In essence, the CIA was using what today we would call PPP to compare the budgets of the two superpowers, a concept that Bill Greenwalt uses to raise the Chinese budget from the SIPRI amount of between $184 billion and $252 billion to $518 billion.
… Not only does Greenwalt argue that the Chinese budget is really more than twice as large as the official estimate, but that there are about $200 billion of non-defense items embedded in the US defense budget such as health care and grocery stores…
A much better comparison for determining whether we need to increase or decrease defense spending is to compare, in real terms, what we spent during the Reagan buildup or the peaks of the Korea and Vietnam Wars to our current level. Doing so shows that $753 billion, which is the proposed budget of the Biden administration for 2022, is substantially higher. While there is no doubt that Chinese military power is increasing, it is still nowhere close to that of the former Soviet Union, and somehow we won the Cold War even though the Soviets theoretically outspent us.
That was former ASD Lawrence Korb, China Is Not Outspending US On Defense; ’22 Budget Is Enough. He was responding to Bill Greenwalt’s article, China Already Outspends US Military? Discuss.
There are two things going on. First is the point of converting Chinese military expenditures into US Dollars for apples to apples comparison. Korb argues that Market Exchange Rates (MER) should be used while Greenwalt argues for the Purchasing Power Parity (PPP).
I’ll chime in to say that there is little doubt in my mind that the PPP should be used on purely economic grounds. I detail the rationale here and discuss it with professor Richard Connolly here. Here’s the essence:
The Market Exchange Rate fails because:
- It reflects the supply/demand for currency based on international trade. Not only is this figure swayed by market speculation, the things military’s buy are not well reflected by the things internationally traded (we don’t trade for Chinese labor or military sensitive technologies).
- China actively manipulates its currency. China makes sure its currency is undervalued in the MER to boost industrial production and exports. This fact alone means that the MER severely understates China’s real military spending.
The Purchasing Power Parity does better because:
- It compares the prices of a basket of consumer goods which includes traded and non-traded goods. Everyone knows that the price of services like haircuts are relatively cheaper in poorer nations, meaning a Chinese consumer can afford more consumption than the MER would make it appear. That’s why economists prefer the PPP. This is especially important considering that more than half of US military spending is on services!
- Some may fault the PPP for not measuring the prices of military outputs, but we don’t want that because (1) it would be highly subjective and (2) we care about the real resources made available to military planners and not the outputs of their decisions. The cost-effectiveness of military decisions is interesting, but not the point of the debate.
- A consumption basket better reflects relative prices of military inputs. The Chinese military competes for labor and materials with the commercial economy. And consumer prices reflect the costs of labor and capital inputs to the production process. While we would prefer a PPP based on military inputs, that is unavailable and the consumption PPP gets us pretty close (see the blog post for more details).
In the MER vs. PPP debate, the clear winner is Bill Greenwalt. SIPRI, the international organization with a bunch of PhDs, has an objectively poor rationale for their choice of the Market Exchange Rates. But SIPRI has its own motivations for coloring the analysis in a particular way. I don’t really care one way or another, I just want to know what makes the most economic sense.
And that takes us to the second issue of composition. The US defense budget may include $200B or more in healthcare, commissaries, and so forth, but it doesn’t include $260B for the Veteran’s Administration. However, I simply have no clue whether China funds retirement, healthcare, subsidized food, etc., through its military budget or otherwise. One thing I could find comes from CSIS:
… perquisites for retired senior officers — including offices, assistants, and special access to hospital facilities — are all funded through China’s defense budget. In many other countries, these functions and associated costs are typically incurred by nonmilitary organizations.
In the question of composition, I don’t quite know where to land. Perhaps China’s military budget does include more costs like benefits or social programs than does the US. But we do know that China wants to manipulate its budget to appear lower than in reality. So I call the composition problem a wash until I find better information.
In the end, Lawrence Korb says that the better way to analyze whether the US spends enough on defense is to look at the Reagan buildup in the 1980s, and concludes that today’s budget is more than enough. Here is Korb testifying to the Senate in May 2021:
Defense budgets during the Reagan years represented 7% of Gross Domestic Product (GDP), whereas President Biden’s budget proposal is 4% of GDP.
The DoD’s budget peaked at 6.81% of GDP in 1982. With GDP standing at $3.32B in 1982, that translates into $221B in then year dollars. If we take 6.81% of GDP in 2020 ($20.93B), then we get a defense budget of $1.43 trillion. That’s double where we are today. So Korb’s own conclusion makes no sense.
What Korb must have done is take the Reagan era defense budget and adjust it for inflation. Using the GDP Price Index to measure inflation, a dollar in 1982 was worth about 44 cents today. That method returns ($221B divided by .44 =) $502B. But the economy grows faster than inflation, as do the prices of military inputs like labor, aircraft parts, shipbuilding equipment, etc.
[Update: I’ve been informed that the Ministry of Industry and Information Technology is responsible for some military RDT&E. It’s not clear what proportion of military RDT&E is funded in their defense budget, especially considering civil-military integration may keep state-owned enterprise development off the defense budget.
Also, Peter Robertson from the University of Western Australia developed an initial military PPP. It estimates that the Chinese budget at 79% of the US.]
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