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Country survey XIX: MexicoEduardo Morales Ramos aa Programa de Actuaría, ENEP Acatlán , Ed. A‐2 PB, Sn JuanTotoltepec s/n, Sta Cruz Acatlán , Naucalpan , México CP 53150 ,MexicoPublished online: 25 Jan 2007.

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ISSN 1024-2694 print: ISSN 1476-8267 online © 2004 Taylor & Francis LtdDOI: 10.1080/1024269042000164513

Defence and Peace Economics, 2004,Vol. 15(1), February, pp. 83–99

COUNTRY SURVEY XIX: MEXICO

EDUARDO MORALES RAMOS

Programa de Actuarıa, ENEP Acatlan, Ed. A-2 PB, Sn Juan Totoltepec s/n, Sta Cruz Acatlan,Naucalpan, Mexico CP 53150, Mexico

(Received 21 November 2002; In final form 3 April 2003)

This paper presents a survey of Mexican military expenditure (ME), which assesses the role of ME in Mexicaneconomic growth. After presenting a description of the armed forces, Mexican military policy and the Mexico–USmilitary relationship, this paper outlines a demand–supply model to analyse the effects of ME on growth. Theempirical results suggest interesting insights on the ME–growth relationship for the Mexican case. These resultspresent evidence against the crowding-out hypothesis of ME on growth. For the Mexican case, ME produces apositive effect on growth.

Keywords: Mexico; Military expenditure; Growth; Supply-demand model; crowding-out.

INTRODUCTION

Military expenditure (ME) data are characterized by limited availability and low reliability.Data for the Mexican case are no exception: hence, there have been few studies of MexicanME because of poor data availability and also for political reasons. Some defence economicsstudies of ME and development for Latin America and developing countries have includedthe Mexican case: Lahera and Ortuzar (1998); Benoit (1978), and Murdoch et al. (1997).However, neither these studies nor those applied to other types of countries have establisheda final conclusion about the impact of ME on the economy. According to some other studies(Morales-Ramos, 2001) to understand the economic impact of ME on a country’s economyit is more relevant to perform a case study than include that country in a pool of countries.So, the objective of this paper is to present a survey of Mexican ME to understand the roleof ME in the Mexican economy.

This paper is structured as follows. Following the introduction, Section 2 describes brieflythe macro-economic situation of Mexico for recent years, and the Mexican military historicalbackground, and then analyses the contemporaneous defence policy that the Mexicangovernment has followed, which includes the role of the armed forces and the Mexico–USmilitary relationship. Section 3 presents the relevant figures that describe the trend of ME inMexico and presents an econometric model (supply–demand) that assesses the economiceffects of Mexican ME on its development and growth.

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MEXICAN ECONOMY AND ARMED FORCES

The last 60 years of the Mexican economy can be divided into two periods: from the SecondWorld War to the end of the 1960s, and from 1970 to now. The first period is characterizedby a substitution of imports policy, which led Mexico to a sustained growth and a macro-economic stability based on an intense industrial expansion. The second was the product ofa deep crisis in 1982, which gave pass to a policy of insertion of the Mexican economy intothe international economy. The major features of the second period were an oil boom and anincrease in the exports of manufactured goods.

During the period 1988–1994, the Mexican economy had an apparent success with apolicy that emphasized the deregulation and privatization of key industrial sectors, andstressed the importance of labour relationships. The new policy considered salaries as a costfactor of productivity rather than an aggregated demand factor, which led real salaries todecrease during this period. At first sight, the structural transformation of the Mexican policyled the economy towards success (decreasing inflation, controlled unemployment, increasingper capita income and a dynamic exporting sector). The integration of Mexico into theinternational economy was consolidated through the North American Free Trade Agreement(NAFTA) in 1994.

However, the 1994 financial and economic crisis gave evidence that the performance of theMexican economy was based on a fragile exports policy. The Mexican government hadcontrolled inflation and kept an exchange policy that lead the peso to be overvalued. Hence,the Mexican economy faced a deficit in current account close to 8% of the GDP during1991–1994. This crisis can be noticed clearly in Table 1: for 1995 the main macro-economicvariables show a negative impact.

Table 1 also shows a fast recovery of the economy after 1995. This recovery was based ona stabilization of the financial market, a monetary restriction to control inflation, the recoveryof the investment sector, the continuation of structural reforms, but mainly to the financialloans from the US government and international organizations. According to the IMF (1999),the Mexican economy has improved in recent years through stronger exports and industrialproduction, which has been reflected in stable growth. However, such growth is dependenton the US economy, because of the close relationship between these two countries. For a

TABLE 1 Mexico: Macro-economic Indicators (1990 prices)

Year GDP1 GDP per capita2 Growth (%) Population InflationIndex

Balance ofPayments3

Unemployment(%)

1990 738897516 9094.16 2.49 81249645 29.93 –5964.20 2.81991 778200905 9405.01 2.25 82743216 18.79 –7409.47 2.61992 798431623 9475.33 1.12 84264243 11.94 –12783.67 2.81993 812432693 9467.45 7.55 85813230 8.01 –10128.80 3.41994 859900088 9839.72 2.47 87390691 7.05 –12778.07 3.71995 795028965 8933.19 –3.41 88997149 51.97 2213.12 6.21996 834192759 9204.06 2.09 90633139 27.7 1328.10 5.51997 875909766 9489.89 2.12 92299202 15.72 –741.97 3.71998 919644808 9783.88 2.12 93995892 18.61 –2776.50 3.21999 938417121 9803.39 0.88 95723770 12.32 –1980.09 2.52000 1026931788 10534.43 3.91 97483412 8.96 –2444.12 2.2

1 Thousand of Pesos2 Pesos3 Million of USDSource: INEGI (1999); and own calculations

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COUNTRY SURVEY XIX 85

detailed analysis of the Mexican economic policy see Aboites Aguilar (1998) and AspeArmella (1993).

