Does onslaught of globalisation induce pro-efficient government expenditures in a large transitioning economy? Empirical evidence from India

Certain critical minimum requirements like presence of economic, political, social stability along with rules regulating the entry and operation of business which can largely determine FDI inflows in a country. Other factors are standard of treatment to foreign affiliates, business facilitation, investment incentives, market size, growth, structure and accessibility to raw materials, low cost, efficient labour force and physical infrastructures such as roads, telecommunication, ports and power amongst many others. FDI has proven as a major stimulus to growth in developing countries through its contribution to transfers of technology, balance of payments, employment generation and industrial diversification amongst others (Umar and Alabede 2017).

One can examine productivity of government expenditure i.e. how total output including private sector output is responding to both capital and current public expenditures vis-à-vis FDI inflows and private domestic investments, which is not focus of present study. Besides, the issue of whether privatisation and globalisation have led to increasing/decreasing poverty, and therefore resulted in widening income inequality, are extremely important policy issues for ever needing careful investigation for individual countries. However, this is also not focus of this analysis.

Fiscal Responsibility Legislations (FRLs) implemented by Indian States over time although have a bearing on fiscal discipline at the State(sub-central) level in India, but only few states such as Tamil Nadu, Karnataka and Kerala had adopted FRLs little prior (in early 2000s) to Centre’s implementation of Fiscal Responsibility and Budget Management (FRBM) Act in 2004–05, while majority states, except West Bengal and Sikkim adopted their FRLs by 2008. Thus by considering centre’s year of adoption as the period of overall fiscal discipline for the country as a whole, would not require introduction of another fiscal reform dummy for States. Even one introduces, while investigating the effects of fiscal rules on general government capital expenditure and private investment in India, effects of both may overlap.

Blomstrom and Wolff (1989) investigated the difference between productivity growth in local and foreign firms for Mexican industries during 1965 to 1984. They examined the extent to which penetration of a sector by foreign-owned firms affect productivity of local firms in that sector, and whether there is any evidence of convergence in productivity between domestic and foreign industries from USA. They showed productivity levels of locally owned firms in Mexico had converged to those of foreign-owned firms. Considering 15 multinational firms, Mansfield and Romeo (1980) observed only a small share of FDI had accelerated local competitors’ access to new technology.

Maastricht Treaty, formally known as the Treaty on European Union, is an international agreement amongst member countries responsible for creation of the European Union (EU) signed in 1991 for further European integration and it was in force since Nov. 1993. It comprises a group of 28 countries which operate as a cohesive economic and political block and UK leaving the EU since Jan 2020. The treaty paved for creation of Euro. One of the obligations of the treaty for members was to practice "sound fiscal policies, with an annual deficit no greater than 3% of GDP and debt to GDP limit of 60% with intent to achieve price stability. Although many countries had later violated these limits but did not have any implication on their membership with European Economic and Monetary Union (EMU).

The medium term fiscal policy statement released as part of union budget document in 2018, the Finance Ministry mentioned that in a country with numerous development deficits, an undue focus on revenue deficits may be detrimental to equitable development. Human capital and its development by focusing on schools and hospitals and also maintenance of assets, having the nature of revenue expenditures, are as important to improving productivity as buildings and roads. However, the prevailing opinion is that since physical infrastructure is deficient in India, it is useful to fix the deficiency before doing away with targeting revenue deficits. Social infrastructure like health and education should be financed through increases in tax-GDP ratio, while fiscal deficit can be used to finance physical capital formation while keeping revenue deficit in balance.

The efficiency argument posits that enhanced globalisation increases pressure on governments to lower taxes to prevent exodus of mobile capital and attract foreign capital. Since international integration of financial markets also punishes deficit spending, therefore, governments are pressed to reduce their spending. In contrast, ‘compensation’ thesis, framed by David Cameron (1978) argues that governments respond to economic internationalisation not by lowering public spending, but by increasing it. The governments expand the welfare state to cushion deleterious impact of economic openness and external risks (Garrett 1998) which in turn serves as an economic and political precondition for further economic integration (Adserá and Boix 2002).

When there is greater dependence of an economy on foreign markets for its exports, if external demand and prices do not move in correspondence with increased domestic costs (reduces profits of exporting firms) or, alternatively when external demand and prices increase more than the costs (increases their profits), irrespective of profits (high or low), unemployment which is mainly a function of aggregate demand against a given supply capacity, can increase uncontrollably. This implies that any lack of profits in export sector may cause reduction of funds available for capital investment and ultimately affecting income growth. Similarly, by contrast, high export profits may contribute to inflation, when it improves the scope of justifying higher wages in export industries and increases in wages feeds into non-exporting sector through centralised collective bargaining power. Several authors suggest state intervention to reduce vulnerability of an open economy (Cameron 1978).

Private domestic fixed capital formation is interchangeably used as domestic private fixed capital formation or private domestic fixed investment. Since foreign portfolio/equity investments are short term flows, we did not separate out this foreign component of investment from gross private domestic fixed investment while excluding FDI inflows. Moreover, RBI reports these foreign portfolio investments on a net basis. By netting it out, it may underestimate its importance even if one tries it to separate out from gross domestic private investment. The same residual domestic private fixed investment variable which appears as independent variable for government expenditure model is also taken as a dependent variable in our domestic private investment model by substituting with gross private domestic fixed investment.

Computation of user cost of capital draws on the methodology of computing cost of capital services (rental price of capital) for private sector. Following, Hebbel and Miller (1992), user cost of capital (UCC) is equal to ( =) PK = \({\text{(r(1 - t) }} + \delta - \pi^{e}\)))/ P. Where PK = price of capital goods, r = bank lending rate, t = tax rate, \(\delta\) = depreciation rate, \(\pi^{e}\) = expected rate of change in capital goods price (inflation) proxided by previous year’s inflation rate, and P = the general price level. The price of capital goods (PK) is measured in terms of implicit price deflators for gross private fixed capital formation (2010 = 100). The lending rate of State Bank of India (SBI) which is the largest commercial entity having broader financial network in the country is taken to represent the bank lending rate (r). Since year–wise data on income tax rate (t) is not directly available, tax rate is computed by dividing combined government revenues from direct taxes with private sector income in aggregate national income. \(\pi^{e}\) is expected inflation rate on capital goods price P_K, represented in terms of three year moving average of rate of capital goods’ price measured from implicit price deflator for private sector, with a one-year lag. The depreciation rate is assumed to be at a constant rate of 14 per cent per year. Finally, general price level, P is captured from GDP implicit price deflator.

Since there could occur multiple structural breaks in a series, we further subjected incorporated variables to Bai-Perron(1998) structural break tests mostly focusing on breaks appearing in our dependent variables. We tried to take care of common structural breaks occurring in years, 1986–87, 1992–93, 1999–2000, 2004–05, 2007–08, 2014–15 in our estimating models but inclusion of these year dummies neither found significant nor improved our results. Therefore, we report our results without year dummies except FRBM dummy which yielded some significance.