Size and Growth: Thorvaldur Gylfason Small States in the Global Economy

Big countries and small To paraphrase Ernest Hemingway: nSmall countries are different from big ones in that … n… they have fewer people Do small countries differ also in other respects? If so, how? Do small countries differ also in other respects? If so, how? What are the benefits and costs of being small? What are the benefits and costs of being small? What are the challenges for future? What are the challenges for future?

Blessing or curse? nControversial issue n“Our shortage of people is our most serious social evil,” said our national poet, Einar Benediktsson nConsider arguments and evidence 1

Being small: Benefits nHomogeneous population Social cohesion is good for growth Social cohesion is good for growth nOpenness to trade and investment Being small and closed is not an option Being small and closed is not an option nSmall agriculture and natural resource base Too much agriculture impedes growth Too much agriculture impedes growth nEveryone knows practically everything about everybody else 2 What are the benefits? What are the costs?

Being small: Costs nEconomies of scale and scope Public sector, defense Public sector, defense Private sector Private sector nLack of diversification Vulnerable to external shocks Vulnerable to external shocks nPoor location Remote, landlocked Remote, landlocked High transport costs High transport costs nFew like, and far between nFew like Mozart, and far between

Empirical evidence: Sample of countries 3 nThere are now 207 countries in all reporting to World Bank, and Taiwan nOf these, 61 have fewer than 1.3 million inhabitants … n… and 18 have fewer than 100,000 nSo, there are 43 countries with population between 0.1 million and 1.3 million nOf which, 26 are islands: Our sample What do the data tell us?

Sample of 26 small island economies I Bahamas ,500 Bahrain ,600* Barbados ,000 Cape Verde 428 4,500 Channel Islands 149 Comoros 544 1,400 Cyprus ,100 Fiji 801 4,800 French Polynesia ,200 Guam 152 Figures refer to GNP is adjusted for purchasing power parity. * Thousands 2 USD Population 1 GNP per capita 2

Sample of 26 small island economies II Iceland ,200 Maldives 269 3,400* Malta ,900 Mauritius 1,174 9,000 Mayotte140 Micronesia 116 Netherlands Antilles 215 New Caledonia ,100 Samoa 169 4,100 Sao Tome & Principe 145 1,300 Figures refer to GNP is adjusted for purchasing power parity. * 1998 Population GNP per capita

Sample of 26 small island economies III Solomon Islands 429 2,100 St. Lucia 154 5,200 St. Vincent & Grenadines114 5,000 Trinidad & Tobago 1,293 7,700 Vanuatu 193 2,900 Virgin Islands (U.S.) 120 Average for all ,600 Average for world 28,740 6,900 Figures refer to GNP is adjusted for purchasing power parity. Population GNP per capita

Empirical evidence: Research strategy 4 nCompare small island economies with world economy at large nStress variables that have proved to be strong and robust determinants of economic growth across countries Openness to trade and investment Openness to trade and investment Education and health Education and health Manufacturing vs. natural resources Manufacturing vs. natural resources Investment Investment

Exports and FDI (% of GDP) Results Small countries are more dependent on trade than larger ones; even so, differences in FDI are not statistically significant t = 4.4 t = 1.8* * t-value is 2.7 if world’s net FDI is taken to be nil

Duties and reserves (% of imports) Results Small countries levy higher duties on imports and keep more reserves, but differences are small t = 0.7 t = 0.4

Education (%) More results Small countries spend significantly more on education, or 5.7% of GNP against 4.2% t = 1.0 t = 3.3

Health (%) More results Small countries spend a bit more on health, or 5.3% of GNP against 5.1%, but difference is insignificant t = 6.1 t = 0.4

Government spending (% of GDP) More results Public services cost more to provide in small countries; small islands cost less to defend t = 3.0 t = -1.8

Manufacturing exports (% of exports) More results Need manufacturing and high-tech exports for rapid growth t = t = -1.6

Agriculture and personal computers More results Too much agriculture, too few computers t = 3.4 t = 0.5 * 1999

Investment and growth (%) Bottom line Small countries invest a bit more than larger countries, but growth differential is small and insignificant t = 1.8 t = 0.2 * Bosnia and Herzegovina, Azerbaijan, Ukraine, and Turkmenistan not included 2.1% 2.0%

Investment and growth (%) Bottom line No evidence either of greater volatility of investment and growth in small countries t = 1.8 t = 0.2 * Bosnia and Herzegovina, Azerbaijan, Ukraine, and Turkmenistan not included 2.1% 2.0%

Empirical evidence: Conclusion 5 nSmall countries seem remarkably similar to larger ones More open to trade, yes More open to trade, yes More public expenditure on education More public expenditure on education More – and better? – investment More – and better? – investment More government spending More government spending More dependent on natural resources More dependent on natural resources Good for growth Not so good for growth nIn sum, their growth performance has been similar as elsewhere

Empirical evidence: Conclusion The End nThis is good news Many have expressed concern that small is more dangerous than beautiful Many have expressed concern that small is more dangerous than beautiful nThe key to further economic success is greater openness to trade and also investment to break outside the confines of small domestic markets Small countries must have market access Small countries must have market access Can buy insurance against trade risks Can buy insurance against trade risks nMust share gains from trade fairly