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

  • Erauskin-Iurrita, Inaki

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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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 10619.

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Date of creation: 15 Sep 2008
Date of revision: 15 Sep 2008
Handle: RePEc:pra:mprapa:10619
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  1. Kraay, A. & Ventura, J., 1997. "Current Acounts in Debtor and Creditor Countries," Working papers 97-12, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Stephen J. Turnovsky, 2000. "Methods of Macroeconomic Dynamics, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262201232, March.
  3. Stephen Turnovsky, 1998. "On the Role of Government in a Stochastically Growing Open Economy," Working Papers 0073, University of Washington, Department of Economics.
  4. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2006. "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004," CEPR Discussion Papers 5644, C.E.P.R. Discussion Papers.
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  6. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October.
  7. Rodrik, Dani, 1996. "Why do More Open Economies Have Bigger Governments?," CEPR Discussion Papers 1388, C.E.P.R. Discussion Papers.
  8. Maurice Obstfeld, 1992. "Risk-Taking, Global Diversification, and Growth," NBER Working Papers 4093, National Bureau of Economic Research, Inc.
  9. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
  10. Wacziarg, Romain & Alesina, Alberto, 1998. "Openness, Country Size and Government," Scholarly Articles 4553014, Harvard University Department of Economics.
  11. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, March.
  12. Kim, So Young, 2007. "Openness, External Risk, and Volatility: Implications for the Compensation Hypothesis," International Organization, Cambridge University Press, vol. 61(01), pages 181-216, January.
  13. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  14. Devereux, Michael B. & Saito, Makoto, 1997. "Growth and risk-sharing with incomplete international assets markets," Journal of International Economics, Elsevier, vol. 42(3-4), pages 453-481, May.
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  16. Liberati, Paolo, 2007. "Trade openness, capital openness and government size," MPRA Paper 44371, University Library of Munich, Germany.
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  18. Devereux, Michael B & Smith, Gregor W, 1994. "International Risk Sharing and Economic Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(3), pages 535-50, August.
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