Too big to succeed

The past couple of weeks have reminded that political institutions in several large developed countries are deeply challenged.  The Brexit deal that PM May presented to her (rapidly shrinking) Cabinet on Wednesday represents progress, but remains markedly inferior to the status quo.  This is widely known, but a chaotic political process has – at least at the time of writing – been unable to stop this act of damage.

And the rhetoric around the US midterm elections – from caravans of refugees to the media as ‘enemies of the people’ – showed the increasing political polarisation in the US.  This is damaging to political institutions and to policy-making.  US trade and fiscal deficits continue to expand, as do the trade tensions with China – with no easy resolution in sight.  The spectacle of the President’s visit to France gave the sense of an America turning inwards.  And the US presence at the round of regional summitry in East Asia this week reinforces the impression in Asia that the US is less than fully engaged.

Around the world there are examples of a hollowing out of the political centre, with the rise of authoritarianism and populism.  From Germany and Italy to Brazil, recent elections have highlighted the shifting centre of gravity in domestic politics.  And in China there is a centralisation of power under President Xi with a reversal of the ‘reform and opening up’ phase.

But the picture looks a little different from a small country perspective.  I was on the road in Europe last week, for meetings in Latvia, Denmark and Switzerland before heading back to Singapore.  I watched the US midterm election results come in from my hotel room in Riga, which was a slightly jarring experience.  Latvia, currently celebrating 100 years as an independent state, has also just held elections and coalition negotiations are underway: anti-establishment parties made gains, but the pro-EU and NATO stance is set to remain.

The level of trust and confidence in political institutions is stronger in many small countries than in larger jurisdictions: measures of expressed trust, the absence of corruption, and the assessed effectiveness of governance are all consistently higher in small countries.  And small countries have maintained political and public support for openness and globalisation, albeit with measured restrictions (such as on foreign investment in residential real estate, or limits on migration).  Public support for the EU, and the Eurozone, remains high across small countries in Europe.

Small countries are not immune to populist pressures.  Recent elections in Austria and Sweden (where there is still no government, two months after the election) saw strong showings by populist parties – motivated more by concerns about migration than openness in general.  And there has been growth in populist parties in Denmark, Finland, the Netherlands, and elsewhere.  But in general, the political centre is holding in smaller countries better than in many large countries.

The resilience of political institutions in small countries is partly because it is easier to maintain trust and consensus in smaller jurisdictions.  But it also reflects policy choices that have been made in these small countries.  Policy has been deliberately set to capture opportunities and manage costs and risks from intense globalisation, disruptive technologies, changes to labour markets, and so on.  Among other things, income distribution and social mobility outcomes are better in small countries, labour market outcomes are superior, and GDP growth has been consistently higher.

In contrast, many large countries have not responded effectively to the forces of globalisation and technology – and policy has been captured by interest groups and elites.  The subsequent dislocation, and the uneven sharing of gains from growth, has contributed to the political anger.  Large national scale makes the politics of disruptive change much harder to manage.

Of course, small countries are exposed to the decisions made by larger countries – protectionism, undermining of global institutions, and poor domestic policy-making, have spillover effects onto small open economies (Ireland is exposed to Brexit, for example, and small Asian economies to US protectionism).  So small countries should be concerned about the weakening of political institutions and processes in large countries.

But the political resilience of small countries is a source of competitive advantage, supporting better policy-making.  Across the small advanced economy group, there is intense policy action and debate around engaging with emerging dynamics: developing policies to respond to automation, AI, and so on (note Denmark’s ‘Disruption Council’; and Singapore held a major global fintech conference this week); developing new institutions to manage external risks (the Hanseatic League 2.0 of small Northern European economies); acting to improve the underlying competitiveness of their economies (addressing high cost structures); and investing more in human capital and innovation.

Far from the small economy model being in danger, successful small economies are doubling down on the model – working to strengthen competitive positions in global markets (which are already strong, as measured by the 2018 release of the World Economic Forum’s global competitiveness report).  And although economic momentum is easing in small advanced economies, they continue to out-pace most larger advanced economies.  Small economy GDP growth rates into Q3 have held up relatively well, although there is slowing in economies like Singapore, Austria, and the Netherlands.

To respond to the current political mood, large countries should learn from the way in which small advanced economies have responded to globalisation, technology, and so on.  And to succeed, one message may be that large countries need to devolve decision-making to smaller sub-national units, where coherent policies can better be pursued.  To succeed, think small.

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Dr David Skilling

Director, Landfall Strategy Group

David Skilling