How does Trade openness Influence Budget Deficits?

The influence of trade openness on economic growth via budget balance is surprisingly neglected in the literature, particularly since the theoretical and empirical studies have provided a positive and robust relationship between budget balance and economic growth. In this paper, we provide theoretical and empirical explanations about the way that trade openness influences budget balance by distinguishing the effects of natural openness from those of trade policy. The panel data analysis focuses on 66 developing countries for which we have the required data. We find that, theoretically and empirically, the effects of trade openness on budget balance through its effect on the instability of government revenue is quite clear: trade openness increases a country's exposure to external shocks (whether it is due to natural openness or to trade policy). This enforces the negative impacts of the instability of term of trade on budget balance. We also find that trade openness affects budget balance through many others channels (corruption, inequalities, etc). In this case, the additional effects on budget position of natural openness and trade policy are opposed: trade policy seems enhance budget surpluses, on the contrary, natural openness seems deteriorate budget deficits.