Small states: not handicapped and under-aided, but advantaged and over-aided.

• Author: Anklesaria Aiyar, Swaminathan S.
• Position: Report

Small states have long been viewed by international organizations as a special category with special handicaps requiring special assistance. The United Nations has created an Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries, and Small Island Developing States. The very wording makes it clear that the UN regards small developing states that are landlocked or islands as being on par with the least developed countries. A very substantial academic literature has been devoted to small states, to which the World Bank and Commonwealth Secretariat have made contributions. They constituted a Joint Task Force that submitted a report in April 2000, Small States: Meeting Challenges' in the Global Economy, proposing an agenda for assisting such states in various ways, including increasing foreign aid (World Bank 9.000). This report was followed in 2005 by a review of progress on the 2000 agenda, Towards an Outward-Oriented Development Strategy for Small States (Briguglio, Persaud, and Stern 2005), henceforth referred to as the World Bank-Commonwealth review. This review also suggested increasing foreign aid. In 2006, the Independent Evaluation Group (IEG 2006) of the World Bank produced an evaluation of World Bank assistance to small states. During that same year, the World Bank also commissioned four regional studies of small states, which formed the basis of a subsequent book, Small States, Smart Solutions (Favaro 2008). Finally, in 2008, the World Bank released The Growth Report, also known as the Spence Commission report, which devoted a special section to small states (World Bank 2008).

Economic theory suggests that small states may have intrinsic disadvantages (Easterly and Kraay 2000, Alesina and Spolaore 2003, World Bank 2008). The provision of public services may have indivisibilities that yield increasing returns to scale, so small states suffer from scale diseconomies. Returns to private investment may also have increasing returns to scale, which may be difficult to realize in small states. Small size may limit an economy's scope for diversification. Many small states are islands or landlocked, and face problems of remoteness. Small states produce only a few items and import file rest, and so are relatively open economies, and hence more exposed to trade shocks. They are disproportionately exposed to natural hazards like hurricanes.

However, empirical studies do not, in general, find concrete evidence that smallness is a disadvantage. Among developing countries, small states actually have a higher GDP per capita than all states (IEG 2006, World Bank 2008). So, while small states may have some special disadvantages, they clearly have some special advantages too. This undercuts the rationale for viewing them as a special category requiring special assistance. To propose additional foreign aid in view of the disadvantages, while ignoring the advantages, does not make sense.

Most recent studies define small states as those with a population of less than two million. (1) There are 50 such small states. The World Bank-Commonwealth review also covers Jamaica and Namibia, which have slightly over two million people each. Many studies exclude oil-rich countries like Brunei, Bahrain, and Kuwait, and small European states like Luxembourg and Lichtenstein. The list of small states covered in the World Bank-Commonwealth review is given in Table 1.

Does Size Really Matter?

Several studies (Easterly and Kraay 2000, World Bank 2008) show that small developing states have higher gross national income (GNI) per capita than large ones. (2) Indeed, differences among small states are more dramatic than average differences between small and large states. This suggests that size is not a key determinant of outcomes. The main issues are elaborated below.

Small States Are Relatively Rich, Not Relatively Poor

The World Bank-Commonwealth review shows that the mean GNI per capita of small states in 2005 was $5,180 (Table 1). By contrast, the mean GNI per capita for all developing countries was $1,753. Even the mean for all middle-income countries, $2,647, was lower than the small country average.

Of the 43 small developing states, only seven were low-income countries (classified by the World Bank as having GNI per capita below $875 in 2005), and of these Bhutan has subsequently graduated to middle-income status. This hardly suggested that small states were especially handicapped. As many as six small states in the study were high-income countries, defined as having GNI per capita exceeding $10,126 in 2005. Three of these were rich in oil and gas (Brunei, Bahrain, and Qatar). Three others achieved high-income status by harnessing financial services and tourism (Antigua/ Barbuda, Bahamas, and Barbados).

