Theory and Applied Fiscal Policy

1. Introduction

The development process of developed countries brought out high government debt. In other words, the development of countries was associated with high government debt (Mencinger et al., 2014). Hence, the government debt issue has become a vital agenda following the 2008 global financial crisis in the European Union (EU). The government debt issue is not specific to the EU; in most advanced countries, the government debt has reached a record level (Schuknecht, 2022). Specifically, the EU is one of the most indebted groups in the world. According to Schuknecht (2022), the debt problem originated from a high deficit during bad economic conjunctures and increasing expenditure during the good economic conjunctures. Also, due to the slowdown of economic growth, the government debt did not decline. However, recent data shows us that the EU’s general government deficit declined from −4.7% in 2021 to −3.3% in 2022, which remains an essential problem in the EU. Regarding this, the general government debt ratio over GDP was 83.5% in 2022. Greece, Italy, Portugal, France, Spain, and Belgium are the most indebted countries in the EU (Eurostat, 2023a).

Government debt is not only affected by domestic macroeconomic conditions. Along with globalization, financial and trade openness are critical factors affecting government debt. The world economy has become more open regarding finance and trade since the 1980s. As part of globalization, the mainstream view emphasizes that financial and trade liberalization fosters economic growth in developing countries. However, as experienced during the global financial crises (GFC), financial liberalization has exposed significant risks for developing countries.

Cameron (1978) and Rodrik (1996) assert that government expenditure increases in countries exposed to external shocks. In terms of compensation hypothesis, the impact of globalization on government debt occurs through different channels. Firstly, economic globalization increases government expenditures. Because of trade and financial integration lead to external risks and uncertainties. Hence, governments tend to use government expenditures as a policy to protect their citizens from the harmful effects of economic globalization. Secondly, along with globalization, international competition forces developing countries to reduce trade taxes. It is well-known that tax revenue is an important income source for developing countries. Decreasing tax revenue causes a rise in borrowing and increases fiscal deficit (Bataka, 2023). In contrast, the efficiency hypothesis supports that economic globalization reduces tax revenue, welfare policies, and government expenditures. Therefore, economic globalization tends to be more competitive and reduce government size (Kim et al., 2018; Tanzi, 2004; Cengiz & Manga, 2021). Specifically, the interaction between financial development and government debt occurs via some mechanisms. (i) Financial development stimulates the accessibility to foreign funds. Hence, with increasing financial development, government debt in developing countries increases as well; (ii) As mentioned above, in terms of the compensation hypothesis, economic globalization triggers government intervention to prevent welfare losses; (iii) Another possible link occurs through the growth effect of financial development. Financial development incentivizes economic growth and negatively affects government debt (Dong, 2021).

Over the past decade, there has been a rapid liberalization process in most developing countries. The Visegrad Group (Poland, Czechia, Slovakia, and Hungary) (V4) is one of the groups in the EU that started to liberalize their economy in 1990. The V4 countries have a similar and common interest in the EU, and since the beginning of the 1990s, they have progressively liberalized their markets.

As shown in Figure 1, economic globalization has increased in all V4 countries. From 1993 to 2021, the economic globalization index increased from 59, 54, 40, and 51 to 81, 81, 73, and 81 in Czechia, Hungary, Poland, and Slovakia, respectively. Adopting liberal policies inevitably tends the V4 countries to reduce trade and financial barriers. To make a comprehensive analysis, it is necessary to investigate the trend of government debt in the V4 countries. In other words, assessing whether globalization increases at the expense of rising government debt is essential. Figure 2 plots the general trend of government debt in the V4 countries. On average, government debt is higher in 2022 compared to 2000 in all V4 countries. The share of government debt over GDP was 36.4% in 2000 in Poland, and it has risen to a record level of 57.2% in 2020 and decreased to 49.1% in 2022. In Czechia, it was 17.0% in 2000; it steadily increased in 2013 to 44.4% and started to decline until 2020; after that, it began to increase. In Slovakia, the government debt was 50.5% in 2000; it decreased to 28.6% in 2008. Following the GFC, the debt again rose to 57.8% in 2022. Hungary is the most indebted country in the V4 countries. In 2000, the government debt was 55.7%, and sharply increasing to 80.3% in 2011; from 2012, it slightly declined and dropped to 73.3% in 2022.

The theoretical framework offers different channels through which economic globalization affects government debt. However, in the empirical literature, the connection between economic globalization and government debt is ambiguous and could be more apparent. The controversial results can be attributed to using different indicators, samples, and econometric methodologies. The current study aims to investigate the impact of economic globalization on government debt in the V4 countries, including Poland, Czechia, Slovakia, and Hungary, spanning the period 2001–2021. The contribution of our paper is threefold. This is the first study investigating the association between economic globalization and government debt in the V4 countries. Secondly, we observe the role of financial and trade liberalization separately. Thirdly, we perform an augmented mean group (AMG) estimator, a second-generation estimation technique. The AMG estimator provides efficient, robust, and reliable results regarding cross-sectional dependence (CSD) and slope heterogeneity (Jian et al., 2022; Eberhardt & Bond, 2009). Following the Introduction Section, the remainder of the paper is organized as follows: Section 2 summarizes the literature review. Section 3 describes variables and provides empirical methodology and estimation techniques. Section 4 reports empirical findings and discusses findings. Section 5 presents the conclusion and policy recommendations.

3 Methodological Design

This study’s methodological structure is designed to include data description, model specification, and estimation strategy