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Advice on strategic issues for governments

On how small economies make the world go around

David Skilling
22 March 2013

This is the latest edition of a series containing reflections on recent global economic and political developments and debates from a small country perspective. This week, a few observations on why small economies should be seen as a vital part of the global system even in a world of big powers. In a complex, uncertain world, the policy innovation and experimentation from small economies is vital and space should be made for small country perspectives in the major international groupings.

The small economies of the US
The lead story in last week’s Economist noted that while Washington was in disarray, “at the regional and local level America is already reforming and innovating vigorously”. This bottom-up activity from the smaller state and local economies is providing an important spur for dynamism, both imposing competitive pressure on other local economies to upgrade as well as providing numerous policy laboratories. This insight is an important reminder that there are broader benefits from a distributed model of smaller economies that are able to pursue a range of approaches that fit their context. Economies are trying to get an edge, making their policy settings as strong as possible to generate the best economic and social outcomes for their region. Competition is a good thing in general, and competitive intensity in terms of the best policy approaches to a range of economic, social and other challenges can help to improve welfare. As Mancur Olson and others have noted, the openness of small economies creates a powerful imperative for this innovation. This pressure can be uncomfortable of course; as Nobel Laureate Sir John Hicks noted “the best monopoly profit is a quiet life”. Small economy policy-makers in the US and elsewhere may not have a quiet life, but the competitive disciplines that they face create pressure for better quality policy settings and outcomes. And, just as in the private sector such innovation diffuses rapidly to others leading to productivity improvements, so support for the diffusion of policy insights from small economies can lead to broad welfare gains.

Small countries at the innovation frontier
Small economies have a record of policy innovation; central bank independence, tax reform, flexible social insurance models, new approaches to public sector management, and many, many other examples. More broadly, the OECD has noted that “small countries [are] sometimes found to undertake more reform” because of ease of decision-making as well as an openness to trade that increases competitive pressures. As I have noted previously, the small country response to the crisis provides one recent example of world-leading economic policy behaviour. There is also evidence of this small country innovation in non-economic policy areas. Small economies have been at the creative end of the FTA agenda. And the recent European Council for Foreign Relations’ (ECFR) European foreign policy scorecard noted the outsized contribution of small states, individually and collectively, in a range of foreign policy initiatives. This record suggests that there should be serious efforts to incorporate the small country voice into the policy groupings at the OECD, the IMF and elsewhere. This is not charity, but a recognition that small countries – as the canaries in the mine of the global economy – have been actively responding to the emerging challenges and opportunities in the global economy and as such are an important source of policy insights. We need to move away from a presumption that the answers will systematically come from large countries; small countries have an important voice.

The competing states of Europe
The benefits of distributed decision-making are not just a recent phenomenon. Consider the economic history of Europe over the past few hundred years, with its transformation from backwater to the leading economic region of the world by the 19th century. There are many explanations for this, ranging from geography to culture (remember the Protestant work ethic?). But one powerful reason for the economic take-off was the intense competition between rival small states in Europe. It is estimated that in Europe in 1500, there were over 500 political units of various sorts. Competition between these states led to insecurity and conflict but also to economic dynamism. The competitive pressure that this environment created spurred innovation and growth, in a way not observed in the more ordered system of China. It was harder to control the spread of new ideas and technologies. This experience has echoes for current debates in Europe and elsewhere on the extent to which integration and policy autonomy should be traded off. To get the global economy growing again, the world needs to be both open as well as allowing for diversity so that competing policy approaches can flourish. Centralised models, or global one-size-fits-all approaches, may have some advantages in some policy areas but should be treated with caution – history suggests that this may dampen the competitive intensity, as well as compromising resilience. Even in an environment of big powers, the world needs the small.