China’s defense spending has been hitherto perceived in two dimensions—international academic opinion on the transparency of China’s defense expenditure and the reasons for its growth, and domestic researchers’ analysis of the relationship between public expenditure and economic development in China. There is no consensus on the impact of the changes in the 20th century global military landscape on China’s defense expenditure requirements. This study combines Smith’s (1989, 1995) neoclassical defense expenditure demand and Schelling’s (1960, 1966) deterrence models for an econometric analysis of the factors influencing China’s defense expenditure demand between 1978 and 2018. The results show that China’s defense spending during this period is mainly affected by its military expenditure in the previous period, the relative changes in defense expenditure of the military superpowers, namely, the USA and the Soviet Union (Russia), as well as China’s economic development. At present, the dominance of the USA, which ranks first in the world in terms of military expenditure, and the lack of comparable military superpowers may be an important source of China’s external threat perception. This study sheds light on the reasons for the changes in China’s military expenditure over the past 40 years and empirically establishes the relevance of Schelling’s deterrence theory for modern strategic military analyses.

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