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Empirical Economics

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24-01-2021

Does national income mediate the relationship between trade and government size?

Author: Kevin Williams

Published in: Empirical Economics | Issue 6/2021

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Abstract

This paper estimates a panel model in which the relationship between trade and government size is determined by countries’ per capita GDP. The panel model covers 126 countries during the 1980–2018 period. Estimates of the model show that the correlation between trade and government size is decreasing in the level of countries’ per capita GDP. For high-income countries with a per capita GDP above $12000US, the association between trade and government size is negative. For low-income countries with a per capita GDP below $1000US, the relationship between trade and government size is positive. In the year 2018, the average country had a per capita GDP of about $14228US. For this country, the estimated coefficients suggest that a 1% increase in trade had a predicted association with the long-run level of the size of government of over 0.17%. The paper also presents estimates suggesting that the relationship between trade and the composition of government spending differs depending on countries’ incomes.

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I use government size and government spending interchangeably.

I thank an anonymous referee for this explanation.

Brueckner and Liderman (2018) use similar definitions from the World Bank to define low-income countries ($1000US) and high-income countries ($12000US).

These interpretations are speculative as the empirical analysis does not allow for these more refined conclusions.

The long-run computations are: Nigeria is ((0.49 + (−0.06 × 7.3)) × 1)/(1 − 0.48) = 0.10%; USA is ((0.49 + (−0.06 × 10.4)) × 1)/(1 − 0.48) = −0.257%.

See the World Bank WDI for this information.

The first observation is 1980. Subsequently, I use the observation for each of the years 1985, 1990, 1995, 2000, 2005, … , 2018. These non-overlapping five-year data (not the average for a five-year period) reduce serial correlation (Acemoglu et al. 2008).

The main result in Table 1 is also robust to a static model specification that excludes the lagged dependent variable and also to model specifications that use 10-year, 5-year, and 3-year average observations.

The short run is given by (0.49 + (−0.06 × 9.6)) × 1 = −0.086%; the long run is: − 0.09/(1 − 0.48) = −0.173%.

In Figs. 1–3, I do not transform the variables in logs, because logs would mask outliers and thus allow one to infer wrong decisions from the box plots (Cox 2013).

I thank an anonymous referee for suggesting this exercise.

The net inward stock of FDI is from UNCTAD.

The Polity2 index is a popular measure of democratic political institutions. See, for example, Acemoglu et al. (2008) and Williams (2017).

I thank an anonymous referee for suggesting these exercises, which highlights the robustness of the main finding.

However, I reestimate a model in which I only include lagged trade, per capita GDP, the interaction, and the control variables. I find significant estimate for lagged trade, the interaction, per capita GDP, and urbanization. I thank an anonymous referee for this suggestion.

I reestimate a mode in which I restrict the data after 2008. The sign of the estimates are similar, but not significantly different from zero. These results are not informative because of the small sample size.

Dreher et al. (2008), Rodrik (1998), and Rickard (2012) also used these dimensions of government expenditures. According to the World Bank data government expenditure on health is “public expenditure on health from domestic sources as a share of total public expenditure”; government expenditure on education is “general government expenditure on education expressed as a percentage of total general government expenditure on all sectors”; government expenditure on subsidies and transfers is expressed as a share of total public expenses as “subsidies, grants, and other social benefits include all unrequited, non-repayable transfers on current account to private and public enterprises”; Goods and services are also expressed as a share of total pubic expenses as “goods and services include all government payments in exchange for goods and services used for the production of market and non-market goods and services.”

Difference GMM and least squares fixed effects estimates are qualitatively similar to system GMM estimates.

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Title: Does national income mediate the relationship between trade and government size?
Author: Kevin Williams
Publication date: 24-01-2021
Publisher: Springer Berlin Heidelberg
Published in: Empirical Economics / Issue 6/2021
Print ISSN: 0377-7332
Electronic ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-021-02017-3

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