Since its war of Independence in 1810, Mexico experienced many armed conflicts. Duringthe 19th century, Mexico was one of the countries with the highest ratio of militarymanpower to inhabitants in the world (Castro and Ledesma, 2000). Table 2 shows that afterits independence from Spain, Mexico reached its second highest ratio of military manpowerto inhabitants at the end of the French invasion. During the Diaz’s dictatorship, this ratiodecreased considerably, but it reached its highest point at the end of the Mexican Revolution(1/160). From 1940 to 1980, Mexico consolidated its institutions and the country’s lowestmilitary manpower to inhabitants ratio occurred in 1980 (1/746). However, during the 1990s,the country experienced a new increase in this ratio, which presumably was due to theemergence of insurgent groups, EZLN, EPR and ERPI, in the Mexican South-east and inorder to combat drug dealing.

Although armed forces have been present in Mexico since it was created as a republic, thefoundation for the forces as institutions was developed only after the Mexican Revolution in1910. The first antecedent of the modern Mexican Army is during the Mexican Revolution.However, it was in 1926 when the first Army Organic Law was promulgated that the MexicanArmy was considered a professional army. A professional army allowed Mexico to separateits political life from the armed forces. The first antecedent of the Mexican Air Force wascreated in 1915 and was the “Arma de Aviacion Military”. Although the Air Force evolvedindependently from the Army, they currently share the same missions:

(1) Defence of the national integrity, independence and sovereignty.(2) Guarantee of Internal Security.(3) Help to the civil population where necessary.(4) Perform civic actions and social work to contribute to the country’s progress.(5) In the case of natural disasters help to keep order, help people and their goods and help

to rebuild the affected zones.

The Mexican Navy has an older tradition than the Army and Air Force because of the Spanishnaval influence prior to Mexican Independence. Coincidentally, the need to defend its

TABLE 2 Ratio of Military Manpower to Inhabitants: Mexico VariousYears

Year and/or historical period Ratio of military manpowerper inhabitant

1821: Independence from Spain 1/5001867: End of French Invasion 1/1711884: Start of Diaz’ Dictatorship 1/3671900–1910: End of Diaz’ Dictatorship 1/5301

1910: Start of Mexican Revolution 1/5831917: End of Mexican Revolution 1/1601940 1/3931950 1/5151960 1/6841970 1/7181980 1/7461990 1/4371995 1/413

1 Average per yearSource: Castro and Ledesma (2000), pp. 17–20.

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Independence from Spain led Mexico to create the first Mexican Navy around 1821.However, the legal bases to consolidate the Mexican Navy were established in 1917, andreached the status of State Secretary in 1940.

These three institutions evolved in such a way that their objectives have been defined inthree war plans and doctrines, which define Mexican defence policy: DN-I, DN-II and DN-III. However, the navy’s main missions are in plan DN-III, and its participation in plan DN-IIis marginal. These plans will be explained below.

Mexican Defence Policy

The use of the armed forces in Mexico is based on three war plans and doctrines: DN-I incase of external threat; DN-II to keep internal security and social peace; DN-III to protectthe population in the case of natural disaster. Plan DN-I is of low relevance for Mexicandefence policy and has been kept only in the hypothetical case of war, because theprobability of external war is low. Mexican neighbours possess strong armed forces. In theNorth, the US armed forces are the strongest in the world, while in the East the Cubanarmed forces are one of the strongest in the Americas. In addition, the Central Americanneighbours possess strong military forces compared with Mexico. Guatemala’s army ispowerful compared with its population and territory (50–55 000 armed forces personnel),which is the equivalent to one quarter of the Mexican Army. Belize, the other CentralAmerican neighbour, does not have an Army, but it is protected by a UK battalion.Nevertheless, thanks to its political position, Mexico keeps good relationships with all itsneighbours, whom are not seen by the government as enemies and they do not representa military threat for the country.

An important consequence of the Mexican defence policy is a low ME, which, as will beexplained below, is one of the lowest in the Americas. Nevertheless, Mexican external policyhas changed recently, since Mexico entered the UN Security Council in January 2002. Thisis expected to influence Mexican defence policy, but it is not yet clear how. Initially, thearmed forces would be the winners from this change in Mexican policy, since the MexicanArmy would gain in preparation and prestige by getting training and additional instruction.Another advantage for the Army members is monetary, since they would receive extraincome from participating in Peace Keeping Operations.

