How can small countries grow economically when they can’t shape the international framework?
The nations of the G20 account for 80 percent of the world’s GDP and 80 percent of its trade – but only two-thirds of its population. This means that roughly 2.3 billion people live in countries with economies too small for them to carry much weight at the top table.
These small nations cannot shape the institutions of international law, trade, finance, security and cooperation to reflect their own needs and circumstances. They must take these structures as given and work within them.
The international framework imposes real constraints. For instance, if large economies have agreed on a liberalised financial model of floating exchange rates and unrestricted capital flows, then large pools of internationally mobile capital will develop. This capital may rush into and subsequently flee from smaller economies according to market sentiment; creating an economic bubble and bust in its wake. Or, in better circumstances, it may mean that substantial amounts of investment capital are available to finance development. Either way, international financial liberalisation defines the risks and opportunities small economies must navigate.
Multilateral institutions may be mandated to promote free trade by imposing retaliatory tariffs on countries that protect the home markets or ownership of domestic firms
Likewise, if large economies create multilateral development and financing institutions that embrace a particular economic ideology – free-market liberalism or statist developmentalism, for example – then the choices of smaller economies are affected. If they do not share the ethos of these bodies, they are likely to be viewed negatively and will find it harder to obtain capital for development or funding to help with short-term economic difficulties.
Multilateral institutions may be mandated to promote free trade by imposing retaliatory tariffs on countries that protect the home markets or ownership of domestic firms. This precludes an import-substituting development strategy and inhibits one in which corporatist relationships between government and industry are used to promote development. Protectionism and corporatism have well-known pitfalls – but some countries that are advanced today used them to escape backwardness in the 19th century; so precluding them entirely may not be wise.
I could go on, but these examples are enough to show that the fate of small nations is deeply intertwined with the institutional framework established by big ones. This being so; what can small economies do to grow? To address this question, I look at several small nations with different geographies, histories, economic experiences and income levels, and at the question of whether their lessons can be generalised to others.
The Nordic model
Sweden was in the third wave of countries to industrialise, after Britain in the first wave and Belgium, Germany, the US and France in the second. Until the late 19th century, its economy was traditional in structure and reliant on primary commodity exports such as timber and iron ore, which were the only major areas of mechanisation. Reforms to create corporations, banks and other commercial institutions, combined with large imports of capital, then led to strong growth after about 1870.
Sweden benefited from cheap coal shipments from northern mainland Europe and the extensive hydroelectricity resources of Scandinavia. It excelled in electrical engineering and was the first nation to smelt iron by a purely electrical method. After 1945, Sweden developed its renowned Social Democratic model, with extensive state involvement in the economy and a generous and efficient welfare state combined with efficient private corporations. A banking crisis was overcome in the early 1990s, and the statist approach has retreated only slightly. With average growth above three percent since 1992 and GDP per capita at $49,000, Sweden has outperformed most advanced countries.
The entrepôt strategy
Singapore has become rich on trade and capital flows. It is theoretically a democracy but is governed on fairly authoritarian lines. However, corruption is low and it is seen as business-friendly. Taxes are light (14 percent of GDP) but, through large sovereign wealth funds, the government has partial stakes in major corporates accounting for 60 percent of GDP. Prices are free-floating – albeit with an exchange rate that is a managed float – but the state uses its industrial stakes to engage in some economic planning. At present it is encouraging the development of a biotechnology sector.
In terms of actual activities, the economic model of Singapore has been described as “extended entrepôt trade”. It imports unfinished goods, converts them into more valuable products and sells them. This includes computer chip manufacture, oil refining and chemicals. Its high-quality port is a vital asset and is the busiest in the world. Overall, Singaporean trade flows are equal to 4.3 times its GDP. Another form of flow – international capital movement – is also important and $350bn of assets are managed from Singapore. At $50,800, Singapore’s GDP per capita is among the highest in the world.
The ‘Celtic Tiger’
Before the 1990s, Ireland was a laggard; adopting leading technologies and practices slowly and having a GDP per capita barely 60 percent of that of the UK. But the foundations of success were laid the 1960s, when the government realised that education was vital and began to reform schools and invest in Universities. In 1973, the country joined the European Economic Community – leading to access to the single market and infrastructure subsidies. In response to economic strains in the 1980s, targeted incentives to attract foreign corporations were introduced alongside collective bargaining in labour relations, with the latter aiming both to control wage-driven inflation and show that income was being shared equitably.
The reforms of the 1980s drew foreign multinationals at the same time as the first graduates from the new education system were entering the workforce and the benefits of EEC membership were materialising. High unemployment and emigration persisted for a few more years but, from the early 1990s, there was GDP growth exceeding seven percent per annum, fuelled by manufacturing in advanced sectors such as electronics, software, pharmaceuticals, fine chemicals, medical devices and biotechnology.
By the 1970s, the limits of industrialisation in a small closed market were being reached and world economic shocks compounded matters
This process had run its course by the first years of the 21st century, but Ireland then found a dubious new engine of growth: an exuberant credit bubble in property and consumption driven by lax banking supervision, low eurozone interest rates and hot money attracted by low corporation taxes. The bursting of this bubble naturally led to a deep recession – but GDP per capita is still $46,000 and many of the gains of the 1990s will persist.
