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Financial openness and the size of the public sector: a portfolio approach

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Erauskin-Iurrita, Inaki

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Abstract

A good deal of time has been devoted to whether more open economies have bigger governments (compensation hypothesis) or sma-ller ones (efficiency hypothesis). However, most of the research has been focused mainly on trade openness, which is clearly restrictive in a world with increasingly integrated financial markets. This paper offers an alternative view to the relationship between financial openness and some key economic variables (the size of the public sector, ...), based on a portfolio approach. A central result of the model is that an open economy implies a higher consumption-wealth ratio, lower growth, higher welfare, and a higher size of the public sector than in a closed economy due to the risk diversification that an open economy allows. The empirical evidence for 22 OECD countries in the period 1970-2004 broadly supports the main results of the model.

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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 10564.

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Date of creation: 15 Sep 2008
Date of revision: 15 Sep 2008
Handle: RePEc:pra:mprapa:10564

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Related research
Keywords: Financial openness; consumption-wealth ratio; growth; welfare; optimal size of the public sector.;

Find related papers by JEL classification:
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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  6. Turnovsky, Stephen J., 1999. "On the role of government in a stochastically growing open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 23(5-6), pages 873-908, April. [Downloadable!] (restricted)
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  7. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, December.
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  9. Stephen J. Turnovsky, 2000. "Methods of Macroeconomic Dynamics, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262201232, December.
  10. Dani Rodrik, 1998. "Why Do More Open Economies Have Bigger Governments?," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 997-1032, October. [Downloadable!] (restricted)
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  11. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April. [Downloadable!] (restricted)
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  12. Turnovsky, Stephen J., 1996. "Fiscal policy, growth, and macroeconomic performance in a small open economy," Journal of International Economics, Elsevier, vol. 40(1-2), pages 41-66, February. [Downloadable!] (restricted)
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