[lg policy] Undersized: Could Greenland be the new Iceland? Should it be?

Sun Aug 9 20:04:39 UTC 2009

  Undersized: Could Greenland be the new Iceland? Should it be?

Anne Sibert <http://www.voxeu.org/index.php?q=node/106>
10 August 2009
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As Greenland moves away from Denmark and acquires more autonomy, this column
asks whether it might be too small. In assessing the relationship between
country size and economic performance, it warns that small states have more
volatile GDP, more volatile consumption, and more incompetent civil
servants.
*

Greenland’s population of about 60,000 make it as about the same size as
Bismarck, North Dakota. It is blessed with natural resources such as rich
deposits of minerals, and oil and gas reserves are believed to lie below its
ice cap. It is protective of both its fishing industry and its long
tradition of killing appealing marine mammals. Greenlandic, an Eskimo-Aleut
language, is spoken by few outside its borders.

On 1 May 1979, this miniscule country began its move toward autonomy when
the Danish parliament granted Greenland home rule. Greenland swiftly
distanced itself from Europe by exiting the EU in 1985 – the only country
ever to have done so. The goal was to avoid the EU’s Common Fishery Policy
(the ban on seal skin products also played a role). Greenlanders approved a
referendum on greater autonomy on 25 November 2008 and on 21 Jun 2009
Greenland expanded its sovereignty by assuming authority over its judiciary,
policing, and natural resources, leaving only finances and foreign affairs
in Danish hands. The Danish queen attended a celebration at the parliament
in Nuuk, and Greenlandic became the country’s official language.
Can a country be too small?

Although it is not yet heavily involved in international banking,
Greenland’s progression toward independent statehood is strikingly
reminiscent of Iceland’s experience (especially its desire to maintain its
own culture and protect its natural resources at the cost of isolation from
the rest of the world and its wish to limit its economic relationship with
Europe). This raises questions – does the recent experience of Iceland
suggest that a country can be *too* small to be a nation state, and what are
the costs and benefits of being isolated from the rest of the world?

The answer to these questions is relevant not only for Iceland and Greenland
but also other tiny countries that have gained sovereignty in recent
decades; since 1990, 33 new countries have been formed and, as seen in
Figure 1, many are very small.1<http://www.voxeu.org/index.php?q=node/3857#fn>

*Figure 1*. Country size (population in millions)

In this column, I argue that there is little economic justification for
preferring small size and that there can be significant costs. I also argue
that Iceland’s small size was probably a key factor in Iceland’s failure to
stop its financial crisis.
Do smaller countries enact better economic policies and grow faster?

It is usually claimed that the benefit to small size is social homogeneity
which leads to cohesion and an ability to build a consensus. This may
promote flexibility in the face of changing circumstances and make it easier
to enact policies that promote growth. Indeed, some small economies such as
New Zealand, and, in many respects, Iceland are widely viewed as paragons of
economic virtue. Formal empirical evidence linking small size to
growth-promoting policies appears to be lacking, however.
Easterly<http://www.voxeu.org/index.php?q=node/3616>and
Levine <http://www.voxeu.org/index.php?q=node/1716> (1997) find a strong
negative correlation between ethnic diversity and indicators of
growth-promoting public goods such as the number of telephones and paved
roads and the amount of schooling. However, Easterly and Kraay (1999) assert
that a lack of consistent data makes it hard to test whether small size is
associated with growth-promoting public goods.

While many small economies have grown rapidly, the existing empirical
literature finds that the effect of country size on growth is inconclusive.
Easterly and Kraay (1999) find that, after controlling for location, small
states are wealthier than large states but do not have significantly
different growth rates. This may be because country size has an
insignificant effect on growth or it may be due to limited data; there is a
lack of consistent data sets that include a large number of small countries.
See Armstrong and Read (2002) for a discussion of this literature.
Smaller countries have more volatile output

The recent experience of Iceland suggests that, while there is no clear
evidence that small countries experience *higher *average growth rates, they
do have more *volatile* growth rates. As shown in Figure 2 below, Iceland’s
output growth is less smooth than that of either the UK or the US. The
reason for this seems clear. As a small country, Iceland is far less
diversified in endowments and production than the much larger UK or US. A
shock in the aluminium, fishing, or banking sector has a major effect on
Icelandic output; shocks to different sectors in much larger economies tend
to average out.

