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Global macro & geopolitics from a small economy perspective

Think Local, Act Global

David Skilling
Singapore Straits Times, 1 December 2012

Much of the world’s attention seems focused on large countries. Most recently, it has been the US elections and the leadership transition in China. And developments like the rise of China and India with their billions of citizens, the establishment of large country institutions like the G20, and the pressure for greater integration in the EU, seem to suggest that the future lies in large economic scale. So will small countries, like Singapore and others, become increasingly peripheral relative to large countries and groupings?

Of course, size does confer power and influence. Large countries can advance and protect their interests more forcefully. Large countries and groupings are better able to absorb the shocks of a more volatile world, and benefit from big domestic markets. These advantages create pressure for small countries to engage with these large economies, though free trade agreements, regional integration and the like. Being small and alone can be uncomfortable.

But a sole focus on large scale misses an important dynamic, obscuring as much as it reveals. Indeed, public attention over the past several weeks has also been focused on the other end of the economic size spectrum: the pressure for independence or greater autonomy in several European countries. The movements in Scotland, Spain, Belgium and elsewhere are partly based on cultural nationalism, but also on a desire to set economic policy that fits with their local context and preferences. And these pressures are not just seen in modern-day Europe; the number of independent countries in the world has increased sharply from 80 in 1945 to 193 today.

Similar forces are also evident within large countries. There have been several calls recently for greater decentralisation in India because of concerns about the effectiveness of governance at the centre. And the provinces and cities in China are famously governed with a substantial amount of autonomy.

This suggests a more complicated story than an inexorable shift towards larger economies. Indeed, I argue that in a globalising world there is a premium to being able to tailor economic policy to local context and preferences. In a competitive, fast-paced global economy, the successful countries are those that have a clear sense of their specific competitive advantage and invest deliberately behind it. This clarity of strategic focus is much easier in the more local setting of small economies. Small countries have economic and political systems that allow them to be purposeful, responsive, and flexible; characteristics that will likely become increasingly valuable.

The strong performance of small advanced economies over the past few decades is due to their ability to respond effectively to the challenges and opportunities of globalisation. A key part of this has been setting policies that are adapted for local context and conditions. Small economies are better able to identify a distinctive competitive position and to align a range of policy settings and other actions behind it. Small economies are also generally better-placed to identify new opportunities or risks, and to understand when change is required to maintain their competition advantage. Ironically perhaps, the intense process of globalisation means that local context becomes more central to policy-making.

This policy-making process is supported by the political economy of small countries. Small countries tend to have higher levels of social capital and trust, enabling them to achieve a social consensus around a strategic policy direction. It is easier to set policies in a way that reflects local preferences in small countries, because there are more likely to be broadly shared perspectives. This trust and social consensus also enables governments to take the required actions to respond quickly and flexibly to shocks, most recently evident in the response of many small countries to the global financial crisis. Political institutions that allow change to be made in a politically acceptable way will become increasingly valuable in a turbulent, fast-paced global economy.

In contrast, the scale, complexity, and diversity of large economies can make it more challenging to tailor policy to local context and preferences. The diversity makes it more difficult to develop a coherent, context-specific economic strategy. And large country politics are more complex, with a greater number of special interest groups, lower levels of social cohesion and trust, and a wider distribution of views on the way forward. As many large countries and groupings are currently experiencing, this makes it more difficult – both politically and technically – to undertake structural change.

Of course, not all small countries will do well and not all large countries will do poorly. But the enhanced ability of small country governments to map policies onto local context and preferences is a powerful source of national advantage. Policy-makers that are closer to the ground may be better-placed to respond to the pressures that intense globalisation is placing on governments to deliver on the economic and social expectations of the population.

So what does this mean? First, small countries need to better understand their distinctive capabilities and assets and to invest behind them to ensure that they can fully use this as a source of competitive advantage. Although small economies have some assets, they are also highly exposed to the global economy with little margin for error, and so need to act with seriousness of purpose to continue to perform.

Second, large countries and groupings will likely experience ongoing pressure for devolution as local policy-makers seek greater autonomy to make decisions. To capture the benefits that come from local decision-making, large economies should act more as a portfolio of local economies rather than as a unitary bloc – allowing room for local experimentation and innovation rather than imposing one-size fits all rules. In this way, they can capture the benefits of scale as well as the increased competition, innovation, and resilience that comes from a more diverse set of local approaches.

Finally, international institutions like the IMF, G20, and EU should write international rules in a way that respects the need for local approaches, and should not simply apply large economy perspectives.

To understand the shape of the emerging global system, more attention should be paid to smaller economies. These economies may not have direct power, but are likely to be a source of innovation and dynamism. In an intensely global world, governments that respond in a way that reflects local context and preferences are likely to out-perform. The future is small.