Plan DN-II has led the Mexican Army to be divided into 12 regions and 40 military zones,the Navy into six regions (50% in the Pacific and 50% in the Mexican Gulf) and the Air Forceinto three regions (centre, north and south). Within its preventive and intelligence objectives,the two major missions of plan DN-II are war against drug dealing and insurgent groups. Onthe other hand, plan DN-II also comprises civic actions, especially in rural areas, whichDeger and Smith (1983) call factors of mobilization and organization of production (roadsand schools maintenance, health campaigns, prevention of crime, vigilance of ways ofcommunication, distribution of water, etc). Nevertheless, plan DN-II has been criticizedbecause most of the activities included within its objectives may be performed by civilinstitutions, namely, public security corps. According to Sierra-Guzman (1999), DN-II plansare performed only in Less Developed Countries as a consequence of a poor control of thearmed forces by government.

Plan DN-III has been applied since the 1970s and is the most welcomed of the threeMexican military plans. This plan has been used frequently when hurricanes, floods andearthquakes have severely affected the Mexican population. Plan DN-III has also beenexported to Central America and Venezuela in 1998 and in 1999 when natural disastersaffected those countries. The main objective of this plan is humanitarian and no critique hasbeen raised about the use of armed forces for those purposes.

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This defence policy has led Mexico to have a low ME, but the economic consequences ofsuch ME are not clear. Further, it is not clear how the Mexican defence policy is going toevolve, especially with respect to its military relationship with the USA.

Mexico–US military relationship

Historically, the Mexican–US military relationship has not been close since the Mexicangovernment preferred to remain independent from the strong military power of the US.However, this relationship changed during the 1990s as a consequence of the end of the ColdWar, which changed the US concept of national security. The new concept was related toprotecting borders, especially the Mexican border, from immigration and drug transit. Thissituation changed the military relationship between these countries since the US classifiedMexico as the principal drug-transit route into the United States. As a result, the USgovernment increased military assistance to the Mexican military and police.

Willson (1997) reports that between 1984–1993 Mexico obtained ten times more US armsthan it accumulated between 1950–1983. The equipment received by Mexico during1984–1990 included F-5 aircraft, Bell 212 helicopters, C-130 transport planes and otheraircraft, excess jeeps and light trucks, various communications equipment, and spare parts forUS-origin vehicles, planes and naval craft. In addition, Mexico leased UH-1H helicopters.

One of the most important sources of US military assistance has been through theInternational Military Education and Training Program (IMET), which provides “pro-fessional” military training for selected foreign military personnel. According to Willson(1997) during the second half of the 1980s and the 1990s Mexico was the country that sentmost military personnel to US training programme.

During the 1990s, the training programme for Mexican forces was delivered together with73 UH-1H helicopters and four C-26 aircraft for counter-drug use. However, after muchcontroversy about the use of those helicopters, the Mexican government returned all of themto the United States in 1999, but it purchased 73 Cessna aircraft as replacements. The majorcontroversy was that the UH-1H could be used to fight insurgent groups in Chiapas, Oaxacaand Guerrero, rather than to fight drugs dealing. Significantly, the donated helicopters wereend-use monitored by the US government, and their use was restricted to counter-drugsactivities, but the Cessna aircraft that Mexico purchased with its own money have no suchlimitation (see Latin American Working Group and Center for International Policy, 2002).Table 3 shows some recent figures that summarize the relationship between Mexico and theUSA.

Although the military relationship between Mexico and the USA is restricted almostexclusively to the counter-drugs fight, there is much controversy on the use of the militaryequipment and the training of Mexican military personnel by US armed forces. As explained,Mexico has not required a high ME because of its external policy. However, the recent changesin Mexican external policy (especially the entrance of UN Peace Keeping Forces) seem tosuggest that Mexican military policy could change in the long-run. An interesting question,which this paper does not pretend to answer, is whether Mexico and the US (and probably alsoCanada) could direct their policies towards creating a regional military coalition.

MILITARY EXPENDITURE, DEVELOPMENT AND ECONOMIC GROWTH

The impact of ME on the economy has been widely studied by the defence economicsliterature, but the results from the diverse studies have not reached a definitive conclusion.Some of these studies conclude that defence expenditure has a negative impact on the

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economy, other studies conclude that the impact is positive, and a third group affirms thatthere is no causality between ME and the economy (see Sandler and Hartley, 1995, ch 8).Most of these studies apply econometric techniques to test whether ME is a burden or abenefit for the economy (i.e. they test the crowding-out hypothesis of ME on the civil sector).To test this hypothesis, three types of models have been used: demand models (Smith, 1980;Faini et al. 1984; Mintz and Huang, 1990; Gold, 1997); supply models (Alexander, 1990,1995; Atesoglu and Mueller, 1990; Huang and Mintz, 1991; Mueller and Atesoglu, 1993);and demand–supply models (Deger and Smith, 1983; Deger, 1986). According to Morales-Ramos (2002) the demand–supply models are the most robust models to test this hypothesis,so a demand–supply model will be applied in Section 2.2 to the case of Mexico. Beforemodelling the ME effects on the Mexican economic growth, it is helpful to know the trendsin Mexican ME.

