The Impact of Trade Openness on Government Size: The Case Study of Lower Middle Income Country Group (2000-2006)

The compensation hypothesis, that is proposed by Rodrik (1998), predicts a positive relationship between trade openness and the size of the public sector, as governments perform a risk mitigating role in the face of internationally generated risk and economic dislocations. This research tests this hypothesis for a sample of 35 lower middle income countries, including Iran, from 2000-2006. Our findings based on panel data regression model indicate trade openness positively and significantly influences government size; then in reducing process of government size, policy makers should consider compensation role of government.