Openness and government size: Revisiting the relationship using a large cross-country panel

We reconsider whether and how trade and financial openness can affect government size using panel data on 165 countries over the period 1980-2016. We find a significant inverted U-shaped effect of trade openness on government size but no evidence of a significant effect from financial openness. Further causality tests suggest that trade openness affects government size through various economic volatility channels, and the marginal effect of trade openness on government size also depends on financial openness and trade imbalances. We also find that governments in countries with a floating exchange rate regime have to grow bigger than those with a peg arrangement. The results of the paper extend the findings of Rodrik (1998) and provide a new perspective for understanding the long-standing debate over the relationship between openness and government size.

Automated summary

This paper reconsiders the impact of trade and financial openness on government size and examines the panel data of 165 countries from 1980 to 2016. The study finds a significant inverted U-shaped effect of trade openness on government size, but no significant impact from financial openness. Causality tests suggest that trade openness affects government size through various economic volatility channels and the effect of trade openness on government size also depends on financial openness and trade imbalances. The study also reveals that countries with a floating exchange rate regime have larger governments than those with a peg arrangement.