Trade, Democracy, and the Size of the Public Sector: The Political Underpinnings of Openness

Abstract

Politics remains prominently absent in the literature showing that higher levels of trade integration lead to a larger public sector. As openness increases, the state, acting as a social planner, adopts a salient role to minimize the risks of economic integration and secure social peace. Given the highly redistributive nature of both trade and fiscal policies, we claim, however, that the interaction of the international economy and domestic politics leads to three distinct political-economic equilibria. First, nations may embrace protectionist policies to shore up the welfare of key domestic sectors—without engaging, therefore, in substantial public spending. Second, to maintain trade openness in democracies, policymakers develop compensation policies to muster the support of the losers of openness. Finally, given the tax burden of public compensation, pro-free trade sectors may impose an authoritarian regime to exclude (instead of buying off) their opponents. After formally stating the conditions under which each regime emerges, we test the model on a panel data of around sixty-five developing and developed nations in the period 1950–1990 and explore its implications through a set of key historical cases drawn from the last two centuries.