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On Globalization and the Growth of Governments

Author

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  • Gino Gancia

    (CREI and UPF)

  • Paolo Epifani

    (Bocconi University)

Abstract

This paper investigates the relationship between trade openness and the size of governments, both theoretically and empirically. We argue 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. Our main theoretical prediction is that the relative strength of the two explanations depends on a key parameter, namely, the elasticity of substitution between domestic and foreign goods. Moreover, while the first mechanism is inefficient from the standpoint of world welfare, the second is instead optimal. In the empirical part of the paper, we provide new evidence on the positive association between openness and government size and we explore its determinants. Consistently with the terms of trade externality channel, we show that the correlation is contingent on a low elasticity of substitution between domestic and foreign goods. Our findings raise warnings that globalization may have led to inefficiently large governments.

Suggested Citation

  • Gino Gancia & Paolo Epifani, 2007. "On Globalization and the Growth of Governments," 2007 Meeting Papers 217, Society for Economic Dynamics.
  • Handle: RePEc:red:sed007:217
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    Cited by:

    1. Gancia, Gino & Bonfiglioli, Alessandra, 2008. "North-South trade and directed technical change," Journal of International Economics, Elsevier, vol. 76(2), pages 276-295, December.

    More about this item

    JEL classification:

    • F1 - International Economics - - Trade
    • H1 - Public Economics - - Structure and Scope of Government

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