European NATO Fiscal Space before the Russo-Ukrainian war

Abstract

The threat of war limits the fiscal space via direct fiscal items and indirect macroeconomic flows. The Russo-Ukrainian war has edged the fiscal challenge of the growing need for military spending in different regions of Eu-rope. This study examines the impact of war-related threats on the fiscal capacity of European NATO countries. The research employs cluster analysis to evaluate the preparedness of these countries to reallocate fiscal re-sources in response to these pressures. Furthermore, the paper utilizes a dynamic panel Generalized Method of Moments (GMM) regression model to assess the influence of fiscal space determinants and geopolitical risk factors on military expenditure. The cluster variables are: military expenditures per capita in USD, public finance risk expressed as the credit default swap (CDS) spread, gross public debt representing the original sin, tax wedge as a mitigating items of reallocation of expenditures, the Gini coefficient as the origin of social spending needs, and finally distance from Russia as the pressure of military threat on the public finances. The GMM regression is extended with geopolitical risk indicators, development indicator and economic growth. The findings suggest that while a country’s level of development is a primary determinant of its per capita military spending in USD, the fiscal space exerts a particular influence on these expenditures, too.