Based on attached document, I would like to have a research paper (it is actually my final paper) – Why do more open economies have bigger governments

Why do More Open Economies Have Bigger Governments?
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Abstract
This research paper examines the reasons for the positive relationship between government size and trade openness. Numerous studies have found evidence for the existence of this relationship in many countries, both the developed and the developing. The correlation holds true for all categories of government spending. More so, this paper reports that this relationship tends to be strong as a country’s foreign trade increases, and plays a critical role in cushioning the domestic economy against shocks arising from international markets. As the government spends more, it develops the local economy, thereby making it more resilient against risk spillover from the global markets. Given the positive relationship between openness and government size, this paper supports the view that foreign trade policies may have a significant impact on the economic development of developing countries. It is because, with favorable foreign trade policies and greater international competition, governments in developing countries commit substantial budget resources to enhance the outlook and competitiveness of the domestic economy. Similarly, developed countries spend more on the local economy to boost their trade.

Why do More Open Economies Have Bigger Governments?
In recent years, there has been increasing interest regarding the relationship between openness and government size. The notion that the size of the government may be correlated to openness has been proposed by many economists and researchers and is the basis for numerous theoretical models such as the compensation hypothesis.

There is considerable evidence in research to show that openness exposes countries to greater external risk, which in turn compels countries to have large governments as a guarantee for social insurance. Based on this assertion, this research paper explores reasons why countries with open economies have large governments.
Definition of Terms: Open Economy and Government Size
An open economy refers to a country where there are trade and other economic activities between the outside world and the domestic community. Open economies are characterized by the absence of barriers to international trade. In such economies, exports and imports contribute greatly to gross domestic product. A closed economy, in contrast, is one in which foreign trade activities do not take place. In the modern world, closed economies are virtually non-existent (Alesina & Wacziarg, 1998). Development of international markets and globalization are some of the factors that have made open economies the norm. However, no economy can be said to be fully open as governments often impose control over cross-border movements of capital. The degree of openness in an economy shows the willingness of the government to pursue specific economic policies and influences a country’s exposure to economic cycles in the global economy (Benarroch & Manish, 2002). Open economic models allow countries to access resources, technologies, and materials that cannot be found in the domestic market. It ensures that domestic consumers get access to a variety of goods and services. Often, bilateral and multilateral trade agreements and treaties are signed between open economies to ensure mutually benefitting, free and fair trade.
Government size refers to the volume of expenditure incurred by the government and is usually described regarding government budget. Defense, internal security, health care, education, public service, development projects and social welfare are some of the most common expenditures that determine government size. According to Benarroch and Manish (2002), government size is best understood in relative terms by comparing it to national GDP, which is a measure of national revenue. Studies indicate that government size is positively correlated with national economic growth as well as social outcomes such education attainment and life expectancy. Across the world, government sizes have grown dramatically in during the past century.
Country Size and Openness
Rodrick (1998) argues that as long as countries participate in international trade, they are exposed to external economic shocks and thus need a large government size to play a stabilizing role. According to this a researcher, the size of the government (as determined by the public sector) increases proportionally with a country’s volume of international trade. Essentially, the more a country participates in international trade, the greater the risk exposure and hence the need for a comprehensive public service to absorb the effects of this risk exposure. This hypothesis effectively explains why the highly open economies of Europe such as Norway, Austria, and Netherlands record high shares of government spending relative to national income in terms of GDP.
Rodrick further explains that as countries participate in international trade, they are exposed to various risks, which affect not only the domestic economic programs but also social and economic processes. For this reason, governments turn to the public sector for social insurance against the turbulences emanating from the global markets. In this regard, increased government spending among open economies performs the insulation function, which in turn makes the domestic economy more stable and capable of competing internationally. It means that in countries that rely exclusively on foreign trade, external risks are mitigated significantly by having the public sector take command of a large share of resources.
The above view is supported by Alesina and Wacziarg (1998), who argue that participation in free trade enables countries to reach higher levels of social welfare and economic growth, and these achievements are evidenced by increased government spending. More international trade stimulates greater economic activity in the home market (Benarroch & Manish, 2002). For the increased economic activity to be sustained in the long run, the government must intervene in economic processes by providing necessary infrastructural and social services. It means that trade openness and the willingness by countries to participate in international trade entices governments to take stock of resources and capital to improve productivity.
In their study, Benarroch and Manish (2002) investigated the nature of the relationship between economic growth and the level of participation in global trade. The findings of this study showed evidence for unidirectional causality linking trade openness and economic growth. The study further revealed that government expenditure increases in proportion to the potential adverse trends in the international economy. In other words, if a country perceives greater vulnerabilities as a result of its participation in international trade, it will increase the size of government spending to absorb the shock. In the converse (though less likely), the absence of risks in the international market will result in less government spending in the local economy.
