In Uncertain Seas: Positioning small countries to succeed in a changing world

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Executive Summary

Small, developed countries – advanced economies with populations of less than 20 million people – have out-performed larger developed countries over the past few decades on multiple dimensions. These small countries are over-represented in terms of measures such as per capita income, economic competitiveness, international economic engagement, as well as various social outcomes.

This paper identifies three classes of reasons for this strong small country performance. First, the global economic and political environment over the past several decades has provided a supportive environment for small countries. Small countries are commonly argued to be one of the primary beneficiaries of the globalisation process experienced over the past few decades. However, this is better seen as the removal of disadvantage to small size than as conferring an advantage on small countries.

Second, small countries have domestic intrinsics that support performance. Small countries tend to have high levels of social capital and trust, well-functioning political institutions, and a well-developed sense of external orientation. These factors make it easier to sustain a deliberate strategy and to change course when appropriate. This combination of shared purpose and agility makes policy management easier, particularly in challenging times, and has supported the design and delivery of policy agendas that have positioned many small countries to perform well.

And third, many small countries have well-deserved reputations for the quality of their policies, and this has contributed to their strong performance. There are some policy areas in which small countries have distinctive policy settings, such as R&D and fiscal policy. But more importantly than these policy specifics, small countries tend to adopt a more deliberate policy approach that is focused on competing in the global economy. Small countries choose to compete in different ways, but it is the ability to adapt policy to the external environment that has been the key driver of strong small country performance.

However, although small countries have performed well as a group, there is substantial variation in performance among small countries. Those small countries that have not been active globalisers, that have weak domestic intrinsics, or that have not adapted their policies to emerging global realities, have performed poorly. And this distribution of small country outcomes is likely to widen further as the world continues to change in structural ways, placing additional pressure on small countries.

Over the past two decades, globalisation has moved into a more intense phase, with economies much more tightly linked together. In addition to the opportunities this creates, the intensity of competition, the pace and scale of change, the global economic – and political – reordering, combine to make the global environment more complex. Performing in this environment will require a sustained, deliberate response by governments of all developed countries, both large and small.

This emerging environment also raises two additional challenges specific to small countries. First, the weakening of multilateral institutions, and the increased importance of big powers in the global political system, both reduce the influence of small countries. Small countries are better placed to perform in an open, rules-based global environment because it provides a relatively level playing field. And second, the potential for a sustained increase in the level of economic turbulence and the incidence of shocks,

In Uncertain Seas: Positioning small countries to succeed in a changing world 2

which creates particular exposures for small economies. So is this the end of the golden weather for small countries?

Not necessarily. Indeed, many small advanced economies are responding successfully to this emerging environment; they are continuing to generate strong economic outcomes, are investing heavily in R&D and education, are strengthening their macro policy settings (including through fiscal consolidation), and are strengthening their external relationship (such as through negotiating FTAs). But this environment will be very challenging for some small countries; indeed several small countries have been hit hard by the ongoing financial crisis.

And even for well-performing small countries, the challenges will likely continue to intensify, and small country governments will need to work hard – and to do things differently – to navigate this more challenging environment. Small countries will need to invest in strengthening their competitive positioning. And in a more volatile and complex international environment, small countries will also need to make judgements about where they enter into external alliances and relationships to bulk up their size – and where they remain independent, to retain the flexibility and benefits of small size. In some areas, being a small, independent country may be an uncomfortable and exposed place.

The ability of small country governments to make these policy changes rests on their domestic intrinsics. The cohesion, effectiveness of institutions, and external orientation of countries will become increasingly important as drivers of national performance. In these respects, small countries may be better placed than large countries: the challenges may be substantial, but many small countries seem to have the capacity, institutions, and social consensus to respond. In contrast, some large countries may struggle to accommodate themselves to this new world; the ability to respond, and to overcome sclerotic tendencies, may be weaker in large countries than in small countries.

For these reasons, small countries are likely to continue to be over-represented at the frontier of economic and social outcomes. However, the distribution of possible outcomes among small countries is likely to widen significantly. Well-managed small countries will continue to out-perform, but small countries with even average strategies and approaches are likely to struggle and to under-perform – as is clear from recent events in Europe. Small countries have much less margin for error.

In sum, central to the success of many small countries over the past decades has been the ability to respond appropriately to a changing world through deliberate policy, supported by strong domestic intrinsics. These characteristics will matter even more in the future. In many cases, but not all, small countries are well-positioned to prosper in the emerging environment. Delivering on this potential will require ongoing hard work, deliberate strategy, and policy innovation to prosper in an unforgiving environment. In this regard, small countries are likely to play a global leadership role, providing guidance to other advanced countries in how to respond to a changing global environment.

David Skilling