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Trade openness, political institutions, and military spending (evidence from lifting Iran’s sanctions)

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Abstract

Under the recent nuclear deal on Iran’s nuclear program, many of the most punishing sanctions are poised to be lifted. This study examines how trade openness (due to lifting the sanctions against trade) could affect the political institutions and military expenditure in Iran based on the available dataset for the period of 1960–2011. Using impulse response functions (IRF) and a variance decomposition analysis (VDC) on the basis of a vector autoregressive (VAR) model, the results imply that the response of political institutions to an improvement in international trade is negative and statistically significant, whereas that of military spending is positive and significant. Moreover, the shocks to trade openness influences military spending more than non-military spending over the all years after the initial shocks. These results are robust to other indicators of political institutions, different orderings of variables in the VAR and alternative specifications of trade, and government revenues and expenditures.

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Notes

  1. International trade can affect government revenues, but not to their distributions among different types of spending. In order to find how trade (through lifting the sanctions) will influence different categories of government spending, we need to take the political characteristics of the government into account. This point was also suggested by one of the referees.

  2. This is more realistic for the case of Iran as it is well known as a resource-abundant country.

  3. Naka and Tufte (1997) demonstrate that the loss of efficiency from VAR estimation is not critical for the short horizon. Engle and Yoo (1987), Clements and Hendry (1995) and Hoffman and Rasche (1996) show that an unrestricted VAR is superior in terms of forecast variance to a restricted VEC model on short horizons. Also see Farzanegan and Markwardt (2009), Farzanegan (2011), Dizaji and Bergeijk (2013), Dizaji (2014) and Dizaji et al. (2016) for the same approach.

  4. Dizaji (2014) finds that the strong causality is running from government revenues to government expenditures (both current and capital) for the case of Iran, while the evidence for the reverse causality is very weak.

  5. FPE and AIC criteria suggest 3 lags to be used in the VAR model to be estimated, but when we use 3 lags to estimate the proposed VAR model, the residual serial correlation LM test and residual normality tests are not satisfied.

  6. Dizaji and Bergeijk (2013) discuss that the positive development in Iranian government revenues and specially oil and gas rents increases the sources for financing imports and other expenditure, and ultimately this changes the political behavior of the government.

  7. Since the GIR results are identical to those obtained by the Cholesky ordering, I have not reported them here. They are available upon request.

  8. The diagnostic statistics results are available upon request.

  9. I also do estimations using a one standard deviation increases in the “positive changes” of exports and imports in two separated VAR models to see if Iranian government become more autocratic and increases her spending on military (non-military), facing positive shocks in exports and imports separately. The results show that a one standard deviation increase in “positive changes” of the Iranian exports (imports) accompanied with negative and statistically significant responses of political institutions (although in the case of using imports as the shock variable the response of democracy index is only marginally significant), and positive and statistically positive response of revenues, defense and non-defense expenditures. The estimations results pass the diagnostic tests. The estimations are available upon request.

  10. The diagnostic statistic results are available upon request.

  11. I also do estimations using a one standard deviation increases in the “positive changes” of the ratio of trade openness to consider the case of asymmetric shocks in line with Mork’s definition of asymmetric shocks. I estimated an unrestricted VAR model with a Cholesky ordering of [positive changes of the trade to GDP ratio, revenues to GDP ratio, Polity2, defense to GDP ratio, and non-defense to GDP ratio]. The results of symmetric and asymmetric shocks by and large agree. The results are available upon request.

  12. - In this case, there is some evidence of autocorrelation among the VAR residuals on the base of LM autocorrelation test.

  13. I also do estimations using a one standard deviation increases in the “positive changes” of the trade openness per capita to consider the case of asymmetric shocks in line with Mork’s definition of asymmetric shocks. I estimated an unrestricted VAR model with a Cholesky ordering of [positive changes of the trade per capita, revenues per capita, Polity2, defense per capita, and non-defense per capita]. The results of symmetric and asymmetric shocks by and large agree. The results are available upon request.

  14. It should be noted that this interpretation is on the basis of historical trends and changes of the variables. I have used available data for the period of 1960–2011 to estimate my VAR models. Although this kind of interpretation by applying previous trends of the variables to simulate their changes and trends in the future has been used in the VAR literature frequently (for example see Farzanegan 2011; Dizaji and Bergeijk 2013; Dizaji et al. 2016), we need to be cautious in generalizing the estimated results for the future as the changes in economic and political conditions may influence the political and spending behavior of the government in the future. This point is raised by one of the referees.

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Acknowledgements

This paper was written while I was a visiting scholar at the International Institute of Social Studies of Erasmus University Rotterdam. I would like to thank ISS for hospitality and support. Special acknowledgement is due to Prof. Peter A. G.van Bergeijk for comments and helpful suggestions. Also, I would like to thank the two anonymous reviewers for their reading of this manuscript and their insightful comments.

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Correspondence to Sajjad Faraji Dizaji.

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Faraji Dizaji, S. Trade openness, political institutions, and military spending (evidence from lifting Iran’s sanctions). Empir Econ 57, 2013–2041 (2019). https://doi.org/10.1007/s00181-018-1528-2

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