Globalization and Government Spending around the World.(Statistical Data Included)

1. Introduction

This article explores the two major contending perspectives on the effects of the international integration of markets for goods, services, and capital on national economic policy choices. The common metaphor of a globalization-induced race to the bottom suggests that governments are under heavy "efficiency" pressures to reduce their economic policy activism to promote competitiveness and to keep mobile capital within national borders. In marked contrast, numerous scholars have argued that globalization increases material inequality (Wood 1994) and economic insecurity (Rodrik 1997), and that this creates incentives for governments to "compensate" the losers from globalization by increasing their economic policy activism (Garrett 1998a).

The article presents two major findings with respect to patterns of government spending in more than one hundred countries during the period 1970-1995. First, high levels of trade are associated with high levels of government spending, but countries in which trade grew more quickly between the 1970-1984 and 1985-1995 periods witnessed slower growth in government spending between the two periods. The levels relationship is very interesting in its own right. Since small open economies have had large public sectors for much of the postwar period, however, it would be hard to argue that this correlation is evidence in favor of the compensation hypothesis that increasing globalization in recent years has prompted governments to expand the public economy. On the contrary, the fact that countries in which trade has expanded more quickly have experienced slower growth in public spending suggests that the efficiency constraints imposed by trade growth outweigh the political pressures for compensation trade generates.

The second major finding of the article is a null result, but an important one nonetheless. There is no evidence that either higher levels of capital mobility (measured in terms of the portion of the 1985-1995 period for which countries had open capital accounts) or more rapid growth in capital mobility (countries that opened their capital account between the 1970-1984 and 1985-1995 periods) had any significant impact on government spending. Thus, even though most globalization pundits highlight mobile capital as the primary impetus for the purported race to the bottom in economic policy, the best available evidence does not support this contention.

There is considerable empirical work on the globalization-government spending nexus among the stable industrial democracies. Cameron (1978) demonstrated more than twenty years ago that the public sector tends to be larger in the smaller European countries that have long been heavily exposed to trade. This positive trade-spending association has been replicated and updated in more sophisticated analyses of panel data (Hicks and Swank 1992; Huber, Ragin, and Stephens 1993). However, Garrett and Mitchell (2001) argue that the relationship is reversed when one examines trade and spending growth (rather than their levels). With respect to the integration of capital markets, Swank (1998a; 1998b) contends that, if anything, increasing capital mobility has been associated with greater spending (and higher corporate taxation). Garrett (2000a) argues that it is fixed exchange rates, rather than capital mobility, that constrain public sector expansion. Finally, Boix (1998) and Garrett (1995, 1998b) argue that the effec ts of globalization on government spending are heavily mediated by partisan politics. Taken together, these results tend to be more consistent with the compensation perspective on the domestic effects of globalization than with the efficiency view.

Analysts should be very cautious, however, about generalizing from these OECD-based studies to the rest of the world. In particular, the advanced industrial democracies may well be less vulnerable to the efficiency constraints of globalization and more sensitive to demands for compensation. High levels of income and productivity may afford governments the luxury of maintaining large public economies even if these are inefficient. Stable democracies might create unusually large political demands for government compensation. Moreover, given their power in the international system, the OECD countries might be able to shift the costs of globalization onto the LDCs. Thus, it seems reasonable to hypothesize that the purported efficiency constraints of globalization are likely to become more evident as one moves from the OECD to less developed nations.

There is scant systematic research on the globalization-government spending relationship outside the OECD. Two important exceptions stand out. Both suggest that the compensation perspective on globalization is just as accurate outside the OECD as within it. First, Rodrik (1998) affirms Cameron's result for a sample of over 100 countries around the world. That is, in both the developed and developing world, countries that trade more have larger public sectors. Second, Quinn (1997) finds that higher levels of capital mobility are associated with higher levels of government spending for a sample of 38 countries that includes 18 non-OECD nations.

Both of these studies, however, have significant limitations. Quinn's sample of LDCs only extends to the East Asian and Latin American NICs. More importantly, both Rodrik and Quinn are primarily concerned with isolating partial correlations between levels of trade and capital mobility and levels of government spending. [1] Influential commentators have questioned what such correlations tell us about globalization (Rogwoski 1998; Leamer 1996). Globalization is a term that is supposed to describe a relatively recent phenomenon, and one that is a process rather than a steady state--the increasing international integration in recent years of markets for capital, goods and services. Levels of trade and capital mobility for different countries, in contrast, are relatively stable over quite long periods of time. They are also greatly affected by factors such as country size and level of development that are for all intents and purposes invariant in the short-run (Garrett 2000b). Thus, it is entirely possible that t he marginal effects of changes in trade and capital mobility (the salient issue with respect to globalization) may be very different from the correlates of levels of openness.

