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On Globalization and the Growth of Governments

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Author Info
Paolo Epifani
Gino Gancia ()

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Abstract

This paper investigates the relationship between trade openness and the size of government, both theoretically and empirically. We show that openness can increase the size of governments through two channels: (1) a terms of trade externality, whereby trade lowers the domestic cost of taxation and (2) the demand for insurance, whereby trade raises risk and public transfers. We provide a unified framework for studying and testing these two mechanisms. First, we show how their relative strength depends on a key parameter, the elasticity of substitution between domestic and foreign goods. Second, while the terms of trade externality leads to inefficiently large governments, the increase in public spending due to the demand for insurance is optimal. We show that large volumes of trade may result in welfare losses if the terms of trade externality is strong enough while small volumes of trade are always beneficial. Third, we provide new evidence on the positive association between openness and the size of government and test whether it is consistent with the terms of trade externality or the demand for insurance. Our findings suggest that the positive relationship is remarkably robust and that the terms of trade externality may be the driving force behind it, thus raising warnings that globalization may have led to inefficiently large governments.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 915.

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Date of creation: Nov 2005
Date of revision: Jan 2008
Handle: RePEc:upf:upfgen:915

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Related research
Keywords: Openness; government size; terms of trade externality; elasticity of substitution between imports and exports;

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Find related papers by JEL classification:
F1 - International Economics - - Trade
H1 - Public Economics - - Structure and Scope of Government

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References listed on IDEAS
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alessandra Bonfiglioli & Gino Gancia, 2007. "North-South Trade and Directed Technical Change," UFAE and IAE Working Papers 713.07, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 27 Jun 2008. [Downloadable!]
    Other versions:
  2. Rubén Segura-Cayuela, 2006. "Inefficient policies, inefficient institutions and trade," Banco de España Working Papers 0633, Banco de España. [Downloadable!]
    Other versions:
  3. Alejandro Cuñat & Szabolcs Deák & Marco Maffezzoli, 2008. "Tax Cuts in Open Economies," Working Papers 332, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
    Other versions:
  4. Paolo Epifani & Gino Gancia, 2008. "Openness, Government Size and the Terms of Trade," IEW - Working Papers iewwp359, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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