Talk of the end of the small economy model much exaggerated

Published in the Straits Times

Concerns about the outlook for global openness are often accompanied by predictions of a cloudy outlook for small economies, both in a specific sense (such as the impact of trade wars) and in a more existential sense. Financial Times columnist Janan Ganesh recently wrote that ‘the belle époque of the small nation is over’ because ‘globalisation has been the era of small countries but that time may now be passing’. It is increasingly argued that national scale matters in a world of economic and geopolitical turbulence and uncertainty.

Similar concerns are often expressed in Asia. Asia has been a primary beneficiary of the past several decades of intense globalisation, and nowhere more so than in Asia’s small open economies such as Singapore, Hong Kong and Taiwan. Singapore’s surge from third world to first since 1965 has been underwritten by globalisation: Singapore’s export share is over 170% of GDP and inward FDI is over 400% of GDP – both among the highest shares in the world.

It is certainly true that the potential for trade wars and broader US/China strategic tension, as well as the weakening of the liberal, rules-based order, creates an exposure for small economies. From Singapore to the Nordics and Ireland, small advanced economies have performed well over the past few decades, supported by strong global growth, globalisation, and a liberal, rules-based system.

But the rumours of the end of the small economy model are much exaggerated. My assessment is that small advanced economies will continue to out-perform.

Recall that concerns were also raised about the small economy outlook a decade ago during the global financial crisis. And since then small advanced economies have continued to perform strongly. Despite sluggish global growth, modest world trade growth, and the headwinds posed by QE in large economies, small economy GDP growth has out-paced that of larger economies in the post-crisis period, fiscal discipline has been maintained, unemployment rates are lower, and pressures on the income distribution have been managed.

Even those small economies that were hard-hit by the global financial crisis – think Ireland, Iceland, and the Baltic states – have recovered, and are treated as good examples of managing through an economic crisis.

And small, open Asian economies – from Singapore to Hong Kong – have managed through these external headwinds at the same time as dealing with structural dynamics such as slowing labour force growth and new sources of competition. Although GDP growth has been lower than before the crisis, small Asian economies have continued to perform relatively well.

More recently, small advanced economies have been resilient to growing concerns about trade wars and a less open global system over the past year or so. The small advanced economy group has generated GDP growth rates of just under 3% for the past several quarters (2.9% in the year to Q2), well above larger advanced economies. In Asia, Singapore and Hong Kong had a very strong period through 2017, benefiting from the global economic recovery, and generated growth of 3.5-4.0% in the year to Q2.

Although economic momentum has been easing through 2018, Singapore is expected to generate GDP growth of around 3% for 2018. The advance estimate for GDP growth for the year to Q3, released on Friday, was 2.6%.

The IMF’s World Economic Outlook, released in Bali this week, marked down forecast world GDP growth for 2018 and 2019 from 3.9% to 3.7% - on the back of trade tensions, higher oil prices, tighter monetary policy, and so on. But the growth downgrades were focused primarily on larger economies, such as the US, China, and Germany. On average small advanced economy GDP growth forecasts were marked up slightly, and are projected to retain a growth edge relative to larger economies.

Of course, small economies in Asia and beyond are exposed to a weakening in the intensity of globalisation. Indeed, this past week has seen sharp downward moves in equity markets around the world, as concerns about trade wars, higher interest rates, and so on, come to the fore. Small open economies have not been spared: equity markets in Singapore, Hong Kong, Taiwan and elsewhere have been hit hard.

But it is not clear that small economies are more exposed to these risks than larger economies. Indeed, my assessment is that small advanced economies are relatively resilient to the current trade tensions because of the characteristics of their external footprint: deep regional integration and comprehensive portfolios of FTAs (95% of Singapore’s merchandise exports are covered by FTAs); high shares of exports of services and of outward FDI; and so on.

More broadly, it is important to recognise that strong small economy performance is not simply a function of the supportive post-1990 environment. The economic performance of small economies over the past 200 years shows resilience to economic and political regime change. Despite their deep exposure to the external economic and political environment, many small economies have sustained positions near the global income frontier, and have navigated major shocks, from wars to protectionism, relatively well.

And although small economies are not immune to populism (note the recent Swedish elections), the small economy model – of openness, flexibility, social insurance, deliberate policy-making – is well-suited to responding to economic and political pressures from globalisation, disruptive technology, and so on. If anything, it is large countries, from the UK to the US, that have more fundamental political problems.

Small economies rank well on measures of political institutions, effective government, social capital and trust – all supportive of ongoing performance. Small economies continue to be at the forefront of policy innovation, and many have been actively positioning for emerging challenges. To give just a few examples: leading on new trade deals (such as the Trans-Pacific Partnership) as well as reducing public debt and investing in building competitive strengths. Small economies have focused on supply-side measures during the post-crisis period, whereas larger economies have placed more emphasis on demand-side measures.

Of course, there are real risks. A slowing pace of globalisation and a more fragmented global system will require meaningful changes in the economic models of several small economies. For example, Ireland and Singapore are heavily reliant on the location decisions of multinational companies – that may be different in a new world. But my money is on these – and other – small advanced economies to respond effectively.

The priority, as always, is to position Singapore to capture maximum value from the prevailing global environment. This will be more challenging than it has been, but progress can be made in terms of building additional domestic growth engines and further strengthening resilience to shocks.

The acute external exposures that face small economies impose a competitive discipline that forces better decision-making than in larger economies that have the luxury of scale. Small economies make better choices partly because they have fewer options and more constraints, whereas larger economies have greater scope for poor decision-making. As in other domains, the paranoid tend to survive.

In sum, don’t write off small economies. Although a global regime change is underway, with the norms and institutions that have underpinned growth and globalisation changing markedly, this does not mean that small economies are at existential risk. Small economies are resilient and flexible, with a range of political and economic characteristics that position them well for a more complex environment.

Dr David Skilling

Director, Landfall Strategy Group

twitter: @dskilling

David Skilling