According to Benarroch and Manish (2002), the relationship between openness and government size can be explained using the compensation hypothesis. This hypothesis states that increased international trade causes the domestic economy to be dependent on the economic development of foreign trade partners. Since foreign trade partners may pursue different economic policies, the government has to provide social insurance against slow economic development in the international market. This view explains why the world’s most developed economies have huge government expenditures and high volumes of international trade (Alesina & Wacziarg, 1998). For example, the United States of America’s big government size is positively related to its participation in international trade. Being among the largest exporters and importers in the world, the US has a robust public expenditure program, which protects the domestic economy from fluctuations in international trade. Similarly, trade openness in many developed countries such as Japan, Canada, Britain, and Germany has resulted in governments responding to increased trade activity through more public expenditure. Compared to smaller economies, these developed countries have huge public services and are the leading players in international trade.
In a world with limited or nil international trade,y markets are identified by political boundaries. In contrast, the more a country trades with the outside world, the less the need to identify with politically defined markets. This assertion has two important implications. First, as global trade becomes open, different countries find it plausible to break away from overreliance on domestic markets. More generally, countries find it beneficial to participate in international trade (Alesina & Wacziarg, 1998). Conversely, as small countries take center stage in the global economy, a supportive trade regime become favorable, precisely because the small countries need more trade to attain high levels of economic viability. In other words, struggling economies face more incentives to promote open economic policies so as to access large markets. This means that although small countries (in terms of population and size) may face limitations regarding resources, they nonetheless have incentives to increase government spending and participate more in international trade. Without international trade, countries can easily lose their economic competitiveness and the ability to control the domestic economy.
Rodrick (1998) sought to determine whether the relationship between government size and openness is stronger in countries that are exposed to greater external risks. The study found that in countries with minimum market imperfections, external terms of trade are the main measure of external risk. It is for this reason that as countries trade more, they commit more resources to public expenditure with direct links between trade volumes and government size (Alesina & Wacziarg, 1998). To the extent that there are economies of trade linked to participation in international trade, open economies will always have a large share of government expenditure in relation to closed economies and those that have restricted their involvement in international trade. As a matter of fact, there are economies of scale derived from establishing institutions as well as monetary and legal systems to foster unrestrained participation in international trade. Indeed, countries that play a bigger role in international trade report better economic outcomes at the domestic front.
According to Alesina and Wacziarg (1998), increased government spending can cause a massive decline in the domestic economy unless the government allows foreign trade to prevail. It points out to the fact that the two variables (openness and government size) cause each other. In essence, the two variables are positively correlated such that they are mutually reinforcing. It means that, in the absence of international trade, the size of the government will decrease significantly and vice versa (Benarroch & Manish, 2002). This phenomenon perfectly captures the reality of the modern economic systems, where countries that participate more in international trade have big government sizes that those whose level of international trade is small. Overall, there is sufficient evidence from research to support the notion of positive causality between government size and trade openness.
Implications
A key implication of the above findings is that it is difficult to disentangle economic growth and foreign trade. As explained by Alesina and Wacziarg (1998), a higher degree of participation in foreign trade (openness) causes a proportionate increase in government spending and hence the government size. In turn, increased government size boosts higher levels of economic growth. Therefore, countries that wish to enhance their economic competitiveness should pursue policies that promote openness. Ideally, an open economic regime will translate into rapid economic development as the government is forced to increase its spending in crucial social and economic systems (Benarroch & Manish, 2002). In this regard, developing countries should implement favorable foreign trade policies so as to support their domestic economies. Emerging economies such as India, Brazil and China have stepped their involvement in international trade, and this has enabled them to make good progress in terms of domestic economic growth.
Since government size and openness are complementary, increased foreign trade is often seen as an attempt to enhance the effectiveness of government action at the domestic level. In many countries, the private sector is a major player in the international trade (Alesina & Wacziarg, 1998). This means that it is imperative for governments to offer incentives for the private sector to participate more in international trade (Benarroch & Manish, 2002). These incentives should be mainly in the form of increased spending on infrastructure development as well as in the implementation of supportive policy regimes. Favorable trade policies facilitate rapid movement of more capital into the country, which boosts the local economy. Policies also make it easier for local investors to pursue investment opportunities in foreign markets. All these result in enhanced competitiveness in a country’s international trade, which translates into increased government spending.
Conclusion
The goal of this paper was to explain why open economies have big governments. As noted in the preceding discussion, increased government spending serves to absorb risks inherent in the international markets. Openness stimulates greater government expenditure especially in economies that are subjected to greater external risks. As such, increased foreign trade compares favorably with expansion in government size. It can be noted that in the past few decades, the scope of government spending in many countries has increased in parallel to the level and volume of international trade. Overall, there is sufficient evidence from research to support the notion of positive causality between government size and trade openness.
References
Alesina, A., & Wacziarg, R. (1998). Openness, country size, and government. Journal of Public Economics, 69, 305–321.
Benarroch, M., & Manish, P. (2002). The relationship between trade openness and government size: Does disaggregating government expenditure matter? Journal of Macroeconomics, 34, 239–252
Rodrick, D. (1998). Why do more open economies have bigger governments? Journal of Political Economy, 106(5), 997-1032.