Due to a prolonged slowdown and a slow recovery from the recession, high-income countries have managed to grow by around 2.3% per year from 1990 to 2007. The per capita GDP growth after adjusting for inflation has fallen to just 2% in five years from 2008 to 2013. However, small countries, with a population of less than 1.5 million, have actually witnessed a contraction in their GDP with per capita GDP growth shrinking by 2.3% from 2008 to 2013.
An analysis of 48 states classified as small states as per the World Bank’s classification shows that the 29 million people residing in these countries have had it pretty rough in the past five years. Although exceptions like the Marshall Islands, with a per capita GDP growth of 8%, exist, most small states have experienced significant economic problems due to the global slowdown over the past five years. St. Kitts and Nevis saw a 12% fall in its GDP growth while Antigua and Barbuda witnessed a 21% drop over the past five years.
An IMF research paper that analyzed the problem identified two primary reasons why small states suffer more during economic slowdowns. Firstly, small nations don’t enjoy the benefits of economies of scale that larger nations enjoy. Secondly, these nations face issues like lack of connectivity and higher trading costs due to their lack of size and geographical isolation.
The Federated States of Micronesia consists of 600 islands spread over a million square miles in the Pacific Ocean. Providing public services for a small population spread over such a wide area is a very expensive affair, which inevitably leads to significant deterioration in quality.
Kiribati, another island nation in the Pacific Ocean, suffers due to its isolated location and small population. Trading costs are unsustainably high considering that the island has a permanent population of just 100,000 and is located five hours by air from Hawaii. The twin combination makes it an expensive and unattractive market, which has a deleterious effect on economic growth.
These two basic problems lead to numerous other economic complications. High fixed costs, which is invariably shouldered by the public sector, leads to an excessively high expenditure-to-GDP ratio. Over a period from 2007 to 2011, the spending-to-GP ratio of the smaller nations was a full nine percentage points higher than bigger countries. High government debt is an inevitable consequence of such a strategy.
Another issue that small states suffer is that of lack of export diversification. Weighed down by higher costs, small nations focus on export of a single product or service when attempting to participate in global trade. This makes them more vulnerable to economic slowdowns as compared to nations that export a wide range of products and services.
While recent data may paint a bleak picture, analyzing data over a longer time frame raises doubts about the significance of factors like area, population, and geographical location of a nation. From 1980 to 2010, smaller states actually outpaced larger nations by a miniscule annual margin of 0.7%.
According to one explanation put forth by the World Bank, smaller nations suffered more after 2000 as a result of their increased exposure to the global financial market. However, this explanation does not seem plausible when one considers UNCTAD data related to export of global financial services in the first decade of the new millennium. The contribution of smaller states fell from 0.1% in 2001 to 0.04% in 2008. Further, global remittances from 2007-2013 witnessed an 18% increase.
Another explanation, which seems a lot more plausible, focuses on the drastic downturn that affected the global tourism market. Tourism receipts in small states rose by 50% during the period from 1995 to 2008. From 2008 onwards, the global market contracted by 10%. Since tourism contributes about a quarter of the total export earnings in small states, the contraction led to a significant impact on their economies.
The IMF considers the effect of factors like high emigration and detrimental trade reforms. The latter may be the reason why Caribbean nations that depended on sugar and banana exports were hit hard by the slowdown. Recent EU reforms that led to a 36% reduction in raw sugar prices spread over a short period of four years may have led to reduced exports and a consequent reduction in economic growth. Such changes in the trade environment affect smaller nations that lack export diversification.
Considering the wide range of factors affecting the economies of nations, lack of growth cannot be definitively attributed to lack of size. Mauritius is a small state that has diversified its economy. Till the 1970s, the country as completely dependent on sugar exports for economic growth. The country invested in setting up export-processing zones and has managed to reap the benefits in the form of a stronger economy that can withstand shocks like bigger and more developed nations.
While this may be a suitable long-term strategy, smaller nations affected badly by the recent downturn will require assistance to reach a position where implantation of such a strategy becomes viable again.