In this paper, the authors employ a portfolio approach based on a two-country world to study the impact of financial openness on the size of government and on other key economic variables, including the consumption-wealth ratio, the growth rate of wealth, and welfare (assuming that public spending is utility enhancing). The model suggests that the size of government, the consumption-wealth ratio, and welfare should be greater in an open economy because of higher productivity and/or less volatility because of risk sharing. The theoretical results for the growth rate depend on differences in productivity and in consumption-wealth ratios. The empirical evidence — based on a sample of 49 countries from 1970 to 2009 — broadly supports the main theoretical results of the model.
The data set for this article can be found at: http://dx.doi.org/10.7910/DVN/23327