Financial Globalization and the Increase in the Size of Government: Are They Related?
We employ a stochastic growth model to study the impact of international financial liberalization and changes in volatility on the share of government consumption in GDP. Financial liberalization is specified in terms of reducing the costs of both foreign lending and borrowing. The mechanism is their impact on the international portfolio and its consequences for the share of domestic capital and its effect on domestic activity. Reduced foreign lending costs tends to divert resources from the domestic economy, raising the share of domestic output allocated to the government, while reducing borrowing costs have the opposite effects. Consequently more international financial liberalization is associated with larger governments in creditor countries, but not necessarily so in debtor economies. These results are supported by numerical simulations, as are our results for volatility. The empirical evidence, using the most recent data for a sample of 95 countries over the period 1990 to 2015 also broadly supports the main findings of the model.
KeywordsFinancial liberalization Size of government Borrowing and lending constraints
JEL ClassificationF41 F43
We thank the Editor-in-Chief George S. Tavlas for his constructive suggestions. Iñaki Erauskin acknowledges financial support from Programa de Movilidad del Personal Investigador del Departamento de Educación, Política Lingüística y Cultura del Gobierno Vasco and Programa de apoyo a los grupos del sistema universitario vasco del Departamento de Educación, Política Lingüística y Cultura del Gobierno Vasco (Grupo de investigación IT885-16). This paper was written in part while Iñaki Erauskin was visiting the University of Washington. An earlier version of this paper has benefited from comments received at the 2018 Simposio de Análisis Económico in Madrid. Stephen J. Turnovsky’s research was supported in part by the Van Voorhis endowment at the University of Washington.
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