The impact of military spending cutbacks on economic activity in an incentive-wage two-sector aggregative economy

We examine the theoretical outcomes of disarmament on economic activity in a two-sector model of endogenous equilibrium unemployment rate. Three main shocks are analyzed: Exogenous cutbacks in military spending on the capital good and employment, and a reduction in public sector debt. The first shock is contractionary for equilibrium employment if the capital-goods producing sector is relatively labour-intensive but expansionary under the alternative factor intensity assumption. The second shock is contractionary for employment under either relative factor intensity assumption. If Ricardian equivalence fails, a reduction in public sector debt is likely to expand long-term employment (JEL E24).