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International Integration, Risk and the Welfare State.

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Abstract

How does international integration affect the welfare state? Does it call for a leaner welfare state to reap the benefits of integraiton or is it necessary to expand the welfare state to offset some negative consequences of international integration? This paper addresses these issues in a fully specified intertemporal two-country model focusing on the implications of product market integration reducing trade frictions across national product markets. Lower trade frictions may increase the marginal costs of public funds, which gives an argument for reducing (steady-state) public consumption. However, tighter integration of product markets unambigguously leads to more variability in private consumption, and this gives a case for expanding the social insurance provided by the public sector via state-contingent consumption (automatic stabilizers).

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