Academic journal article Journal of Economic Development

Varieties of Capitalism and Government Spending in Developed and Developing Countries

Academic journal article Journal of Economic Development

Varieties of Capitalism and Government Spending in Developed and Developing Countries

Article excerpt


Recent contributions to the literature explaining government size argue that, beyond optimal allocation,1 voters or interest groups demand for redistribution and risk insurance. Increasing dependency ratios (Heller and Diamond, 1990; Shelton, 2007), a growing majority of the population below average income (Meltzer and Richard, 1981, 1983; Shelton, 2007), or ethnic fractionalization of the population (Alesina et al., 2003) help to establish well specified interest groups asking for redistribution via more government spending. In the same vein, the population in open economies is assumed to demand for a higher level of government spending compensating for potential losses due to an unstable external environment (Cameron, 1978; Rodrik, 1998).

However, the empirical evidence on the relevance of allocation, redistribution, and risk insurance driving government spending is far from conclusive. Ram (1987) and Aktiobya et al. (2006) do not find support for the income hypothesis. Mulligan et al. (2002) find little evidence for income redistribution driving government expenditure, and Easterly and Levine (1997) show that ethnic fragmentation can actually reduce government spending because of a lack of a consensus about the provision of public goods. Alesina and Wacziarg (1998) and Sachs and Warner (1995) argue that the positive correlation between openness and government size may be rather due to the fact that small countries tend to be more open and, at the same time, have to run relatively large governments because they cannot exploit economies of scale. Aghion et al. (2009) demonstrate that macroeconomic volatility due to openness depends on the ability to establish well-functioning financial markets in the first place.

A potential shortcoming that may explain the ambiguous empirical results is that, especially from a developing country perspective, the literature on government size suffers from neglecting the role of governance. This is rather surprising because governance issues figure prominently in three related strands of the literature:

. The preference for alternative modes of governance, as analyzed in the rapidly evolving Varieties-of-Capitalism (V°C) literature (Hall and Soskice, 2001), implies that actual demand for government spending should depend on the preference for either a liberal or a coordinated mode of governance. This implication and its relevance for developing countries has been neglected in this strand of literature until recently.

. At the same time, the supply side of government spending can be assumed to depend on the quality of governance. This literature, so far, concentrates on specific aspects of good governance like the quality of democracy and the choice of a constitutional framework (Persson et al., 1997, 2000). Examples of recent extension towards analyzing developing countries are, e.g., Acemoglu and Robinson (2009). However, besides voice and accountability, aspects such as political stability, government effectiveness, quality of regulations, rule of law, and control of corruption are also likely to determine the extent to which elites, politicians, and bureaucrats may "capture" governments.

. Finally, a literature that figures prominently in development economics highlights the importance of the ability to tax for government finance (Bird et al., 2004). The ability to tax, a precondition for any demand for government spending to be translated into government spending in the long run, is assumed to depend on the quality of governance.

The contribution of our paper is to introduce the insights from these strands of the literature into the analysis of government size in order to show their relevance for developed as well as for developing countries. Because review papers on traditional aspects are available (Shelton, 2007; Lindauer and Velenchik, 1992), we concentrate in Section 2 on providing our governance related demand and supply side arguments. …

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