The Effects of International Openness on the Public Sector Growth: An Evidence from OECD Countries

The Effects of International Openness on the Public Sector Growth: An Evidence from OECD Countries

Ali R. Özdemir (Gazi University, Turkey)
DOI: 10.4018/978-1-5225-0053-7.ch006
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Abstract

Using Ordinary Least Squares (OLS) with panel corrected standard errors for OECD panel data this chapter, in contrast to Compensation hypothesis, finds a negative relationship between openness and the rate of public sector growth. In addition, this inverse relationship is found to be the strongest when electoral systems are more competitive. The empirical results presented here also suggests that openness constrains government growth more when the governments are run by either left-leaning parties or by left-leaning coalitions. This result holds for most measures of government spending and is robust to the inclusion of a wide range of controls. Unlike the existing empirical literature, which focuses on the ‘compensation effect' of openness on government growth, this study supports the ‘competition effect' of openness drawn from the literature on local public finance.
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2. Literature Review

Reported in the literature are two distinctly opposing effects of openness on national government size. At one extreme, openness is associated with a higher rate of government growth due to its exposure to external risk and macroeconomic instabilities. At the other extreme, openness is associated with a slower rate of government growth through its effect on fiscal competition. Both explanations seem appealing. According to the “compensation hypothesis”, government spending grows faster because of risk-reducing demands by citizens’ fear of greater external risk. According to the “competition hypothesis” however, inter-jurisdictional tax competition for mobile factors of production in open economies helps to tame the Leviathan or lowers the public sector provision.1

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