Transitioning to prosperity
The economy of Communist Czechoslovakia yielded slower growth than Western Europe and was skewed towards producer goods, at the expense of consumer goods. But it still performed to some extent: GDP per capita at Purchasing Power Parity (PPP) stood at $8,400 in 1990 – compared to $6,600 in the USSR and $16,400 in Italy, for example.
From this imperfect but far from disastrous foundation, the new Czech Republic powered through the 1990s and 2000s and now boasts a GDP per capita (at market exchange rates) of $21,000, or 83 percent of the EU average. It now stands as one of the wealthiest so-called ‘transition economies’ of the former Communist bloc.
EU membership and short trading distances with Germany and Austria were clearly beneficial to the Czechs, as was heavy investment from the US, Germany and elsewhere. A decent level of pre-existing development and Western assistance in the period immediately after 1989 created space to develop stronger, less corrupt institutions than countries like Russia, Romania and Bulgaria. These institutions are of the European mixed-economy variety, but are more free-market than the norm with public spending at 37 percent of GDP and thorough privatisation of state-owned industries.
An African success story
Botswana shows that Africa need not be poor. Between independence in 1966 and the end of the millennium it grew at almost 10 percent per annum and GDP per capita is now over $13,000. This happened because Botswana is unlike much of the rest of Africa. It is a functioning democracy and has had four presidents since independence, albeit with the sitting vice president taking the role on two occasions and then being elected in his own right. It has had no significant internal or external conflicts and is part of a customs union with South Africa and other neighbours. Transparency International rates it as the least corrupt country in Africa.
Fiscal policy has not featured the excessive deficit spending or blatant theft seen in other African countries. Indeed, fiscal surpluses and the accumulation of foreign exchange reserves have been the norm. Financial and technical assistance from the World Bank and other multilateral institutions have been more forthcoming and more effective than elsewhere.
This setting has made it possible to use mineral exports to fuel development. Diamonds have been especially important – probably helped by foreign cartels stabilising the world price – but copper, nickel and other resources have also been significant. Mining accounts for 36 percent of GDP, and industry 17 percent, with most of the rest being services.
There are still serious problems: almost 80 percent of people work on the land for low wages and 30 percent are below the poverty line. HIV prevalence is 24 percent amongst adults. Industry was hit hard by the global recession of 2007-2010 and unemployment is now 21 percent. Nevertheless, Botswana has far outperformed the rest of sub-Saharan Africa.
The Southern Cone
Uruguay has had a turbulent economic history but has managed to reach a GDP per capita of $13,600. From the 19th century to the Great Depression, it prospered by exporting meat and wool from its fertile grasslands. But then export prices slumped and Uruguay stagnated.
After 1945, Developmentalism became the leading school of economic thought in Latin America, advocating state investment and Import Substituting Industrialisation (ISI). In Uruguay and elsewhere in the “Southern Cone” of the continent, this produced rapid growth in metallurgy, machinery, electrical equipment, oil refining and chemicals. But continued exposure to agricultural price shocks ultimately caused several bouts of volatility.
EU membership and short trading distances with Germany and Austria were clearly beneficial to the Czechs, as was heavy investment from the US, Germany and elsewhere
By the 1970s, the limits of industrialisation in a small closed market were being reached and world economic shocks compounded matters. This caused renewed stagnation – and inflation as money was printed in pursuit of growth. The military ruled from 1973 to 1985 and they cut public spending, tariffs and money creation while attempting to attract foreign investment. This did not help: stagnation, inflation and financial crises continued – with intermittent growth.
So what might we advise a small country – say Scotland; currently contemplating independence from the UK – in setting economic strategy? Latching on to new technologies is vitally important. Sweden did so with electricity. Ireland may not have been at the forefront of research and development, but it carved out a niche in making advanced products when they were new. Singapore did likewise.
Also important is making use of the resources and starting point you find yourself with. Sweden had hydroelectricity. Ireland had a young English-speaking population that could be educated, and it could be competitive on price because it was low-income but still in Europe. The Czechs had their not-terrible legacy of Communist economic development and a good location in central Europe. Botswana had diamonds; Singapore had its port and Uruguay its grasslands.
Efficient government and institutions are crucial. In Sweden, the Czech Republic and Botswana, a deliberate effort to create such institutions occurred at the outset of their success stories. Functioning institutions were also present in Ireland and Singapore. This lesson is not particularly revolutionary for leading countries that already have good institutions, but it can be vital for others.
Institutions should involve a balance of state and market. Of our example countries, the roots of development in all involve government support for industry in one way or another. Several of them have substantial regulation and state sectors: in Sweden, Ireland, the Czech Republic, Botswana and Singapore, respectively, public spending is 56 percent, 41 percent, 37 percent, 16 percent and 12 percent of cyclically-adjusted GDP.
Singapore manages its economy through pubic stakes in corporations. In general, the human and physical capital and benign socio-economic conditions fostered by an activist state are needed for development. Indeed, when Ireland failed to regulate its financial sector, the result was a success story gone sour.
Finally, although some external barriers may help, nations should not turn inward. Large countries such as Germany, Russia and Japan played industrial catch-up in the 19th century partly through protectionism, but an inward-looking approach won’t work as well for small countries today. Their internal markets are too small and, with so many commercial powers out there today, a period of being closed off from competition would leave them complacent and uncompetitive.
In the end, it is not rocket science. The solutions are: latch on to new technologies, tailor your strategy to your circumstances, maintain efficient government and institutions, balance state and market, and don’t turn inwards.