A study of small states (Easterly and Kraay 2000) also showed that, after controlling for location, small states were richer in per capita GDP than large ones. Being open economies with high trade dependence, their GDP was relatively volatile. But the same openness that increased volatility was also an advantage that tended to provide high GDP per capita. This study concluded that small states should be treated exactly as all others, with no special benefits.

Not a single small state in the Caribbean or Pacific is a low-income state. Even the worst-governed countries in the region, such as Guyana and Surinam, are middle-income countries. The absence of any low-income small state in the Caribbean is striking, given that the region is peppered with small island states. The only low-income country in the Caribbean is Haiti (GNI per capita of $453), and it is not small--it has a population of over 8 million (World Bank 2007).

Most striking is the picture in Africa. This is the poorest of all regions. Yet the average per capita GDP of small states in Africa in 2005 was $2,930, against $627 for large African states. So, small states were, on average, more than four times as rich as large ones in this region. The poorest countries in the world get ultra-soft aid from the IDA window of the World Bank, while better-off countries have to borrow at quasi-commercial terms from the bank's IBRD window. In Africa, every quasi-commercial IBRD borrower--except South Africa--is a small state. That chives home their relative affluence (Domeland and Sander 2007).

In the eight countries of South Asia, one of the poorest regions, the richest and third richest states in 2005 were both small-Maldives ($2,390 per capita) and Bhutan ($870 per capita). Much poorer in per capita terms were India ($730), Pakistan ($690), Bangladesh ($470), and Nepal ($270).

Disproportionately few small states are both heavily indebted and poor. Of the 41 countries covered by the Heavily Indebted Poor Countries (HIPC) initiative, only five are small--Comoros, Gambia, Guinea-Bissau, Guyana, and Sao Tome and Principe. So, one-fifth of all countries (41 out of 208) are HIPCs, but only one-eighth of small states (5 out of 41) are in this category. Many small states have a relatively high public debt/GDP ratio, but these include middle-income and high-income states, especially in the Caribbean.

A recent study (World Bank 2005) found no statistical correlation between per capita income and the population of small states after controlling for life expectancy, trade openness, inflation, and the size of government.

The World Bank-Commonwealth review (Briguglio, Persaud, and Stern 2005) showed that in 1990-2005, small states had on average slower economic growth (3.5 percent per year) than all developing countries (4.2 percent). However, another study (Easterly and Kraay 2000) found that in 1960--95 small states grew as fast as large ones. The Spence Commission (World Bank 2008) concluded that small states did not on average have lower incomes or slower growth than large states.

Within Africa, the poorest region, small states have averaged 4.1 percent GDP growth since 1980, much higher than the 2.8 percent recorded by large African states (Domeland and Sander 2007). The worst small performers have been highly aided middle-income Pacific islands, of which Marshall Islands, Micronesia, Palau, Solomon Islands, and Vanuatu experienced a fall in per capita income in 1998-2002 (Duncan and Hakagawa 2007).

Small and Large States Have Comparable Policies and Institutions

High incomes are generally correlated with better policies and institutions. This might lead us to expect that small developing states, which are much richer than large ones, should have better policies and institutions. In fact the differences between small and large states do not seem significant. In any event, small states cannot be said to suffer from weaker policies and institutions, and this cannot be a rationale for giving them high levels of aid.

The World Bank-Commonwealth review looks at World Bank ratings for 16 different aspects of policy and governance, which are combined into an index called the Country Policy and Institution Assessment (CPIA). The CPIA ratings for 34 small countries and 101 large countries among World Bank borrowers are much the same. The small states are better in financial stability, banking regulation, business regulatory environment, transparency and corruption, and property rights and rule-based governance. They are weaker in macroeconomics, debt and fiscal management, trade barriers, human resource development, and revenue mobilization. On balance, there is no evidence that small states are particularly disadvantaged in policies and governance.

A similar conclusion--that small and large states have roughly comparable policies and institutions--is reached by a study comparing policies in small and large states, focusing on policy parameters such as import tariffs, export subsidies, and direct taxes (Winters and Martins 2004).

In Africa, the poorest and worst governed of all regions, small states score consistently better than large...