The Effects of Trade and Financial Openness on Government Size in Ghana

ABSTRACT

Ghana’s pursuit of outward-oriented trade liberalization and capital account liberalization polices since the 1980’s has the proclivity of subjecting the economy to external shocks that may affect the size of government. It is therefore imperative that the effects of external interferences within the domestic economy on government’s spending behavior are examined. In this light, this study investigate the short-run and long-run effects of trade and financial openness on government size in Ghana using annual time series data over the period from 1970 to 2017. The study utilizes the Bootstrap Autoregressive Distributed Lag approach to cointegration and the Toda and Yamamoto causality test procedure to empirically examine the relationships and the direction of causality between the variables. The study found that in both the short-run and the long-run, trade openness positively affects government size whiles financial openness was found to negatively affect the size of government in only the long-run. The findings from the causality test also indicated a unidirectional causality from trade openness to government size whiles no causal relationship was observed between financial openness and government size. In conclusion, the study finds validity for the compensation hypothesis whiles the efficiency hypothesis only holds in the long-run. A more progressive tax structure is recommended for government to pursue in order to ensure equitable income distribution and a provision of tax incentives for firms to increase the production of goods and services in which the country has comparative advantage over, as well as rolling out of capacity building programmes to equip the indigenous labour force. Additionally, sound macro-economic environment such as efficient financial markets, healthy public debt positions and low incidence of corruption in order to promote domestic investment.