Dundee Discussion Papers in Economics 164: On the causal relationship between trade openness and government size: evidence from 23 OECD countries

In the literature on the effects of economic globalisation, the compensation hypothesis predicts a positive relationship between trade openness and the size of the public sector, as governments perform a risk mitigating role in the face of internationally generated risk and economic dislocations. Statistically, support for the compensation hypothesis should entail a positive causality running from trade-openness to government size. We use time series data - for 23 industrialised OECD countries over the 1948-1998 period - to test this hypothesis within the framework proposed by Sims and Granger. Our findings fail to provide overwhelming support for it.