Government Size, Trade Openness, and Intersectoral Income Fluctuation: An International Panel Analysis

Abstract

Using the between-sector variation in income as a new measure of economic uncertainty, this article proposes simple models and supportive empirical evidence for the simultaneous relationship between economic uncertainty and government size in the open economy setting. Main empirical findings are that (i) a larger government reduces economic uncertainty, and, at the same time, (ii) an economy facing higher uncertainty has a larger government. However, (iii) the government tends to resort to redistributive policies to reduce the uncertainty, while (iv) government direct spending is also an effective option for the purpose. The study also finds that (v) the new cross-sectional measure of economic uncertainty tends to rise when a country becomes more open to international trade. Our results suggest that there is some trade-off between economic stability and a small government.