ME Trends

Mexico is a country with a low ME. Lahera and Ortuzar (1998) report Mexican public MEfor 1990–1995 as a share of GDP, which compared with other Latin American countries wasthe lowest for the group. Mexican ME for that period was comparable with the ME incountries such as Jamaica and the Dominican Republic, whose economies are less developedthan the Mexican one. Table 4 shows Mexican ME for the 1969–2000 period, which

TABLE 3 Mexico–US Relationship in Figures (USD thousands)

Grant Aid

1996 1997 1998 1999 2000 2001 2002 2003

International Narcotics Control 2,200 5,000 5,000 8,000 4,071 10,000 12,0001 12,0001

International Military Education andTraining 1,000 1,008 921 918 865 1,000 1,150 1,250Emergency Drawdowns2 0 37,000 1,100 0 0 0 0 0Section 1004 Counterdrug3 0 37,236 20,317 13,591 13,300 0 0 0Other 2,851 6,800 1,100 0 0 0 0 0Total 6,051 87,044 26,238 22,509 18,236 11,000 12,150 13,250

Sales

Foreign Military Sales4 4,430 9,527 2,722 1,799 4005 9,0005 3,0005 NADirect Commercial Sales6 991 3,331 21,321 5,521 7,6497 36,7287 39,0867 NA

Training (number of Students)

School of the Americas 149 305 219 60 31 0 NA NANavy Small Craft and TechnicalTraining School 0 0 6 0 0 0 NA NAInter American Air Forces Academy 141 260 336 0 0 0 NA NACenter for Hemispheric DefenseStudies 0 0 3 7 4 10 NA NA

1 Estimate2 Presidential authority to grant defence equipment from US arsenal3 Funding of equipment, training, eradication and other programs of the State’s Department’s Bureau for International Narcotics and

Law Enforcement (INL)4 Government-to-government sales of defence articles, training and services5 Agreement6 Sales from US companies licensed by the US government (Deliveries as of September)7 Expected DeliveriesSource: Latin American Working Group and Center for International Policy (2002).

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COUNTRY SURVEY XIX 89

confirms the idea of a low ME. Mexico reached its maximum ratio of ME to GDP in 1969,which was some 0.7% (considerably lower than the 8.2% spent by the USA the same year).After 1969, the Mexican ratio of ME to GDP presented a cyclical behaviour, it decreasedfrom 1969 to 1980, reaching a historic minimum of 0.405%, but increased from 1980 to 1985until reaching the levels of the 1970s. From 1985 to 1994 the ratio of ME to GDP presenteda similar pattern to that in the period from 1969 to 1985, reaching a minimum in 1990 anda maximum in 1994, which was comparable to the ratio in 1985. After 1994, the ratio of MEto GDP tended to decline, but it is not clear if it will follow the previous cyclical pattern. Thisdata also provide a first indication of the effects of the emergence of insurgent groups in 1994and the end of the Cold War on Mexican ME.

The decreasing trend after 1994 suggests that the appearance of insurgent groups did notproduce an increase in ME, but the government could have anticipated such an appearance,which could explain the tendency to increase ME from 1990 to 1994. Unfortunately, it is notpossible to know when the government knew for first time about the existence of thesegroups. Willson (1997) reports that “The Mexican government possessed large amounts ofinformation as early as 1992 that ‘guerrilla’ insurgency groups were organizing in Chiapasand other regions in southern Mexico. But the Salinas administration did not want known thepossibilities of insurrection because it did not want to damage its image of a stable, emerging‘First World’ nation.” However, this information is not official and there is no way to confirmit. The end of the Cold War seems not to have affected Mexican ME because, after 1990,Mexico increased its ratio of ME to GDP (i.e. a variable capturing the effects of Cold Waron ME is expected to be non-significant). These effects will be tested in the next sectionthrough an econometric model.

The distribution of ME is explained neither by the end of the Cold War nor by theappearance of insurgent groups. Table 4 also shows that, from 1980 to 2001, between 70%and 80% of total ME was allocated to the Army (which includes the Air Force), and the restto the Navy. This constant distribution suggests that the Mexican Army is the major Mexicanmilitary force and is responsible for keeping internal security and social peace.

The Mexican defence industry is a publicly-owned industry, which can be consideredsmall compared with the DIB of developed countries. The first antecedent of the Mexicanmilitary industry was created during Diaz’s government at the end of the 18th and beginningof the 19th centuries. However, the Mexican Defence Industry was created as an organismdependent on government until 1947. Since then, it has evolved until reaching its currentstage, which pursues the following objectives:

(1) To make and repair machinery, weapons, ammunition and other military equipmentrequired by the Armed Forces.

(2) To perform research to improve the material required by the Armed Forces.(3) To make and repair other type of equipment and objects required by the Armed

Forces.

The Mexican military industry consists of 17 firms and a Central Laboratory. Unfortunately,there are no available figures on the number of personnel employed by this industry. Someof the equipment fabricated by the Mexican military industry are semi-automatic pistols(HKP7M13S), automatic rifles (G-3), pistol-machine guns (MP-5), light machine guns (HK-21), canons of different calibre (101.6 mm and 60 mm), ammunition for short and largeweapons, grenades and armoured vehicles for different objectives. The Mexican militaryindustry also maintains diverse military equipment, including imported equipment, and itmakes all the necessary clothing and other minor equipment necessary for the armedforces.

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Table 5 shows the type and number of military equipment that the Mexican Armed forcespossess. The G-3 rifle is the official weapon used by Mexican troops, and is manufacturedin Mexico. The Mexican defence industry does not have the capacity to produce the militaryaircraft that they require, so most have been imported. The acquisition of military aircraft hasfollowed two war doctrines: the first period acquisition was based on the hypothesis ofexternal war (the Second World War and against a possible attack from Central Americacountries in the 1980s). The second period in the 1990s was based on the hypothesis ofinternal war and included the acquisition of combat and transport helicopters (MI-8 and MI-17). However, most of the air force equipment is considered old (e.g. the Hercules aircraftwas bought during the 1960s, the T-33-A aircraft are from the Korea war, and the F-33aircraft was bought during the 1970s).

