A peace dividend for Sri Lanka: The case for a return to prosperity following the end of hostilities

Throughout its long years of civil war, Sri Lanka maintained a healthy rate of GDP growth and increasing levels of military spending. Now that the war has ended, Sri Lanka faces the challenge of rebuilding and switching to a peace-time economy with potentially lower levels of defense spending. We employ a cointegration analysis and an error correction model to examine the relationship between non/military spending in Sri Lanka and identify the possible economic benefits of decreased military spending. We find that GDP growth in Sri Lanka is generally not responsive to military spending, but responds positively to non-military spending. Although non-military spending exerts a positive effect upon economic growth compared to military spending, the outcome is still sub-optimal due to the absence of an income multiplier effect. This prefaces potentially good economic news for Sri Lanka in the coming years assuming that hostilities do not resume, that the government can successfully divert resources from the military to the non-military sector and that private sector investment can be effectively encouraged to exert a crowding in effect.