Concept and origins
Cameron (1978) found more trade-open countries had larger public sectors. Katzenstein (1985) argued small European states absorbed world-market shocks through corporatist bargaining and welfare. The idea links to embedded liberalism and neo-corporatism.
Evidence
Rodrik (1998) showed open economies face more external volatility and use government spending as insurance. Hays, Ehrlich and Peinhardt (2005) found greater spending boosts public support for trade, and Walter (2010) showed individuals exposed to globalisation risks demand more welfare.
The efficiency thesis and debate
The rival efficiency thesis predicts capital mobility triggers tax and welfare competition, a race to the bottom. Garrett and Mitchell (2001) found results vary by period and measure, and Burgoon (2001) showed trade, capital and migration have different effects. Varieties of capitalism research also contributed.
FAQ
- What is the compensation hypothesis in simple terms?
- Governments use welfare to compensate people for job risks created by trade openness.
- What theory opposes it?
- The efficiency thesis, or race to the bottom, which says globalisation forces cuts in taxes and welfare.
Sources reviewed: 2026-10-26
References
- Cameron, D. R. (1978). The expansion of the public economy: A comparative analysis. American Political Science Review, 72(4), 1243–1261. First showed open economies have larger public sectors.
- Katzenstein, P. J. (1985). Small states in world markets: Industrial policy in Europe. Cornell University Press. Small states managing openness through corporatism.
- Rodrik, D. (1998). Why do more open economies have bigger governments? Journal of Political Economy, 106(5), 997–1032. Government spending as insurance against external risk.
- Burgoon, B. (2001). Globalization and welfare compensation: Disentangling the ties that bind. International Organization, 55(3), 509–551. Disaggregates globalisation's effects.
- Garrett, G., & Mitchell, D. (2001). Globalization, government spending and taxation in the OECD. European Journal of Political Research, 39(2), 145–177. Tests compensation against efficiency.
- Hays, J. C., Ehrlich, S. D., & Peinhardt, C. (2005). Government spending and public support for trade in the OECD: An empirical test of the embedded liberalism thesis. International Organization, 59(2), 473–494. Spending raises public support for trade.
- Walter, S. (2010). Globalization and the welfare state: Testing the microfoundations of the compensation hypothesis. International Studies Quarterly, 54(2), 403–426. Individual-level microfoundations.