The Success of Small Countries or What’s Wrong With Being XXL in the World Economy?

“Small is beautiful” in the corporate world and the efficiency and innovation of small and medium-sized companies is duly reflected in the large share of SMEs in developed economies’ GDP (in many cases 50% of GDP and more) and labour force. But is this pattern also observed at the level of countries, whereby small economies turn out to be more successful and innovative compared to their large counterparts? Existing economic research suggests that this may well be the case, with leading small economies exhibiting high living standards, growth and innovation.

One of these studies, a book by Shahid Yusuf and Kaoru Nabeshima “Some small countries do it better” explores the experience of three small economies — Singapore, Finland and Ireland — and concludes that a significant part of the success was derived from investment into human capital development, most notably into education. As noted by World Bank economist Apurva Sanghi, “these three countries augmented physical investment with healthy doses human capital and knowledge; by ‘opening their windows and letting it [knowledge in various forms, for example, that embodied in FDI] stream.”

The contribution of small economies to global GDP increased among both developing and developed countries, with the former delivering a greater increment in their contribution in the past 20 years compared to their small advanced economy counterparts, writes Valdai Club Programme Director Yaroslav Lissovolik.

“Small is beautiful” in the corporate world and the efficiency and innovation of small and medium-sized companies is duly reflected in the large share of SMEs in developed economies’ GDP (in many cases 50% of GDP and more) and labour force. But is this pattern also observed at the level of countries, whereby small economies turn out to be more successful and innovative compared to their large counterparts? Existing economic research suggests that this may well be the case, with leading small economies exhibiting high living standards, growth and innovation.

One of these studies, a book by Shahid Yusuf and Kaoru Nabeshima “Some small countries do it better” explores the experience of three small economies — Singapore, Finland and Ireland — and concludes that a significant part of the success was derived from investment into human capital development, most notably into education. As noted by World Bank economist Apurva Sanghi, “these three countries augmented physical investment with healthy doses human capital and knowledge; by ‘opening their windows and letting it [knowledge in various forms, for example, that embodied in FDI] stream.”

Another study by Credit Suisse titled “The success of small countries” points to a number of advances and advantages on the part of small economies.

• “The rise of new small states in the context of globalization has been one of the key geo-economic megatrends of the past 30 years. We found a negative correlation between size and GDP per capita”

• Wealth inequality is less pronounced for small than large countries

• High scores of leading small economies in the UN’s Human Development Index

• Smaller economies spend more on education and healthcare as a share of GDP

• Small economies are more homogenous, a factor that plays an important role in economic success

Jeffrey Frankel in his paper “What Small Countries Can Teach the World” lists a whole array of superior economic policy practices exhibited by small economies, including Scandinavia’s socially-oriented Nordic economic model, New Zealand’s liberalization reforms, the economic success in attracting FDI in Ireland, the “unique development strategy” in Singapore, as well as Costa Rica in Central America and Mauritius in Africa that opted to forego significant military outlays placing the emphasis on human capital development.

Importantly, small economies form the majority of countries in the world — more than 100 countries have a population of less than 10 million, with the share of these countries in global GDP growing from 6.6% in 2000 to 7.4% in 2020, which compares with the share in total world population of 4.4%. The contribution of small economies to global GDP increased among both developing and developed countries, with the former delivering a greater increment in their contribution in the past 20 years compared to their small advanced economy counterparts.

As noted by Jacob Frankel, “why would one look to small countries when in search of good ideas for policies or institutions? It is because history shows that big countries do not have all the answers”. There is of course nothing wrong with being a large economy, particularly in view of the significant role that the largest economies play in delivering growth impulses across the globe. The latter however, largely depends on the degree of openness of these large heavy-weights and this is where a lot of the problems reside these days. Indeed, the bulk of trade restrictions are either emanating from the world’s largest economies or are directed against the leading powers on the international trade arena. According to the Global Trade Alert (GTA), in the past ten years the largest amount of trade restrictions was directed against China, while the initiations in trade disputes and restrictions were led by the developed economies such as the US and the EU.

Large economies also tend to have significantly more allocations towards defence compared to small economies. Hard power tends to take on significant prominence compared to “soft power” with increasing country size. This in turn comes at an economic cost that may impact the modernization trajectory of the country as well as the broader security context in regional and global settings. Large countries are also typically more perse compared to greater homogeneity typically observed in small economies, which may be considered an asset or a weakness in case this greater persity undermines internal political/economic stability.

Another problem is when large countries/economies get it wrong in terms of economic development priorities — given their size the negative implications of a crisis/downturn could be felt far across the regional realm of the respective large economies. The smaller economies have far greater flexibility (just like SMEs in the corporate world) to innovate, experiment and build alliances across the globe. Singapore is a great illustration of such versatility on the international arena as the country leads the world not only in terms of trade alliances, but also the more modern version of such deals, namely the so-called digital economic alliances (DEAs).

Yet, despite the fact that the economic contribution from small countries has been rising according to some metrics in the past several decades, the trends observed in global governance actually point to increasing concentration and role of the largest economies. Gigantism continues to reign supreme with ever more blocs for the largest heavy-weights created in recent periods — AUKUS and QUAD being some of the more recent cases in point. Regionalism is also displaying signs of overstretch, with mega-regionals and mega-blocs formed in recent periods. But with the rising scale of national and regional projects on the international arena, there may be signs of “diminishing returns to scale”, over-extension and the over-lapping of claims and ambitions across the globe.

In dealing with such imbalances in the world economy apart from building networks among the smaller open economies another gateway to inclusivity in global economic architecture would be a greater role for cooperation among regional integration arrangements and their development institutions. Such platforms would provide for greater involvement of smaller economies in global economic decision-making and raise the legitimacy of the existing global organizations and networks. These platforms could be created on the basis of existing arrangements and economic blocs — in the case of G20 there could be a case for creating a regional R20 composed of the regional integration blocs where G20 countries are members. Similarly, for the BRICS, a BRICS+ format that brings together regional integration arrangements where BRICS economies are members provides for smaller emerging markets to deliver their contribution to the process of economic integration in the Global South.