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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.
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).
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.
Null Hypothesis: Ho=There is no significant difference in comparison between
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.
Null Hypothesis: Ho=There is no significant difference in comparison between
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.
Null Hypothesis: Ho=There is no significant difference in comparison between
changes in spending on defense R&D and total welfare spending in NATO countries.
Alternative Hypothesis: Ha= As percent change in spending on a country’s
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.
Null Hypothesis: Ho=There is no significant difference in comparison between
changes in spending on defense personnel and total welfare spending in NATO countries.
Alternative Hypothesis: Ha= As percent change in spending on a country’s
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
+ELECTION+WARDEATHS+TENSION+ %UNEMPLY
+ %INFLAT
%TOTALWEL= - %R&D + %TOTALEXP+CHIEFPOL+LEGPOL
+ELECTION+WARDEATHS+TENSION+ %UNEMPLY
+ %INFLAT
%TOTALWEL= - %PERSONNEL + %TOTALEXP+CHIEFPOL+LEGPOL
+ELECTION+WARDEATHS+TENSION+ %UNEMPLY
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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 Development of European Defense Industrial Capabilities Across Market
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22
“The Color of Money:” Defense Resource Allocation and Social
Spending Tradeoffs in NATO Countries 1980-2003
Brent Eastwood
POLS 555
Dr. Studlar
19APR04