Unobserved common factors in military expenditure interactions across MENA countries

In this paper we explore the patterns of interactions between military expenditure shares in the MENA region over the period 1979-2007. We explore if there are latent common factors that impact on the military expenditures of 15 countries in the MENA region and whether these factors can be interpreted. Unobserved common factors induce cross-sectional dependence and may lead traditional panel-time series estimators to be inconsistent. To identify these latent factors we apply the Principal Component Analysis. We evaluate the interpretation of the estimated factors using the Multiple-Indicator Multiple-Cause model. We found that there is a substantial evidence of cross-sectional dependence in the MENA region, induced mainly by two unobserved factors, but these factors are difficult to interpret.