Journal Article

Openness, Government Size and the Terms of Trade

Paolo Epifani and Gino Gancia

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 76, issue 2, pages 629-668
Published in print April 2009 | ISSN: 0034-6527
Published online April 2009 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2009.00546.x
Openness, Government Size and the Terms of Trade

More Like This

Show all results sharing these subjects:

  • Public Economics
  • International Trade
  • Macroeconomic Aspects of International Trade and Finance
  • Analysis of Collective Decision-making

GO

Show Summary Details

Preview

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, instead, is 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. Consistent 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.

Keywords: D72; F14; F41; H11

Journal Article.  17583 words.  Illustrated.

Subjects: Public Economics ; International Trade ; Macroeconomic Aspects of International Trade and Finance ; Analysis of Collective Decision-making

Full text: subscription required

How to subscribe Recommend to my Librarian

Users without a subscription are not able to see the full content. Please, subscribe or login to access all content.