*Figure 2.* Percentage change in GDP at constant prices
Smaller countries have more volatile consumption

Output volatility is not necessarily costly; countries care about smoothing
consumption, not output. Residents of a country with variable output can
smooth their consumption across states of nature by holding a diversified
portfolio of home and foreign equity. However, most countries hold
relatively small amounts of net foreign assets. In addition, such risk
sharing is partial at best if it is not possible to hedge against adverse
shocks to the return to human capital.

If shocks to a country’s output were purely transitory, a country could use
its current account to smooth its consumption – borrowing in states where
output is low and lending in states where it is high. Unfortunately, from
the point-of-view of smoothing consumption, most shocks appear to have a
large permanent component. Thus, it seems likely that a country with
relatively variable output will have relatively variable consumption as
well.

In a study of 56 countries over the period 1950 – 1985, Head (1995) finds
that the variances of both output growth and consumption growth are indeed
negatively correlated with population size. Moreover, this effect is
especially pronounced in high-income countries. Figure 3 shows the
relationship between population size and (detrended) consumption volatility
for 20 relatively high-income countries. While some small countries have
very low consumption volatility (Norway, Luxembourg), many have very high
volatility (New Zealand, Trinidad and Tobago, and
Iceland).2<http://www.voxeu.org/index.php?q=node/3857#fn>

*Figure 3*. Consumption volatility and country size (in millions)

*Countries included: US, Japan, Germany, France, UK, Italy, Canada,
Netherlands, Australia, Belgium, Sweden, Switzerland, Austria, Denmark,
Norway, Finland, New Zealand, Trinidad & Tobago, Luxembourg, Iceland;
detrended annual data for 1950-1985. Source: Head (1995). *
Other problems in small countries

A small population has other costs; I will mention three here. First, as the
provision of many public goods has an important fixed cost component, the
per capita cost of public good provision is likely decreasing in country
size. Second, it is also likely that the per capita administrative cost of
income taxes is decreasing in country size. As a result, smaller countries
tend to rely less on relatively efficient income taxation and more on
relatively inefficient taxes, such as customs taxes (see Easterly and Rebelo
1993). Third, a lack of competition in the provision of non-traded goods in
small countries can lead to inefficiency.

I have focused on costs associated with small populations, but there is also
an important cost associated with small geographical size. Many countries
are vulnerable to natural disasters and environmental damage and
self-insurance against these sorts of shocks is easier for larger countries.
If an American city is damaged by a hurricane, residents can move to another
American city. If global warming causes sea levels to rise sufficiently, the
consequences for the residents of Tuvalu are likely to be less favourable.
Problems for civil servants in small economies

In October 2005, David Oddsson was appointed chairman of the board of
governors of the Icelandic central bank. The multi-talented Oddsson had
studied law, been a theatre director, the producer of a comedy radio show, a
political commentator, and the co-author of several plays. He had previously
been the mayor of Reykjavik, a long-time prime minister and, for a brief
period, the foreign minister. Unfortunately, he appears to have had no
expertise in economics and banking and was ineffective at either averting
the financial crisis or playing a positive role in its aftermath.

In addition to Oddson’s apparent acquiescence in the face of looming
disaster, neither the prime minister, nor the finance minister or financial
regulator seems to have made any serious attempt to stem the growth of the
Icelandic banks. This suggests that a significant cost of small size is the
burden that it places on senior government officials.

Despite its miniscule size, Iceland has ministries of business affairs,
communications, science and culture, environment, finance, fisheries and
agriculture, foreign affairs, health, industry and tourism, justice and
ecclesiastical affairs, social affairs, and social security. This causes two
problems. First, it is difficult for such a small country to find enough
talented civil servants, and second, each civil servant is forced to play
more roles than he would in a more populous society. Such multi-tasking can
be demanding and makes it difficult to build up expertise in a particular
area.

In an interesting article, Farrugia (1993) suggests that very small
countries may also suffer because of their high degree of interpersonal
relations. In a tiny nation, everyone knows everyone. This can facilitate
things getting done quickly, but it has its costs. Farrugia comments that,
“Many necessary decisions and actions can be modified, adjusted and
sometimes totally neutralised by personal interventions and community
pressures. In extreme cases, close personal and family connections lead to
nepotism and corruption.”

