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Don’t believe the (large country) hype


Harvard Business Review, 30 September 2014
David Skilling

In the run up to the Scottish independence referendum, the large-country voices that dominated the international discussion converged on a near consensus that small countries are inferior to larger ones, with worse prospects and higher risks; that the pro-independence movement’s motivation was cultural nationalism and an angry defensiveness against the world; and that independence would do significant damage to an open, liberal international order.

When Alan Greenspan, Paul Krugman, and Niall Ferguson all agree on something, it’s a sign that the consensus is either very right — or very wrong. Commentators from big countries would have done well to consider the experiences of the many successful small advanced economies in Northern Europe and Asia. To be sure, there are some less successful small countries as well. But there are dangers in adopting a binary, black and white perspective on the benefits of national scale.

Correctly interpreting the Scottish debate matters as we think ahead. What should we now expect in Scotland and the UK? And will there be more independence movements elsewhere, with disruptive changes in the international economic and political system? I’ll offer some small-country perspectives on these issues.

Scotland’s economic future is bright

Gordon Brown said during the campaign that Scotland’s fight should not be with London but with globalization. There is clearly something to this; while declines in manufacturing employment have hit the Scottish economy hard, manufacturing has also been in decline as a share of GDP across the advanced economies over the past 25 years. But neither is this the full story. There was no UK strategy to enable Scotland to develop alternative engines of growth, as other small advanced economies were able to do. Scotland has been trying to compete in the global economy with one arm tied behind its back.

The key issue has been the absence of micro economic policy levers that Scotland can use to better position itself. Although there was heated debate about whether Scotland would continue to use the British pound, this is a second-order issue (most successful small countries do not have a freely floating exchange rate). What does matter is the ability to set economic policy in a way that reflects local context.

Scotland has the intrinsic qualities of successful small advanced economies; an educated population, social capital, and competitive firms. And with its existing devolved powers and new ones likely to come in the aftermath of the referendum giving it greater ability to pursue a coherent economic strategy, it will likely do even better.

The UK’s future in the EU is uncertain
The consensus view seems to be that the UK is now more likely to stay in the European Union. This optimism is partly because of arithmetic, as Scottish voters are more pro-EU. I hope that this is right. Both the UK and the EU would be significantly diminished if the UK left.

But the events of the past several weeks create room for doubt. At a tactical level, the apparent carelessness with which London treated the Scottish vote until the last weeks raises questions as to whether the government can lead a serious national debate about the UK’s future in Europe in the context of a possible referendum. And at a deeper level, the Scottish debate revealed that the UK thinks of itself as a large country, which it is not. Globalization has reduced the effective size of countries, with external forces limiting the degree of domestic policy autonomy. As small countries know well, independence is never complete and trade-offs need to be made.

For the UK, regional integration is a vital part of its ability to project economic and political power. Although the UK foregoes some independence as an EU member, leaving the EU would not restore fully autonomous status. As soon as the UK began to negotiate free-trade agreements, it would find out that is not independent. But these limits on its independence do not seem to be recognized in the UK debate. To the extent that the UK thinks about itself as a large country, it is more likely to make incorrect strategic decisions about Europe. Because of this, I would put the odds on Brexit at above 50/50.

A wave of independence movements is unlikely
There has been much excited talk about the wave of independence movements that will follow the Scottish vote. But I think these predictions are overblown for two reasons.

First, Scotland was a special case. There were significant devolved powers in place, an existing government and administrative machinery, specific cultural and political history (including internationally recognized sports teams) — and an agreement by the UK Government to the terms of the referendum. These conditions apply in very few other prospective countries.

Second, the Scottish debate has reminded everyone that being a successful small country is demanding. Although the challenges of being a small country were substantially exaggerated in the Scottish debate, small countries do face hard economic realities: higher risk exposures, costs, and market disciplines. Independence is no panacea, particularly in a more turbulent, complex world. Not every small country succeeds.

As a result, although there are powerful centrifugal forces at work as globalization puts existing political structures around the world under pressure, for the most part this will not look like Scottish-style independence campaigns. Regions and cities will continue to get additional powers (as in the U.S.) and decision-making on many issues will become more local. But where the motivation for independence is at least partly economic as opposed to cultural, the economic realities are generally likely to mean devolution short of full independence. It is instructive that support for Welsh independence plummeted after the Scottish vote, I suspect partly because of an increased awareness of the challenges of full independence.

The international system is weakening – but large, not small, countries are the problem
It is clear that many countries are turning inwards, that there is declining public support for an open global system, and that international institutions, such as the WTO, are struggling. But it is a stretch to see the Scottish independence referendum as part of this backlash against globalization.

Indeed, for Scotland to succeed, it needs to be even more deeply engaged in the global economy. Scotland sees this, with clear declarations of intent in the campaign to be open to the rest of the UK, the EU, NATO, and so on. More broadly, successful small countries are highly open and internationally engaged, have been deeply engaged in the process of globalization over the past 25 years, and are active supporters of an open, rules-based, liberal order. To understand the problems with globalization, it is more useful to look around the G20 table — not at small economies.

A key challenge for the global system is that big countries no longer want to underwrite it, and are not adapting themselves at home to a changed environment. Indeed, a recent Pew survey showed little support for free trade and investment in large advanced economies. Large-country commentators on Scotland who worry about nationalism and insularity may want to spend more time talking about challenges closer to home.

Overall, the Scottish debate should remind us that current institutions, approaches and borders are under significant stress. Disruptive changes in the global economic and political system over the past few decades (which will likely continue), together with the declining effectiveness of current policy approaches, combine to create pressures. Balancing integration and interdependence with the demands of democratic legitimacy and local context will be a demanding challenge. There will be experimentation and innovation as people figure out the best way forward. And if the past few decades are any guide, small nations will be among those leading the way.

David Skilling is the Director of Landfall Strategy Group, a Singapore-based research and advisory firm. Follow him on Twitter @dskilling.