Specialisation-based external economies, supply of primary factors and government size

This paper examines the impact of changes in the supply of primary factors on the size of government and welfare. Unlike the existing studies, this paper utilises a model where the presence of monopolistic in the intermediate good sector gives rise to specialisation-based external economies in the final good sector. The size of theses external economies affects the magnitude of most comparative static results presented in this paper. For example, it is shown that, in the presence of specialisation-based external economies, an increase in the supply of either primary factor (i.e., capital or labour) decreases the size of governments even if the private and public sectors were equally capital intensive. Due to the presence of specialisation-based external economies, an increase in the size of the country decreases the size of government. In addition, an increase in the size of the country leads to a larger increase in welfare as long as external economies are present.