Fiscal space, institutions, and sustainable development across fiscal regimes

Achieving sustainable development requires substantial and sustained public investment, yet many governments face growing fiscal constraints arising from high public debt, limited revenues, and increasing expenditure pressures. This creates an important policy challenge: whether governments can maintain sufficient fiscal capacity to support sustainable development and whether strong institutions can improve the effectiveness of fiscal resources under different fiscal conditions. This study examines the nonlinear relationship between fiscal space (FS), institutional quality (IQ), and sustainable development (SD), with particular emphasis on the moderating role of institutional quality across fiscal regimes. Using a balanced panel of 54 countries from 2002 to 2023, the study applies a two-stage empirical approach. First, Panel Threshold Regression identifies an FS threshold of 2.1267, separating countries with ample fiscal space from those with constrained fiscal space. Second, Bayesian regression assesses the effects of FS, IQ, and their interaction within each regime. The results show that a higher FS ratio, reflecting greater fiscal pressure, is negatively associated with SD in both regimes. In the ample fiscal space regime, the posterior mean of FS is −5.2303, while the interaction term is positive at 1.3757, indicating that stronger institutional quality moderates the adverse effect of rising fiscal pressure. In the constrained fiscal space regime, FS remains negatively associated with SD (posterior mean = −3.2021), while institutional quality substantially mitigates this adverse effect, as reflected in the positive interaction coefficient of 2.2332. These findings show that institutional quality improves the effectiveness of fiscal resources and reduces the developmental costs of fiscal pressure across fiscal regimes. The study therefore highlights the importance of combining fiscal sustainability with institutional strengthening in strategies aimed at advancing sustainable development.