomena the “ratchet”

effect” referring to a country’s inability to reduce defense spending to pre-war levels

following conflict. Russett (1982) also examined health, education, and defense tradeoffs

from 1941-1979 controlling for economic, political, and demographic changes. He found

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no major evidence of tradeoffs and no evidence of Republican Party influence on

tradeoffs. Perhaps the most compelling portion of the literature is based on Wildavsky’s

(2004) theory on incrementalism in the budget process. Auten, Bozeman, and Cline

(1984) challenge this notion with their sequential budget model which focused on top-

down budget parameters, influence of interagency competition, and the connection

between revenues and appropriations.

Berry (1986) identified one of the main limitations of empirical studies in the

budgetary process: methodological and theoretical problems in the independent and

dependent variables (ratio variable problems). He offered an alternative approach using a

null hypothesis combined with the concept of incrementalism and other “built-in”

structural variables. Berry found that using simulated data in these alternative

approaches helps alleviate the ratio variable problem.

Other researchers find no real difference between competing models and

Wildavsky’s. Fischer and Kamlet (1984) unveiled a new model called the Competing

Aspiration Levels Model (CALM), which explored trade-offs in defense, non-defense,

and fiscal policy. They test it on US presidential budgetary data from 1955-1980. The

authors found that each ensuing year provides a “secure” budgetary base for the next,

which supports the traditional incremental argument. Gist (1982) compared the

incrementalist theory of Davis, Dempster, and Wildavsky with the competition theory of

Natchez and Bupp. Gist found that the levels of analysis, theoretical construct and

variables used in each model, were interchangeable. He concluded that the two models

are not really in competition with each other.

Baumgartner and Jones make the best argument against incrementalism.

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Jones, True, and Baumgartner (1997) tested their own concept of punctuated equilibrium

on US budget authority since World War II. They found spending can be categorized

under three “epochs”: postwar adjustment until 1956, robust growth from 1956-1974, and

restrained growth beginning in 1974. The authors test each epoch against rival

explanations (changes in growth of postwar economy, partisan divisions, and public

opinion) and find the punctuated epochs hypotheses survive each test.

The comparative literature of western democracies focuses mainly on the Cold

War period. Murray and Viotti’s (1982) analysis was admittedly affected by Waltzian

structuralism and foreign policy pressures on defense spending. Caputo (1975) suggested

using thicker case studies instead of relying on statistical analysis. He recommends these

case studies be focused on economic and political factors. Chan’s (1995) review of post-

Cold War literature found that political and economic constraints discourage change to

the pre-Cold War paradigm of no tradeoffs in military and social spending. Domke,

Eichenberg, and Kelleher (1983) make the most ambitious and complex comparative

model, but found no real short-term evidence of tradeoffs, but they found evidence of

long-term tradeoffs in the aggregate model. Eichenberg’s (1984) later study on West

Germany focused on a disaggregate model of West German social spending. He found

little evidence of tradeoffs and any tradeoff could be attributed to bureaucratic politics.

Nature and Goal of the Research

Through deductive theory development using the “defense and social welfare

tradeoff” (guns and butter) literature, plus the literature on “free-riders and alliances” and

“color of money,” I attempt to answer the following questions on defense and social

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welfare spending. I explore these questions using logistic regression analysis (Stata

Reference Manual 1995) and replicate work done by Domke, et al (1983). These

regressions test whether a significant relationship exists between the changes in total

defense spending and total welfare spending controlling for total expenditures, chief

executive political orientation, legislature political orientation, and presence of an

election year, war deaths, international tension, inflation, and unemployment. The

second group of equations test whether a significant relationship exists between total

welfare spending and spending on procurement, research and development, and personnel

controlling for total overall expenditures plus the same political, economic, and foreign

policy variables.

Theory

Model One: Aggregate Defense Spending

Dependent Variable: Total Defense Spending-TOTALDEF

I use Table 1 “Defense Expenditures of NATO Countries” 1980-2003 from the NATO

web page. Each country’s total defense spending is listed in their home currency or in

the Euro depending upon the year. Total are given for aggregate units of analysis such as

“NATO-Europe”, “North America”, and “NATO-Total.” I change each raw aggregate

into total defense spending as a percent of GDP for each country.

