The best monopoly profit is a quiet life

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I have spent the past week travelling between Singapore, the Gulf States, Scotland and Denmark, as well as France on the day after the first round of the Presidential election.  Taken together, this varied group of economies provides useful insights on which countries are most likely to succeed in a more challenging global environment.

Nobel Laureate British economist, Sir John Hicks, once observed that ‘the best of all monopoly profits is a quiet life’.  Competition is a powerful economic force.  Individuals, firms, and economies that are exposed to competitive discipline tend to perform better, and to have higher levels of productivity and innovation.  Without competition, there is less need to change or to do things differently.  Over time, this breeds inefficiency and deteriorating performance.  This effect is widespread, beyond product markets.  In my doctoral research, for example, I found that political competition within countries had a disciplining effect on fiscal performance.

The deep exposures of small economies, from Singapore to Denmark, to the global economy provide a powerful source of competitive discipline.  External shocks, both in terms of aggregate demand or to specific sectors, have significant impacts on the performance of small advanced economies because of their high external shares (as well as the fact that small economies tend to have a less diversified portfolio of sectors).  These external exposures create higher volatility in the GDP path.

Consider the relative performance of small economies during and since the global financial crisis: Singapore’s GDP was down by about 10% before rebounding; similarly Ireland, Iceland and the Baltics had very sharp crisis experiences.  Or the Gulf States, Scotland and Norway that have been negatively impacted by lower oil and gas prices.  And further across the Nordics, Finland was hit by a series of simultaneous shocks (Nokia, pulp and paper prices, Russian sanctions) and went into a sustained recession.

Small economies are also exposed to external competitive pressures.  Singapore constantly competes for capital and economic activity against other locations in the region (Hong Kong) and beyond.  Denmark, and other high cost small advanced economies, is subject to strong competitive pressure in a range of export sectors.  And, small economies face much stronger discipline from capital markets, a reason that small economies tend to be fiscally conservative – a key dimension of the current debate around Scottish independence.

These various exposures make sustaining economic success a challenging task for small economies.  There is limited margin for error.  But these various exposures are a source of valuable competitive discipline.  It requires small economies to respond quickly to shocks and to changes in the operating environment, which over time is beneficial to their economic potential.  This is one of the reasons that small economies have out-performed their larger counterparts over the past few decades.

The response to the various shocks and challenges of the post-crisis experience is instructive.  Denmark has run a programme of fiscal consolidation to get its fiscal positon back on track, and is actively embracing Industry 4.0 to strengthen competitiveness in its economy.  Singapore continues to upgrade its economy, investing in human capital, infrastructure, and new sectors, and has run two major economic strategy processes to develop a view on the next generation of Singapore’s economic direction. There are ambitious efforts at economic diversification in many of the Gulf States.  And Finland is pursuing a course of fiscal discipline and reducing its cost structure.  Similar patterns of behaviour are observed around the small economy universe from the Baltics to Ireland and Iceland.

The decisive economic and fiscal policy action of many small economies to the crisis contrasts with that of larger economies, many of whom have relied heavily on loose macro policy rather than structural reform.  In general, larger countries, such as France (and others), continue to run inefficient policies without the same competitive sanction.  These large economies have many strengths, but do not face the same urgency to adapt to a changing world.  Although last week’s vote for Mr Macron is perhaps a vote for change in France, a large proportion voted for the status quo (a quiet life?) in some form.

Even in the much more challenging environment over the past several years – sluggish global GDP growth, weak trade growth, and QE – small advanced economies have maintained their performance edge.  And many have been investing to position themselves to respond to emerging new competitive challenges and opportunities.  These small economies are now well-positioned to benefit from the strengthening global economy.

Interestingly, there is perhaps less urgency in less volatile small economies – outside of periods of obvious crisis. New Zealand and Switzerland are two examples, because of their low beta economic and export structures.

So small economies are not simply passively exposed to global economic shocks.  Yes, they have high levels of exposure, but they adapt quickly and well to shocks.  They have strong political and social institutions and capability that enable them to respond – as well as the competitive imperative to do so.  Indeed, to use Nassim Nicholas Taleb’s term, many small economies are ‘anti-fragile’, being strengthened by exposure to shocks.

Looking forward, these characteristics provide a measure of confidence in the ongoing performance of small economies even in a more complex environment.  The return of big power politics, trade frictions, increasing competitive intensity, the potential for economic and financial shocks all create new challenges.  Small economies may be exposed to these developments, but the historical record suggests that they will respond creatively and effectively.

Counter-intuitively perhaps, it is the large countries that are more likely to struggle to adapt – their quiet life makes them less responsive.  In stormy waters, it may be more comfortable to be in a large cruise liner than in a small yacht.  But being in a yacht focuses the mind on responding to the conditions and charting the right course.  After all, being a big boat didn’t save the Titanic.

David Skilling