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Causality between defence spending and economic growth:

THe case of mainland China: A comment
Wolde-Rufael, Yemane. Journal of Economic Studies28.3 (2001): 227-230.

Abstract
This paper challenges the claims of a previous article which tested the long-run relationship between
economic growth and defence spending for mainland China for 1950-1991 and stated that the two
series were integrated of the same order but not Granger-causally related to each other in any
direction. Shows that there is a unidirectional Granger causality running from defence expenditure to
economic growth.

Full text
Keywords China, Defence, Economic growth
Abstract Challenges the claims of a previous article which tested the long-run relationship between
economic growth and defence spending for mainland China for 1950-1991 and stated that the two
series were integrated of the same order but not Granger-causally related to each other in any
direction. Shows that there is a unidirectional Granger causality running from defence expenditure to
economic growth.
Introduction
In a recent article in this journal, Chen (1993) tested the long-run relationship between economic
growth and defence spending for Mainland China for the period 1950-1991. Using the Engle-
Granger (1987) two-step procedure and the Granger (1988) causality test, Chen (1993) claims that
the two series were integrated of the same order but not Granger-causally related to each other in
any direction. The purpose of this note is to challenge these two claims and to show that there is a
unidirectional Granger causality running from defence expenditure to economic growth in the case of
Mainland China.
Further unit roots tests
Using the conventional Augmented Dickey-Fuller (1981) (ADF) test, Chen (1993) claims that the two
series were difference-stationary and integrated of the same order. In this note we shall demonstrate
that only the defence spending series was difference-stationary, while the economic growth series
was level-stationary. As there are many controversies surrounding the unit root testing, our strategy
is to compare results obtained from several of these tests and examine whether the preponderance
of the evidence makes a convincing case for stationarity or nonstationarity. For this purpose, we
shall use not only the ADF test which Chen himself used but also four other additional unit roots
tests of Phillips and Perron (1988), Kwiatkowski et aL (1992), Zivot and Andrews (1992) and, more
importantly, the relatively more powerful unit root test of Elliot et al. (1996)[1].
Results of the five unit root tests are presented in XXFIGR FIGREF="tablel.TIF"&amp;gt;Table I.
For the levels of the economic growth (EG) series, the null hypothesis of a non-stationary is rejected
at the 5 per cent significant level by all the five tests. However, for the defence (DS) series, the
null that the series contains unit root is accepted by all the tests. Therefore, there is convincing
evidence to indicate that the two series were not integrated of the same order: the EG series was
level-stationary, while the DS series was difference-stationary. Hence, as the two series were not
I(1), the Engle-Granger (1987) two-step procedure that Chen (1993) used was not appropriate for
testing for cointegration[2].
Further evidence of causality
Using the first difference of the two series, Chen (1993) claims that there was no Granger-causality
in any direction between economic growth and defence spending. As Table I shows, the levels of
EG and the first difference of DS are both I(0) and Granger causality tests should have been carried
out using these two stationary series and not the first difference of the two series. Results of the
causality tests using the levels of the economic growth series and the first difference of the defence
expenditure series are presented in Table II. The Table indicates that there was a unidirectional
Granger causality running from defence spending to economic growth. This finding, though not
robust to the varying lags, implies that defence spending promoted economic growth in China[3,4].
Concluding remarks
This note has shown that defence spending and economic growth in China were not integrated
of the same order and it was not appropriate for Chen (1993) to use the Engle-Granger two-step
procedure and the Granger (1988) causality tests. Granger causality tests should have been based
on the levels of economic growth and the first difference of the defence spending series, which
are both I(0). Using these two stationary series, unlike Chen (1993), we find that there was a
unidirectional Granger causality running from defence spending to economic growth, implying that
defence spending promoted economic growth in China.
Table I.
Table II

Notes
1. It now well-known that the conventional unit root tests often have lower power against plausible
stationary alternatives. As a result, numerous modifications have been proposed in order to increase
the power of the tests. One of these tests is the procedure proposed by Elliot et al. (1996), that has
a better performance in terms of small-sample size and power. For a concise summary, see Cheung
and Lai (1995) and Pantula et al. (1994).
2. If we agree with Chen that the two series were I(1), both the residual-based cointegration tests
due to Engle-Granger (1987) and the Johansen (1988) procedure clearly show that the two series
were cointegrated. Both the ADF tests of the residuals and the CRDW from the cointegrating
equation are significant. Moreover, the cointegration tests based on the Johansen procedure are
also robust to varying the VAR length. However, with the evidence presented in Table I, this exercise
may seem a heresy.
3. Needless to say, had Chen accepted the 5 per cent significant level for his F-test, instead of the I
per cent significant level, he would also have found that there was a unidirectional Granger causality
running from defence expenditure to economic growth. However, with the evidence presented in
Table I, this exercise may again seem a heresy.
4. When we applied the Toda and Yamamoto (1995) lag-augmented Granger non-causality test,
we found that there was a unidirectional causality running from defence expenditure to economic
growth. This was robust to varying the lag length. For a lucid presentation of the above procedure,
see Rambaldi (1997); and for the main shortcomings of the approach, see Kurozumi and Yamamoto
(2000).
References
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mainland China",Journal of Economic Studies, Vol. 20 No. 6, pp. 37-43.
Cheung, Y-W. and Lai, K.S. (1995), "Lag order and critical values of a modified Dickey-Fuller test",
Oxford Bulletin of Economics and Statistics, Vol. 57 No. 3, pp. 411-19.
Dickey, D.A. and Fuller, W.A. (1981), "The likelihood ratio statistics for autoregressive time series
with a unit root", Econometrica, Vol. 49, pp. 1057-72.
Elliot, G., Rothenberg, TJ. and Stock, J.H. (1996), "Efficient tests for an autoregressive unit root",
Econometrica, Vol. 64 No. 4, pp. 813-36.
Enders, W. (1995), Applied Econometric Time Series, John Wiley &amp;amp; Sons, Inc., New York,
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Granger, C.Wj. (1988), "Developments in a concept of causality", Journal of Econometrics, Vol. 39,
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Johansen, S. (1988), "Statistical and hypothesis testing of cointegration vectors", Journal of
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268-81.
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75, pp. 335-46.
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Journal of Monetary Economics, Vol. 20, pp. 73-103.
Toda, H.Y. and Yamamoto, T. (1995), "Statistical inference in vector autoregressions with possibly
near integrated process",Journal of Econometrics, Vol. 66, pp. 335-46.
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Yemane Wolde-Rufael
Social Services Department, London Borough of Camden, London, UK
The author is grateful to two anonymous referees and to the Editor of the Journal for many useful
comments and suggestions on an earlier draft of the paper that have enhanced its quality and
content. He is especially grateful to one of the anonymous referees for suggesting that he use a
more powerful unit root test other than those conventionally used and also for suggesting that he
also use causality tests in order to build a convincing case for challenging Chen's (1993) results. The
usual disclaimer applies.

Indexing (details)
Defense spending, Studies, Causality, Economic growth, Statistical
analysis
China
9179 Asia & the Pacific, 1130 Economic theory, 9130 Experimental/
theoretical
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Wolde-Rufael, Yemane
Journal of Economic Studies
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