ME and Economic Growth

As explained, the effects of ME on the economy of a country have not been clearly defined.Some studies find that ME stimulates economic growth, while others find that it inhibits

TABLE 4 Mexico: Military Expenditure (pesos at 1990 prices)

Year ME(Millions)

Ratio ofME to GDP

(%)

Ratio of ArmyExpenditure1 to ME

(%)

Ratio of NavyExpenditure to ME

(%)

1969 1892236 0.683 na na1970 1926930 0.619 na na1971 2083701 0.638 na na1972 2343360 0.655 na na1973 2492841 0.638 na na1974 2417120 0.588 na na1975 2873688 0.663 na na1976 2694986 0.557 na na1977 2441966 0.497 na na1978 2466662 0.468 na na1979 2769133 0.471 na na1980 2595677 0.405 72.69 27.311981 3470566 0.479 77.08 22.921982 3846596 0.512 76.72 23.281983 3545952 0.549 76.84 23.161984 3611336 0.558 80.14 19.861985 4243906 0.627 74.61 25.391986 3575331 0.585 76.08 23.921987 3435331 0.541 74.71 25.291988 3084495 0.499 71.08 28.921989 3358898 0.481 73.68 26.321990 3138000 0.425 74.43 25.571991 3482092 0.447 76.14 23.861992 3852619 0.483 75.36 24.641993 4212867 0.519 75.50 24.501994 5264177 0.612 78.42 21.581995 4487085 0.564 75.81 24.191996 4834574 0.580 75.39 24.611997 5051490 0.577 72.56 27.441998 5009050 0.545 70.52 29.481999 4739392 0.505 72.75 27.252000 4848811 0.472 71.27 28.73

1 Includes Air Forcena: not availableSource: SIPRI (various years); INEGI (various years); SHCP (various years); and own calculations

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economic growth. Among the factors explaining the ambiguity of these results are thecausality between defence and growth, the quality and availability of data, the statisticaltechniques and the model used for estimation, and the country or countries included in theanalysis. The causality between ME and growth is not clear, a change in ME could impacton growth, but a change in growth could also increase or decrease ME. Many authors havestudied this problem through statistical causality, finding ambiguous results (Joerding, 1986;Kinsella, 1990; Chowdhury, 1991; Payne and Ross, 1992; Kollias and Makrydakis, 1997;Morales-Ramos, 2001).

A major problem in the studies involving the use of ME data is the availability of reliabledata. However, it is possible to assemble useful series to test some models for certaincountries, including the Mexican case. Some other data problems have been tackled throughstatistical techniques such as cointegration; the use of time-series and cross-sectional data,and the use of error component models (ECM) (see Cappelen et al. 1984; Macnair et al.1995; and Murdoch et al. 1997). Some of these techniques will be applied in the nextsection.

The studies that have included the Mexican case within a pool of countries to analyse theeffect of ME on economic growth have reported different conclusions (Lahera and Ortuzar,1998; Benoit, 1978; Murdoch et al. 1997). Lahera and Ortuzar (1998) is a descriptive studythat identifies Mexico as a country with low ME among a groups of Latin America countries,which according to the authors require a revision of their respective ME policies since theyseem to be spending more than they require on ME. Benoit (1978) is a study of developingcountries, which concludes that developing countries with a heavy defence burden had themost rapid rate of growth, and those countries with the lowest defence burdens show thelowest rate of growth. However, Mexico is an exception to Benoit’s conclusion, becauseMexican ME for the period of study was low compared with its growth. Murdoch et al.(1997) analyses the impact of defence spending on growth for a cohort of Latin Americancountries. This study concludes that ME promotes growth. However, as in the case ofBenoit’s study, Mexico was an exception to that result.

The empirical results for a pool of countries suggest that Mexico is an exception to the restof countries with respect to the relationship between ME and growth. Morales-Ramos (2001)suggests that it is possible to obtain reliable results from pooling data from various country

TABLE 5 Mexico: Major Military Equipment (1997–1998)

Army

Equipment Qty

Air Force

Equipment Qty

Navy

Equipment Qty

M-8 tanks 40MOWAG tanks 25MAC-1 armouredvehicles

15

MEX-1 armouredvehicles

41

VBL armoured vehicles 40AMX-VCI light vehiclesfor transporting troops

409

M-116 lighttanksHowitzers

18

M-2A1 light tanks 16

F-5 aircraft 10F-27 aircraft 2F-33 aircraft 40T-33-A aircraft 27500S commander aircraft 14C-130 Hercules 9Boeing 727 5Bell 205 Huey II 5Bell 206 27Bell 212 25SA-332 for transport 3UH-60 (blackhawk) 2S-70-A for transport 6MD-530F (Sikorsky) 22

FRAM-1 Gearingdestroyers (2448 tons) 2Fletcher destroyers (2050tons)

2

Bronstein (2360 tons) 2Knox ships 2High speed ships (1450tons)

3

Transport helicopters 9Bo-105 combathelicopters

12

Source: Castro and Ledesma (2000)

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studies using an ECM technique. However, the same study finds that models including MEand growth seem to impact in a different way on the economies of different countries, whichsuggests that a case study provides a better option to analyse the effects of ME on growth forindividual countries. That is one of the reasons for a case study of the effects of ME ongrowth for Mexico.