Null Hypothesis: Ho=There is no significant difference in comparison between

total defense spending and total welfare spending in NATO countries.

Alternative Hypothesis: Ha=As total welfare spending goes up, total defense

spending goes down (negative relationship).

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Explanatory Variable: Total Welfare Spending-TOTALWEL

I use Swank’s (2002) measurement of “Total social welfare outlays,” comprised of

OECD publications: Social Expenditure Statistics of OECD Member Countries; Labour

Market and Social Policy Occasional Papers, No. 17, Paris: OECD; New Directions in

Social Policy in OECD Countries, Paris: OECD, 1994. This measurement is in percent

GDP.


total defense spending and total welfare spending in NATO countries.

Alternative Hypothesis: Ha=As total welfare spending goes up, total defense

spending goes down (negative relationship).

Control Variable: Total Government Expenditures-TOTALEXP

The following control variables replicate work done by Domke et al (1983). The total

expenditure data is taken from current editions of national statistical yearbooks such as

the Statistical Abstract of the United States. It reflects total government expenditures for

a particular year as percentage of GDP. I am careful to consider uniform expenditure

categories across the various countries and keep in mind the institutional differences in

record keeping, tabulation, and other operational concerns.

Control Variable: Chief Executive Political Orientation-CHIEFPOL

This dummy variable controls for the political ideology of political executives as

described by Domke et al (1983). The reasoning behind the variable is that the

ideological positioning of chief executives is of paramount importance in driving

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budgetary decisions. Leftist leaning executives (who are more likely to spend on social

programs), i.e. Democrat, Labour, Social Democrat receive a “1”; Republicans,

Conservatives, Christian Democrats receive a “0.”

Control Variable: Legislative Political Orientation-LEGPOL

This variable controls for the political ideology of each country’s legislature as described

by Domke et al (1983). Different political parties have different ideologies concerning

the nature of budgetary spending concerning defense and social welfare. Each country is

assigned a percentage of “leftist” seats from the total number of seats in the main

legislative body.

Control Variable: Election Year-ELECTION

It has been argued in budgetary and electoral literature that election year spending on

social programs and defense increases during election years as policy makers attempt to

win votes through transfer payments (Domke et al 1983). A dummy variable is then

included to control for the presence of a major executive or legislative election in each

country.

Control Variable: War Deaths-WARDEATHS

Domke (1983) et al asserts that the participation in war positively correlates to increased

defense spending. I control for this factor by using “annual combat casualties” as a

control variable. The data are taken from various statistical yearbooks such as Statistical

Abstract of the United States or Facts on File.

Control Variable: International Tension Index-TENSION

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NATO has undergone the ebbs and flows of tension and crises since the end of the cold

war, Bosnia and Kosovo, and 9/11. Domke et all (1983) proposes using a tension index

developed by Goldmann and Lagerkranz (1977). The measure consists of a “coefficient

of imbalance” taken from a content analysis of statements from the leaders of various

countries in the NATO alliance. This index forms a baseline for “tension” in the alliance

and a benchmark to “contrast the strength of relationship” for each polity.

Control Variable: Unemployment-UNEMPLOY

Variable measures percent change of unemployment from previous year.

Control Variable: Inflation-INFLAT

Variable measures percent change of cost of living (inflation) from previous year.

These economic variables reflect the Keynesian countercyclical spending theories

practiced by NATO countries, namely, during recession execute deficit spending; during

recovery execute austerity measures.

These variables combine to form the equation for aggregate defense spending as follows:

%TOTALDEF= - %TOTALWEL+ %TOTALEXP+CHIEFPOL+LEGPOL

+ELECTION+WARDEATHS+TENSION+ %UNEMPLY

+ %INFLAT

Model Two: Resource Allocation (Color of Money)

To account for problems of multicollinearity between the variables total defense

spending and total expenditures and to account for more complex theories of resource

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allocation and the “color of money,” I introduce a separate four-equation model which

disaggregates defense spending and addresses these issues.

