The Impact of Globalization on Components of Government Expenditures in Iran

Over the past few decades, globalization has affected most economic indicators. In this regard, one of the most important questions raised by economists is that how much does globalization affect government spending?
A large body of literature deals with the economic determinants of government size, have put forward two hypotheses:
1. Country size emerges from a trade-off between the economies of scale in supplying public goods in large countries, and the costs of cultural and ethnic heterogeneity, which may be increasing in the size of countries. This result hinges critically on the assumption that, when you can share the costs of partially or completely non-rival public goods over larger populations, per capita expenditure on these goods is lower.
2. To the extent that market size influences productivity, large countries can afford to be closed, while small countries face stronger incentives to remain open; conversely, as trade liberalizes, regional and cultural minorities can afford to split because political borders do not identify the size of the market; therefore, smaller countries can enjoy the benefits of cultural homogeneity without suffering the costs associated with small markets. This hypothesis points toward a negative relationship between country size and the degree of globalization.
 
In this paper, we examined the composition of public expenditures rather than the overall level. Economic theory suggests different kinds of government expenditures to react differently to globalization. According to the disciplining hypothesis, globalization restrains governments by inducing increased budgetary pressure. As a consequence, governments shift their expenditures in favor of transfers and subsidies and away from capital expenditures. The efficiency/disciplining effect is thus expected to reduce the share of capital expenditures.
 
To measure globalization, we employ various proxies, the first is openness to trade measured as the sum of imports and exports as a share of GDP. The second indicator of globalization is the sum of the absolute values of inflows and outflows of foreign direct investment (as a share of GDP), and the third refers to KOF Index of Globalization. The index captures the three main dimensions of globalization – economic integration, political integration and social integration. It is based on a large number of variables that relate to the three main dimensions of globalization. These variables have been combined to form six groups: actual flows of trade and investment, restrictions of international transactions, variables measuring the degree of political integration, variables quantifying the extent of personal contacts with people living in foreign countries, variables measuring trans-border flows of information, and a proxy for cultural integration. These six groups are combined to form the three sub-indices and one overall index of globalization with the help of an objective statistical method. We employ the overall index and the three sub-indices.
 
The purpose of this paper is to test the effectiveness and compensatory hypothesis in examining the effect of globalization on the productive and unproductive expenditures of the Iranian government over the period of 1368-94. Government expenditures are initially divided into capital and consumed expenditures and then it divided into productive and unproductive components, then relationship between the globalization indicators and these components expenditures is analyzed in the form of an econometric model using instrumental variables and the two-stage least squares method (2SLS).
 
The results indicate that the KOF index and its economic and social indicators and trade openness (with a coefficient of +6.27) have a positive and significant effect on government consumption expenditures. Also, financial openness (with a coefficient of -4.44) has a negative effect on the government's capital expenditures, but trade openness (with a coefficient of 23.2) has a positive effect on it. In this way, according to the efficiency hypothesis, globalization has led to a reduction in government's capital expenditures.
Based on trade and financial openness effect on productive and unproductive government expenditures, this study finds a consistent result that favors the efficiency hypothesis over the compensatory hypothesis.