In Iceland, it has been alleged that personal animosity may have played a
role in the central bank denying Glitnir a loan in October 2008 and that the
Independence Party played an unseemly role in the privatisation of
Landsbanki with agreements made to offer plum executive positions to
Independence Party members. Even if such suspicions are untrue, the widely
held belief that they might be is damaging to social cohesion and the
state’s legitimacy.3 <http://www.voxeu.org/index.php?q=node/3857#fn>

A sensible policy solution to the problem of filling sufficiently important
posts when there is limited local talent or to filling a politically
sensitive post where the independence and impartiality that is required
cannot be found at home is to hire foreigners. Prime Minister Johanna
Sigurdardottir has already adopted this strategy by hiring a Norwegian
expert to be the acting central bank governor and a Norwegian-born French
magistrate to investigate the possibility of criminal activities by
Icelandic banks. In the long run, if supervising the banking system requires
more expertise than can be acquired locally, Iceland should hire supervisors
from abroad – the banks can be taxed to fund them.
Island officials should get out more

Many very small countries are islands, and thus isolated. It is more
difficult for senior officials to travel to a neighbouring country if they
live on a remote island than if they live in Luxembourg. This leads to a
danger that policymakers in small and far away locations might become
insular in their thinking and that they might not have access to advice that
their counterparts abroad might offer. It is thus important that senior
officials in out-of-the-way locations make an attempt to attend conferences
and other professional gatherings abroad.
Footnotes

1 At least Pitcairn Island – with its 48 inhabitants – remains a
non-self-governing territory.

2 A caveat is that the extreme variances for some small countries in the
sample make matters seem somewhat worse than they are as the consumption
data includes durable goods.

3 Gylfason <http://www.voxeu.org/index.php?q=node/870> (2009) comments that,
“Iceland is a clan-based society more heavily permeated by politics than any
other in Northern or Western Europe.”
References

Armstrong, Harvey and Robert Read, “The Phantom of Liberty?: Economic Growth
and the Vulnerability of Small
States<http://www3.interscience.wiley.com/journal/93521465/abstract?CRETRY=1&SRETRY=0>,”
*Journal of International Development* 14, 2002, 435-458.

Danielsson, Joh, “Iceland applies for EU Membership, the Outcome is
Uncertain <http://www.voxeu.org/index.php?q=node/3795>,” VoxEU.org, 21 July
2009.

Easterly, William and Aart Kray, “Small States, Small
Problems?<http://siteresources.worldbank.org/DEC/Resources/SmallStatesSmallProblems.pdf>”
Policy Research Paper 2139, The World Bank, 1999.

Easterly, William and Ross Levine, “Africa’s Growth Tragedy: Policies and
Ethnic Divisions<http://www.mitpressjournals.org/doi/abs/10.1162/003355300555466>,”
*Quarterly Journal of Economics* 112, 1997, 1203-1250.

Easterly, William and Sergio Rebelo, “Fiscal Policy and Economic Growth: and
Empirical Investigation<http://homepage.ntu.edu.tw/~kslin/macro/2/Easterly%20and%20Rebelo%201993JME.pdf>,”
*Journal of Monetary Economics* 32, 1993, 417-57.

Farrugia, Charles, “The Special Working Environment of Senior Administrators
in Small States<http://www.sciencedirect.com/science/article/B6VC6-45KN8CY-Y/2/c84091115cd18a05bb4543e04d904f5a>,”
World Development 21, 1993, 221-226.

Gylfason, Thorvaldor, “Iceland Warms to
Europe<http://www.voxeu.org/index.php?q=node/3796>,”
VoxEU.org, 21 July 2009.

Head, Allen C., “Country Size, Aggregate Fluctuations, and International
Risk Sharing <http://www.jstor.org/pss/136137>,” *Canadian Journal of
Economics* 28, 1995, 1096-1119.

United Nations, *Human Development Report <http://hdr.undp.org/en/>*,
published for the United Nations Human Development Programme, 2007/2008.

http://www.voxeu.org/index.php?q=node/3857

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