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Financial openness and the size of the public sector: a portfolio approach

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  • Erauskin-Iurrita, Inaki

Abstract

A good deal of time has been devoted to whether more open economies have bigger governments (compensation hypothesis) or sma-ller ones (efficiency hypothesis). However, most of the research has been focused mainly on trade openness, which is clearly restrictive in a world with increasingly integrated financial markets. This paper offers an alternative view to the relationship between financial openness and some key economic variables (the size of the public sector, ...), based on a portfolio approach. A central result of the model is that an open economy implies a higher consumption-wealth ratio, lower growth, higher welfare, and a higher size of the public sector than in a closed economy due to the risk diversification that an open economy allows. The empirical evidence for 22 OECD countries in the period 1970-2004 broadly supports the main results of the model.

Suggested Citation

  • Erauskin-Iurrita, Inaki, 2008. "Financial openness and the size of the public sector: a portfolio approach," MPRA Paper 10619, University Library of Munich, Germany, revised 15 Sep 2008.
    • Handle: RePEc:pra:mprapa:10619
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial openness; consumption-wealth ratio; growth; welfare; optimal size of the public sector;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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