Supply–demand model

ME can affect the economy of a country through many different channels. Most of the studiesthat have modelled the effects of ME on growth have built the theory accounting only for oneof either demand or supply. However, a more useful taxonomy to analyse such an effectincludes both sides of the economy. Including only one side of the economy leads the modelto capture a partial relationship, which tends to produce biased results. A supply-sideapproach is expected to capture positive externalities, while demand-side models areassociated with an indirect negative effect of ME on growth. Therefore, a completetheoretical framework has to account for both demand and supply sides. Deger and Smith(1983), and Deger (1986) are examples of models including both sides.1

Deger and Smith (1983) distinguish four channels through which ME affects growth: (1)resource allocation and mobilization; (2) organization of production; (3) socio-politicalstructure; and (4) external relations. To capture the influence of these four channels, Degerand Smith propose a model including equations for growth, saving and military expenditure,which for Mexico are:

g = α0 + α1 s + α2 f + α3 l + α4 me + α5 y + α6 r (1)

-s = β0 + β1 g + β2 yg + β3 me + β4 f + β5 p (2)

-me = γ0 + γ1 y + γ2 N + γ3 US + γ4 D1 + γ5 CW (3)

where g stands for growth, s for domestic savings, f for foreign capital flow, l forpopulation growth (a proxy for dL/L because of lack of data for labour), me for ME, y is thelevel of per capita income, r is the growth rate of agriculture, p represents the rate of inflation,N is the population growth, US the US’s ME, D1 is a dummy variable which equals zerobefore 1994 when the EZLN appeared and one after 1994; and CW is a dummy variable tocapture the effects of Cold War (CW = 1 before 1990 and CW = 0 after 1990). Equation (3)differs with respect to Deger and Smith, because the equation set in this paper needs tocapture the particular variables that could affect Mexican ME, which are represented by US,D1 and CW. A possible reason for a low ME in Mexico (military equipment, militarytechnology and armed forces prepared for external war) is that Mexico could be free-ridingon the US (i.e. the strong military power of the US could be seen as a protection againstpossible external attacks). So the US variable is included in equation (3) to capture thepossible effects of free riding from the Mexican to the US ME. As Mexican ME is predictedto be free-riding on the US ME, a negative coefficient for US is expected.

With the public appearance of insurgent groups in the Mexican Southeast (EZLN in 1994in Chiapas, EPR in 1996 in Guerrero and Oaxaca) the Mexican Army increased the numberof active forces in that region. The D1 variable is expected to capture the effects of theinsurgent movements and its sign is expected to be positive since ME presumably shouldincrease as a consequence of the appearance of these groups (however, as suggested by the

1 For a description and derivation of these three models see Sandler and Hartley (1995, ch. 8), and Morales-Ramos(2001).

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data trends, this coefficient could be non-significant). The Cold War dummy variableexplains the effects of the end of the Cold War on Mexican ME. The Cold War affectedpositively ME in most of the developed countries. However, for the Mexican case, thisvariable is expected to be non-significant because Mexico was not directly involved in theCold War.

From this set of equations, α4 in equation (1) is the marginal effect of ME on growth, butthe overall effect is derived from equations (1) and (2), resulting in the followingexpression:

dg/dme = (α1 β3 + α4)/(1 – α1(β1 + β2y)) (4)

where y has to be evaluated at mean per capita income. Equations (1) and (2) show theeffects of ME on growth, but, the whole picture of that effect is given by equation (4).

Empirical Evidence

This section estimates equations (1) to (4) for the Mexican case for the period 1970–2000.However, before assuming a relationship between ME and growth and setting a modelinvolving these variables, testing for unit roots, causality and cointegration is desirable. Unitroots can be tested through the augmented Dickey–Fuller regression (ADF), which for MEand growth relies on the estimation of the following equations:

∆g = c1 + c2 t + φ gt–1 + Σi = l,m βi ∆gt–i + εt (5)

∆me = c1 + c2 t + φmet–1 + Σi = l,m βi ∆met–i + εt (6)

where t represents time and ε is a random variable with mean zero and variance σ2. Table6 shows the results of estimating equations (5) and (6), where the Lagrange Multiplier (LM)test for serial correlation determines the lagged dependent variables necessary to achievewhite-noise in the residuals. The LM statistic in the lower panel in Table 6 shows that bothequations require five differences because LM > χ2. The ADF test for growth does not reject

TABLE 6 OLS Results for ADF Equations (5) and (6)

Growth

Coeff t

ME

Coeff t

Constant 4.197 1.357 Constant –1.694E-2 –2.387*Time –2.106E-3 –0.248 Time 7.508E-6 2.074**gt–1 –0.765 –1.130 met–1 0.378 4.548*∆gt–1 1.312 0.688 ∆met–1 3.252 13.403*∆gt–2 –6.705 –1.677 ∆met–2 –4.350 –10.505*∆gt–3 8.012 2.165* ∆met–3 3.223 7.194*∆gt–4 –3.942 –2.347* ∆met–4 –1.250 –5.199*∆gt–5 0.399 2.261* ∆met–5 0.200 3.953*

