Government Size and Intersectoral Fluctuation

The association between economic uncertainty and government size has recently become a central policy interest, especially in the open economy context. Using the between-sector variation in income as a new measure of uncertainty, this paper proposes simple models describing the interaction between economic uncertainty and government size in the open economy setting, and provides supportive empirical evidence. Our empirical results are as follows: (i) a greater government reduces sectoral income volatility, and, at the same time, (ii) an economy facing higher intersectoral fluctuation has a larger government. However, (iii) the government tends to resort to redistributive policies rather than government spending to reduce the uncertainty, while (iv) government spending is almost as effective as government subsidies and transfers. The results based on the open economy include: (v) for a given external sector-specific shock, intersectoral fluctuation tends to rise when a country becomes more open to international trade.