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Financial Globalization and the Increase in the Size of Government: Are They Related?

Iñaki Erauskin () and Stephen J Turnovsky ()

Open Economies Review, 2019, vol. 30, issue 2, No 2, 219-253

Abstract: Abstract 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.

Keywords: Financial liberalization; Size of government; Borrowing and lending constraints (search for similar items in EconPapers)
JEL-codes: F41 F43 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1007/s11079-019-09525-x

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Handle: RePEc:kap:openec:v:30:y:2019:i:2:d:10.1007_s11079-019-09525-x