LM test order: 1–5 LM = 12·274 > 11·1= χ2

LM test order: 1–5 LM = 23·851 > 11·1= χ2

F test for c2 = φ = 0 F = 1·222 < 7·24= Φ

F test for c2 = φ = 0 F = 15·910 > 7·24= Φ

* Significant at 5%

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the null hypothesis of the unit root, since the F-statistic, also shown in the lower panel ofTable 6 is lower than the Engle and Granger statistic (7.24). In other words, there is acceptedthe null hypothesis that both time and lag coefficients are zero (c2 = φ = 0) for growth, andthat the first differences are not dependent on time (i.e. the series for growth is stationary).On the other hand, the null hypothesis of the unit root ME is rejected since the F-statistic isgreater than the Engle and Granger statistic (7.24). Since the test is rejected for ME, the seriesfor ME are not stationary. In other words, ME is not I(1) and the first difference betweengrowth and ME is not stationary, which implies that the series are not cointegrated.2

Therefore, before applying the demand–supply model, the VAR technique was used to testfor causality between growth and ME through the following equations:

gt = α0 MEt + Σi = l,k αi MEt–i + Σi = l,k βigt–i + εt (7)

MEt = γ0gt + Σi = l,k δi MEt–i + Σi = l,k γi gt–i + ψt (8)

The optimum lag length k for specifying the VAR is determined through the Schwartzcriterion, which consists of choosing the model for which ωt = log Λ(Xt; υ) – 1/2 kt log nis the largest, where Λ(Xt; υ) is the maximum likelihood function and kt the dimension of themodel (see Schwartz, 1978). The Schwartz results shown in Table 7 suggest that equation (7)for growth requires four lags, while equation (8) for ME requires only one lag.

Therefore, for testing causality the null hypothesis α0 = α1 = α2 = α3 = α4 = 0 forequation (7) and γ0 = γ1 = 0 for equation (8) are set. Table 8 shows the results of testingthose two null hypotheses through three different techniques: Wald, Likelihood Ratio (LR)and LM.

Three of the tests presented in Table 8 accept the hypothesis of causality for growth, andreject it for ME. In other words, there is evidence to accept that ME causes growth, whilegrowth does not cause ME. According to these results, explaining growth through ME is

2 To solve this, the supply – demand model has to be estimated with the first differences for growth and ME (alsofor thevariables included in the model).

TABLE 7 Schwartz Statistic for Optimal Lag Length in VAR Growth versusME

Lag Length Equation (7) Equation (8)

ω1 19.549 72.203ω2 19.617 69.747ω3 20.590 67.951ω4 20.777 65.480ω5 20.161 63.476

TABLE 8 The Granger Causality Test

Wald LR LM χ2 Null Decision Causality Decision

Growth vs ME 25.956 18.956 13.234 12.6 Reject AcceptME vs Growth 0.216 0.215 0.214 5.99 Accept Reject

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plausible for the Mexican case, which supports the idea of modelling the effects of ME ongrowth through a demand–supply model.

Supply–demand model estimates

This Section estimates the supply-demand model described above by equations (1)–(4) forthe Mexican case.3 Data used are as follows:

g growth measured as the log of GDP minus the log of GDP in the previous year,s domestic saving measured as the share of domestic saving to GDP,f imports as share of GDP,l population growth as a proxy for labour,me military expenditure measured as the share of ME expenditure to GDP,y per capita income is GDP per head of population,r annual growth rate of agricultural output measured as the log of agricultural output less

the log of agricultural output in the previous year,p inflation rate measured by the GDP deflators,N total population,US US military expenditure measured as the share of the US’s ME to its GDP,D1 a dummy variable for insurgent groups (0 before 1994 and 1 after 1994),CW a dummy variable for Cold War (1 before 1990 and 0 after 1990).

The results for the three-stage least squares estimation are shown in Table 9 for ME, Table10 for saving and in Table 11 for growth. Two models are shown in each of these tables,which were derived from the original equation and from the differences. The most reliableresults from the tables are those from the differences, because they guarantee that the seriesare stationary. The results in Table 9 suggest the population size negatively affects ME, whichcould be explained by saying that a larger population implies a higher civil expenditure ratherthan military expenditure. The coefficient for the US variable suggests that Mexico is notfree-riding on US ME since that coefficient is not significant. In other words, the Mexicanexterior policy of “good neighbour” implies that Mexican ME policy may not respond to

3 To guarantee that the series included in equations (1)-(3) are stationary, they were estimated in firstdifferences.

TABLE 9 TSLS Results for the ME Equation (me = γ0 + γ1 y + γ2 N + γ3 US + γ4 D1 + γ5 CW)

me

Coeff t

∆me1

Coeff t

γ0 7.302E-3 4.667* 2.127E-3 3.625*y –1.88E-4 –1.455 2.566E-4 1.044N –2.23E-11 –1.689 –1.02E-9 –2.579*US 4.041E-2 2.391* 1.282E-2 0.505D1 8.343E-4 2.014** –5.74E-4 –1.874**CW –1.13E-3 –2.826* –5.45E-4 –2.044**R2 0.745 0.600F 6.248* 2.700*DW 1.550 2.433

1 Equation estimated in differences

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changes in US ME (i.e. Mexican government is worried about neither the US ME nor the restof the neighbours’ ME). The dummy variable measuring the effect of the appearance ofinsurgent groups after 1994 is negative and significant, which implies that Mexican MEdecreased after such an appearance. This result is contrary to expectations, but as explainedfrom the Mexican ME tend section, ME was reduced after 1994, but very probably theMexican government decided to increase ME before 1994, when for the first time theexistence of insurgent groups became known. Solving this problem requires changing thedummy variable to the date when the Mexican government knew about the existence ofinsurgent groups, but knowledge of that date is not public. The CW variable also presents anegative impact on ME, but the size of the coefficient is close to zero. That result suggeststhat Mexico reduced its ME during the Cold War, but such a reduction was small.

