DP1388 Why do More Open Economies Have Bigger Governments?

Author(s): Dani Rodrik
Publication Date: May 1996
Keyword(s): Fiscal Policy, Government, Openness
JEL(s): E62, F15, H1
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1388

This paper demonstrates that there is a robust empirical association between the extent to which an economy is exposed to trade and the size of its government sector. This association holds for a large cross-section of countries, in low- as well as high-income samples, and is robust to the inclusion of a wide range of controls. The explanation appears to be that government consumption plays a risk-reducing role in economies exposed to a significant amount of external risk. When openness is interacted with explicit measures of external risk, such as terms-of-trade uncertainty and product concentration of exports, it is the interaction terms that enter significantly, and the openness term that loses significance (or turns negative). The paper also demonstrates that government consumption is the ?safe? activity, in the empirically relevant sense, in the vast majority of countries.