Dependent Variable: Total Welfare Spending-TOTALWEL

I use Swank’s (2002) measurement of “Total social welfare outlays,” comprised of

OECD publications: Social Expenditure Statistics of OECD Member Countries; Labour

Market and Social Policy Occasional Papers, No. 17, Paris: OECD; New Directions in

Social Policy in OECD Countries, Paris: OECD, 1994. This measurement is in percent

GDP.


resource allocated defense spending and total welfare spending in NATO countries.

Alternative Hypothesis: Ha=As resource allocated defense spending goes up,

total welfare spending goes down (negative relationship).

Independent Variable: Procurement-PROCURE

Procurement spending denotes appropriations used to purchase weapons systems and

other investment items which exceed $100,000 in terms of systems unit cost (Roberts

2002). According to Vlachos-Dengler (2002) European-NATO countries showed very

little spending growth in procurement throughout the 90’s. Vlachos-Dengler attributes

this to little incentive for investment in new weapons system since individual county

spending will benefit other countries in the alliance. Along with free rider issues is the

“color of money” problem in which the incremental nature of spending in separate pots is

constrained by standard operating procedures and bureaucratic politics.

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Data Sources: See Mintz (1988). Stockholm International Peace Research

Institute, World Armament and Disarmament: SIPRI Yearbook, United Nations

Document A/35/479, Reduction of Military Budgets. New York. 1981.


changes in spending on procurement and total welfare spending in NATO countries.

Alternative Hypothesis: Ha= As percent change in spending on a country’s

defense procurement goes up, total welfare spending in that country goes down.

Independent Variable: Research, Development, Test, and Evaluation-R&D

R&D includes appropriations used for research, development, test and evaluation efforts.

R&D is historically a laggard in spending compared to the other resource allocations in

defense budgets. This sector is complicated since European countries have varying

degrees of interest and involvement in military R&D. Some countries, such as France,

spend upwards of 50 percent of the defense budget on R&D. However, the incremental

base for budgeting in this “pot of money” is low for many European countries (Vlachos-

Dengler 2002). This is problematic because it is then unlikely that any tradeoff with

social spending will occur. There are low incentives for European governments to invest

in R&D, therefore any tradeoff occurring in social spending is likely negligible or

accidental.


changes in spending on defense R&D and total welfare spending in NATO countries.


defense R&D goes up, total welfare spending in that country goes down.

Independent Variable: Personnel Spending-PERSONNEL

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This variable includes appropriations used to pay military personnel costs such as basic

pay, allowances, special pay, bonuses, and moving costs. Of all the resource allocation

variables, personnel is most likely to vary compared to social spending. According to

Vlachos-Dengler (2002, p. 149), “Europeans spend a larger proportion of their budgets

on personnel versus what they are spending on arming them…rather than reallocating

funding toward equipment budgets to provide forces with transport, precision weapons,

and command and control.” What does this have to do with social spending? It would

appear that decision makers in European countries feel more domestic pressure to provide

for social concerns, so the political and economic control variables may have a greater

effect on the personnel explanatory variable.


changes in spending on defense personnel and total welfare spending in NATO countries.


defense personnel goes up, total welfare spending in that country goes down.

The remaining control variables are identical to the variables in the first model.

The above factors can be taken together in the following equations:

%TOTALWEL= - %PROCURE + %TOTALEXP+CHIEFPOL+LEGPOL


+ %INFLAT

%TOTALWEL= - %R&D + %TOTALEXP+CHIEFPOL+LEGPOL


+ %INFLAT

%TOTALWEL= - %PERSONNEL + %TOTALEXP+CHIEFPOL+LEGPOL


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+ %INFLAT

Findings

I predict that the null will hold in all hypotheses and that no real significant relationships

will emerge in these variables. The color of money institutional constraints of

incrementalism, standard operating procedures, and bureaucratic politics are too much to

overcome. There are also the cultural and normative constraints of low defense spending

due to the free rider problem. However, these findings are still important because

knowledge is still advanced on this topic: budgetary decision making is greatly

influenced by resource allocation constraints. It is an important update on work done by

Mintz (1988) and Domke et al (1983).

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“The Color of Money:” Defense Resource Allocation and Social

Spending Tradeoffs in NATO Countries 1980-2003

Brent Eastwood

POLS 555

Dr. Studlar

19APR04