Public Spending and Trade Liberalization: The Compensation Hypothesis Revisited

29 Pages Posted: 5 Apr 2013

See all articles by Christian W. Martin

Christian W. Martin

University of Kiel - Faculty of Economics and Social Sciences; New York University (NYU)

Nils D. Steiner

Johannes Gutenberg-University of Mainz; Johannes Gutenberg University Mainz - Department of Political Science

Date Written: April 5, 2013

Abstract

Despite a widespread fascination with the so called compensation hypothesis – i.e. the proposition that governments have to provide insurance against the risks of open markets to make integration into the international economy politically feasible – there appears to exist a complete lack of research where a rather straightforward implication of this theoretical mechanism is concerned, namely that liberalization of the trade regime should become more likely with a larger public sector and more social spending already in place. In this paper, we test this hypothesis that can be regard as a complement to existing research on the compensation hypothesis. We draw on a theoretical model that links an individual's (uncertain) assessment of her future position in a liberalized economy to her support for government liberalization policies. By reducing uncertainty, diffusing gains among a larger set of individuals and rendering compensation promises more credible ex ante developed institutions of redistribution and economic insurance are argued to increase support for reforms towards free trade and thereby make liberalization more likely. We test the proposition that trade liberalization is facilitated by higher public spending empirically (a) on data on the evolution of average tariff rates in 20 post-World War II OECD democracies from 1951 to 1993 and (b) by leveraging data on major liberalization episodes from 1950 onwards in a global sample of democratic countries through event history analysis. Overall, we find no support for the hypothesis suggested by the compensation logic that public spending facilitates reforms towards free trade.

Keywords: economic globalization, compensation hypothesis, welfare state, public spending, trade liberalization, trade policy

Suggested Citation

Martin, Christian W. and Martin, Christian W. and Steiner, Nils D. and Steiner, Nils D., Public Spending and Trade Liberalization: The Compensation Hypothesis Revisited (April 5, 2013). Available at SSRN: https://ssrn.com/abstract=2245595 or http://dx.doi.org/10.2139/ssrn.2245595

Christian W. Martin

University of Kiel - Faculty of Economics and Social Sciences ( email )

Westring 400
Kiel, 24118
Germany

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Nils D. Steiner (Contact Author)

Johannes Gutenberg-University of Mainz ( email )

Johannes Gutenberg University Mainz - Department of Political Science ( email )

Saarstrasse 21
Mainz, D-55099
Germany

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