TRADE OPENNESS AND THE COMPOSITION OF PUBLIC EXPENDITURE: EVIDENCE FROM TRANSITION ECONOMIES

The relationship between trade openness and the composition of central-government expenditure in transition economies is examined. The analysis is framed by two competing theoretical approaches – the compensation hypothesis and the efficiency (or disciplining) hypothesis. A budget-constraint channel is also considered, whereby trade liberalisation reduces trade-tax revenue and, when this loss is not fully offset by other tax revenues, may constrain the fiscal space available for particular expenditure categories. Using an unbalanced panel of 27 post-socialist economies over 1995– 2023, the relationship between four expenditure shares and trade openness is estimated using two-way fixed effects and Driscoll–Kraay standard errors. The pooled estimates provide no robust evidence that trade openness affects the share of subsidies and other transfers, nor do they support the budget-constraint channel with respect to transfers. The negative baseline association with the share of goods and services is not robust. The results vary across country groups: among the eleven economies that joined the European Union, trade openness is associated with a higher share of transfers, whereas no such association is observed among the other economies.