Military Spending and the Black Market Premium in Developing Countries

What is it about?

Researchers who have been concerned with the economic implications of military spending have mostly concentrated on its impact on economic growth, corruption, real exchange rate and inflation. In this paper we investigate the impact of military spending on black market premium, an area that has not been tackled so far. After adding a measure of military spending to a well established model of black market premium form the literature, we estimate the model by pooling annual data over the 1985 – 1998 period across 61 developing countries. Results from five panel specifications provide considerable evidence that higher military spending leads to higher black market premium.

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Why is it important?

The issue of military spending is equally important for developed and developing countries. The main body of literature in economics in this area is centered around analysing the impact of military spending on economic growth. It has been argued that higher military spending retards economic growth via lowering savings, investment and infrastructural development; through lower consumption; by lowering the level of other kinds of government expenditures; through higher tax rate and lower productivity of private producers; via lower capital formation and resource allocation; and through lower social expenditures and expenditure on economic services. However, the empirical findings are inconclusive. In this paper, we investigate the impact of military spending on black market premium, an area that has not previously been tackled. Theoretically, we argue that military spending could influence the demand for, or the supply of, foreign exchange in the black market. To establish the empirical validity, we selected a simple model from existing literature and added military spending as another determinant of black market premium. We estimated the model by using data from 61 countries for the period 1985 – 1998 and using measures of military spending from two different sources. Results from five panel estimations provide considerable evidence that higher military spending leads to higher black market premium.

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