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.

Epifani, P., Gancia, G. (2009). Openness, government size and the terms of trade. REVIEW OF ECONOMIC STUDIES, 76(2), 629-668 [10.1111/j.1467-937X.2009.00546.x].

Openness, government size and the terms of trade

Gancia G
2009

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, 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.
Articolo in rivista - Articolo scientifico
size of government
English
629
668
40
Epifani, P., Gancia, G. (2009). Openness, government size and the terms of trade. REVIEW OF ECONOMIC STUDIES, 76(2), 629-668 [10.1111/j.1467-937X.2009.00546.x].
Epifani, P; Gancia, G
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10281/396552
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