Table 10 shows two models for the saving equation, where the results in differences are themost reliable. Those results suggest that saving is affected positively by growth, negativelyby inflation (as expected), but the imports variable is not significant, which is an unexpectedresult. The negative sign for inflation does not supports Benoit’s hypothesis, which says thatunder the presence of high ME some countries relax their monetary fiscal policies, whichleads to higher inflation, but also to use underutilized resources which contribute to realgrowth (Benoit, 1978). The ME expenditure variable presents a negative and significantresult, which suggests a crowding-out effect of ME on saving. However, the low R2 limitsthis result.

The results for the growth equation are shown in Table 11. The results in differences,which again are the most reliable, show that population growth rate is the only non-significant variable in the model. The imports variable affects growth negatively, while therest of the variables show positive impacts. These signs are expected, including the MEvariable which affects growth positively and suggests that there is no direct crowding-out ofME on growth. The marginal effect of ME on growth (dg/dme) suggests that there is not anoverall crowding-out effect of ME on growth, but that ME produces a positive effect ongrowth. Further, that effect was computed using four significant coefficients out of four, asexplained in Table 11.

The results from the supply–demand model suggest that ME positively affects growthdirectly and in an overall way. This result coincides with the results for Turkey reported byOzsoy (2000), which suggest a positive effect of ME on growth for that country. The overallpositive effect of ME implies that any possible negative effect produced by ME isoutweighed by a strong positive direct effect. In general there is evidence to reject the

TABLE 10 TSLS Results for the Saving Equation (s = β0 + β1 g + β2 yg + β3 me + β4 f + β5p)2

s

Coeff t

∆s1

Coeff t

β0 0.179 2.636* –3.49E-3 –0.878g 0.444 1.190** 0.239 2.263*me –5.742 –0.521 –32.000 –2.412*f –0.184 –2.521* 0.200 0.986p –2.30E-4 –1.213* –1.44E-4 –2.412*R2 0.395 0.361F 4.244* 3.528*DW 0.835 2.760

1 Equation estimated in differences2 yg eliminated for collinearity

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crowding-out hypothesis of ME on growth. However, these results may be affected by poordata quality.

CONCLUSIONS

Mexican military policy implies a low ME, since from three of its plans comprising its policythe most relevant is aimed at keeping internal security. External war for Mexico has beenonly hypothetical and of low probability. However, the Mexico–US military relationship hasbecome very important in Mexican military policy, mainly in relation to the counter-drugsfight, which could lead Mexican military policy to follow a different course. In addition,some recent changes in Mexican external policy suggest that Mexican military policy couldchange in the medium term.

To understand the role of ME in the Mexican economy, this paper assessed the relationshipbetween ME and growth for the Mexican case. A causality analysis suggests that ME causesgrowth, while growth does not causes ME. This result supports the idea of using a supply–demand model to assess the impact of ME on growth. The four equations composing thesupply–demand model offer relevant results. The ME expenditure equation suggests thatMexico is not free-riding on US ME, that Mexican ME decreased after the appearance ofinsurgent groups in 1994 and that the Cold War had a negative effect on Mexican ME. Asexplained, three of these results are consequence of the Mexican ME policy and on politicaldecisions. Results from the saving equation imply that ME expenditure negatively affectssaving, which supports the crowding-out effect of ME on saving for the Mexican case.However, that result is of low reliability, because of a low R2. Finally, the growth resultsimply that the partial effect of ME on growth is positive and that its overall effect is alsopositive. The overall positive effect of ME on growth implies that the negative effectproduced by ME on saving is outweighed by the strong positive direct effect. All of theseresults suggest that ME creates a positive effect on economic growth for the Mexicancase.

It has to be recognized that the quality of the data used to model the relationship betweenME and growth is suspect and that the results could reflect that quality. Further research is

TABLE 11 TSLS Results for the Growth Equation (g = α0 + α1 s + α2f + α3 l + α4 me + α5 y + α6 r)

g

Coeff t

∆g1

Coeff t

α0 –0.188 –3.110* 8.340E-3 2.594*s 1.371 7.878* 2.303 6.469*f 0.201 5.755* –0.592 –3.660*l –0.549 –0.412 2.945 1.106me 1.451 0.231 78.760 5.722*y 1.048E-3 0.321 1.559E-2 2.562*r 8.430E-2 1.546 0.125 2.434*R2 0.884 0.897F 30.598* 33.528*DW 1.880 2.007dg/dme –16.4112 11.2643

1 Equation estimated in differences2 Computed with three significant coefficients out of four3 Computed with four significant coefficients out of four

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suggested to analyse the composition of the Mexican ME and the effects of each of itscomponents (e.g. ME on R&D, the effects of the Mexican military industry, the effects ofsalaries to the armed forces, etc).

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