Globalization, fractionalized governments and expansionary fiscal policy

Purpose - As a response to challenges that globalization poses, governments often utilize an expansionary fiscal policy, a mix of increased compensation spending and capital tax cuts. To account for these policy measures that are consistent with neither the compensation nor the efficiency hypothesis, this study examines government fractionalization as the key conditional factor. Design/methodology/approach - We test our hypothesis with a country-year data covering 24 OECD countries from 1980 to 2011. To examine how a single country juggles compensation spending and capital taxation policies jointly, we employ a research strategy that classifies governments into four categories based on their implementation of the two policies and examine the link between imports and fiscal policy choices conditioned on government fractionalization. Findings - This study shows that highly fractionalized governments are more likely to implement an expansionary fiscal policy than marginally fractionalized governments as a policy response to economic globalization and import shock. Social implications - Our findings imply that fractionalized governments are likely to face budget deficits and debt crises, as the expansionary fiscal policy persists over time. Originality/value - By examining government fractionalization as one of the critical factors that constrain the fiscal policy choice, this study enhances our understanding of the relationship between economic globalization and compensation or efficiency policies. The arguments and findings in this study explain why governments utilize the seeming incompatible policy preferences over increased compensation spending and reduced capital tax burdens as a response to globalization, potentially subsuming both hypotheses.