Government expenditure, debt and fiscal adjustment in small states

Abstract

Using a new fiscal dataset for small states, this paper analyses the link between country size, government size, debt, and economic performance. It finds that on average small states have larger governments and higher public debt. Although there are intrinsic factors that explain why governments are bigger in small states, those with smaller governments and lower public debt tend to grow faster and are less vulnerable and more economically resilient to external shocks. Large fiscal adjustments, primarily through expenditure restraint, can underpin growth, especially when embedded in an economic reform programme. Since better governance is associated with lower debt, fiscal adjustment should be supported by governance improvements.