Landfall logo

Landfall

Advice on strategic issues for governments

Small states in stormy seas

David Skilling
Singapore Straits Times, 27 October 2012

The Annual Meetings of the IMF and World Bank just held in Tokyo should serve as a warning of the economic and political challenges that lie ahead. This is particularly so for small countries that are deeply exposed to the state of the international environment. Indeed, the seriousness of the changing international circumstances means that small countries may need to respond in new ways.

The IMF’s annual World Economic Outlook, released to coincide with the Meetings, noted that the global recovery had weakened and marked down its 2013 growth estimates by around half a percentage point. It stated that the “risks for a serious global slowdown are alarmingly high”. Indeed, even the IMF’s relatively downbeat assessment of global economic prospects was based on the optimistic assumptions that the US addresses its fiscal cliff and that the economic issues in Europe are managed.

The companion Global Financial Stability Report noted that “risks to financial stability have increased” since last year’s report and that there is “very fragile” confidence in the global financial system. And the IMF’s Fiscal Monitor concluded that, despite the progress on fiscal consolidation that has been made, fiscal vulnerabilities remain elevated.

There are some bright spots. The Eurozone is currently making genuine progress in resolving its issues, and the Chinese economy may be bottoming out after a period of declining growth rates. And governments have made many policy commitments to address various issues, as noted by Finance Minister Tharman Shanmugaratnam at the Meetings, which now need to be implemented.

However, there was little sign of policy consensus at the Meetings. There was heated debate about the impact of loose monetary policy in the US on other countries, from Japan to Brazil, and concern about the absence of any credible fiscal consolidation plan. Indeed, there were clear differences between countries on the appropriate approach to fiscal policy. South Korea’s Finance Minister noted the differences in perspectives and observed that “the world has a leadership problem.”

The absence of international consensus is not new of course, but the extent of disagreement between countries seems to be growing. Just as sluggish economic outcomes cause political tension within countries, so they also cause tension between countries as each seeks space to promote its own economic growth. This shows up in areas such as exchange rates, capital flows, and trade policy. In turn, these tensions put pressure on the multilateral institutions.

In addition to the gloomy economic outlook, and issues of global economic governance, the Tokyo Meetings were also notable for the intrusion of big power politics. China decided not to send its most senior officials to Japan, in the context of territorial disputes between the two countries. It is a problem when the world’s second largest economy does not fully engage in multilateral economic discussions in the world’s third largest economy.

So the international environment is characterised by large economic challenges and uncertainty as well as by growing tension between countries.

This is a serious problem for small countries that are deeply exposed to the international economic and political environment. For small countries, external developments can be more consequential than domestic events. Small advanced economies have export shares of GDP that are about twice that of large advanced economies, and have benefited greatly from an open, rules-based global system. International economic and political turbulence is particularly challenging when it threatens the strength of the rules-based global system.

But we should not be fatalist about these developments. Many small countries have been navigating a more challenging world with some success, generating relatively strong economic outcomes. So some of the response involves doing more of what they have been doing.

First, in a more competitive, turbulent world, small economies need to continue to invest in strengthening their competitive position. Many small advanced economies have been undertaking structural reform, investing in human capital and innovation, and developing new areas of competitive strength. And many small countries have been in the vanguard of developing new economic relationships through trade agreements and the like. This response to a changing external environment needs to continue given the scale of the emerging economic and political challenges.

Second, there should be increased focus on managing external risks. This may involve economic diversification so that the economy is not overly exposed to specific sectors or markets. Singapore approaches this issue very deliberately, but the connected nature of many external shocks means that redundancy is also important to enable the country to absorb shocks; for example, through strong fiscal positions and well-capitalised banks. And countries also need to ensure that risk is allocated efficiently to enable households to cope with a more turbulent economy; an efficient social insurance system is a key part of managing risks and building resilience in small open economies.

But the seriousness of the emerging international challenges means that small countries should also be doing some new things. In addition to domestic policy responses, small countries also need to step-up their engagement in global policy debates. The emerging shape and functioning of the international environment is a fundamentally important issue for small countries, bearing directly on their national interests. Although their size imposes some limitations on the ability of small countries to shape the global debate, ideas and concerted action from small countries can make a significant difference.

So the third response from small countries should be to find ways to contribute to these global policy debates – both in terms of highlighting concerns and risks, as well as contributing ideas and perspectives on how to strengthen the international system. Small countries have done well in adapting to the emerging environment, and need to continue to do. But the scale and nature of the emerging challenges mean that small countries should move beyond adaptation to stepped-up efforts to shape global action and debate. This requires small countries to get organised, develop ideas, and then to deliberately engage.

I remain positive about the prospects of many small advanced economies because they are responsive, focused on addressing structural issues and strengthening their competitiveness, and they are finding ways to manage risks. But the distribution of possible outcomes for small countries is wide in a stormy international environment. A key part of the small country response to these challenges needs to be investing in contributing to these global debates with constructive, forceful ideas in order to strengthen the global system. This is too important to be left to the large countries.