This article seeks to redress these limitations of existing quantitative research into the relationship between globalization and government spending around the globe. The remainder of the article is divided into five sections. Section 2 briefly reprises the contending theoretical arguments about the domestic policy effects of globalization. Section 3 presents the data. Section 4 elaborates the distinction between analyses based on levels and changes data. Section 5 analyzes the regression results. Section 6 concludes by discussing the implications of this article for the larger debate about globalization and national autonomy.

2. The Political Economy of Globalization

There are two basic positions in the globalization and national autonomy debate. I label the conventional wisdom about globalization constraints on policy interventionism the "efficiency" hypothesis because it highlights competitiveness pressures and threats of exit by mobile asset holders. The "compensation" hypothesis, in contrast, emphasizes the domestic dislocations generated by globalization and the incentives for government interventions in the economy that these generate. In this section, I develop both hypotheses in more detail with respect to government spending. [2]

The Efficiency Hypothesis

The fundamental tenet of the efficiency hypothesis is that government spending--beyond minimal market friendly measures such as defense, securing property rights, and other fundamental public goods--reduces the competitiveness of national producers in international goods and services markets. There is no market for, and hence no market constraints on, publicly provided services. Income transfer programs and social services distort labor markets and bias intertemporal investment decisions. Moreover, government spending must be funded, often by borrowing in the short-term, and ultimately by higher taxes. Taxes on income and wealth directly erode the bottom lines of asset holders and distort their investment decisions, and this is exacerbated the more progressive tax systems are. Borrowing results in higher real interest rates, which further depresses investment. If this also leads to an appreciation in the real exchange rate, the competitiveness of national producers is decreased.

According to the efficiency hypothesis, therefore, there is a zero-sum quality to the relationship between trade and the size of government. It does not matter whether one considers trade liberalization as the inevitable product of exogenous technological innovations in transportation and communication or as the conscious choice of governments to reap the benefits of trade (scale economies, comparative advantage, and the like). [3] Either way, exposure to trade should curtail government spending.

This logic is thought to be even more powerful with respect to capital mobility, particularly financial capital. Traders operating 24 hours a day can instantly move massive amounts of money around the globe in ceaseless efforts increase returns on their investments. For many, the potential for massive capital flight has rendered international financial markets the ultimate arbiters of government policy. The logic underpinning this view is straightforward. Governments are held to ransom by mobile capital, the price is high, and punishment for non-compliance is swift. If the policies and institutions of which the financial markets approve are not found in a country, money will hemorrhage unless and until they are. In turn, financial capital is usually thought to disapprove of all government policies that distort markets, and excessive government spending is among the most prominent villains.

In sum, the efficiency hypothesis contends that government spending should have been subjected to powerful lowest common denominator pressures as a result of the increasingly global scale of markets in recent decades. From the Depression until the 1970s, it may have been possible for governments to expand the public economy at little cost, because this was a period of relative closure in the international economy. In the contemporary era of global markets, however, the trade off between efficiency and welfare is harsh and direct, and governments have no choice but to shrink the state.

The Compensation Hypothesis

The efficiency perspective's focus on the economic costs of government spending overlooks the possibility that there are political incentives to expand the public economy in response to globalization and that these may outweigh the constraints imposed by market integration. Globalization may well benefit all segments of society in the long run through the more efficient allocation of production and investment. But the short-term political effects of globalization are likely to be very different. Expanding the scope of markets can be expected to have two effects that would increase citizen support for government spending--increasing inequality and increasing economic insecurity. [4]

The effect of trade is likely to be more pronounced on inequality than insecurity in the OECD, with the converse more likely to obtain for much of the developing world. In accordance with Heckscher-Ohlin models, expanding trade will reduce demand for relatively scarce factors of production (labor in the "north," capital in the "south") while increasing demand for abundant factors. This should result in increasing inequality in the OECD but more equality in developing countries (Wood 1994). In contrast, trade patterns are not particularly volatile in the OECD and are characterized by very high levels of intra-industry and intra-firm trade. As a result, trade growth is unlikely to increase economic insecurity much in the advanced industrial democracies. But given more specialized patterns of trade in the developing world, volatility--and, hence, economic insecurity--should be more widespread in these countries (Rodrik 1997).

There is less work on the domestic effects of capital mobility. One reasonable premise, however, is that rising capital mobility should increase substantially both inequality and insecurity in the OECD, and that these effects should be even more apparent in less developed countries. The primary beneficiaries of financial market integration are the owners of liquid assets and those in the finance sector--or more specifically, large financial houses in the wealthiest OECD countries. It is less clear that these benefits trickle down to other segments of society, or across national borders. Moreover, unexpected and massive volatility comes hand in hand with financial globalization--as the headline crises of the 1990s all attest. The insecurities associated with this volatility are likely to be large, and more pronounced in countries with …