Working Paper: CEPR ID: DP1388
Authors: Dani Rodrik
Abstract: 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.
Keywords: openness; fiscal policy; government
JEL Codes: E62; F15; H1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| openness (measured by the share of trade in GDP) (F43) | size of government (measured by government expenditure as a share of GDP) (H11) |
| openness in the early 1960s (P17) | expansion of government consumption (H59) |
| government consumption (E20) | risk-reducing function in economies facing external shocks (F41) |
| increase in external risk (F65) | greater income volatility (E25) |
| larger government sector (H10) | stabilize income (E63) |
| openness and measures of external risk (O36) | size of government (H11) |