2
Government spending is an important tool countries use to counter economic
downturns as well as to redistribute income. As globalization progresses, developing
countries are subject to important external economic constraints in their attempts to grow
the economy and address the problems of inequality. The effect of increasing capital
mobility and trade on government spending has been the object of an intense debate.
1
Some
governments have turned to limiting capital mobility in attempts to protect economies from
wild swings in both external and government finance. Though some scholars believe that
capital mobility has a negative effect over government spending (Sinn 1992; Cerny 1994;
Strange 1996), recent results have not confirmed the hypothesis (Garrett 1995; Rodrik 1997;
Garrett 1998).
One of the central tenets open economy macroeconomics is the Mundell-Fleming
framework, which implies that countries can pick only two of three policy alternatives
(capital mobility, fixed exchange regimes, and autonomous monetary policies) (Fleming
1962; Mundell 1963). Therefore, a higher degree of capital mobility would constrain
monetary policy when exchange rates are fixed. This would leave fiscal policies as the main
instrument governments have to influence the national economy, provided it does not affect
monetary policy.
2
The central purpose of this paper is to analyze the effects of capital
mobility on government spending when countries have been committed to a fixed exchange
rate regime.
3
Previous work has been dominated by scholars concerned with the OECD nations
(Frieden 1991; Quinn 1997; Garrett and Mitchell 1999; Clark and Hallerberg 2000; Garrett
1
For a critique of the International Monetary Fund’s push for countries to liberalize capital markets because of
their injurious effect see Stiglitz (Stiglitz). For recent articles on the impact of globalization (both in trade and
finance) on government spending, see (Frieden 1991; Clark and Hallerberg 2000; Garrett 2000).
2
See Frieden (1991) for a more nuanced discussion about the consequences of the Mundell-Fleming
framework.
3
Although fiscal policy also contains taxation, this last aspect is not analyzed.
Convention