Catalog

Box 1. What Makes Small States Different?

Developing small states share characteristics that pose special development challenges. They are especially vulnerable to external events, including natural disasters, that cause high volatility in national incomes; many of them are currently facing an uncertain and difficult economic transition in a changing world trade regime; and they suffer from limited capacity in the public and private sectors. More specifically, the following characteristics define the special development challenges and vulnerabilities that many small states face.

• Remoteness and isolation. Of the developing small states, three out of four are islands and in some cases widely dispersed multi-island states; others are landlocked, and some of them located far from major markets. For many small states, like those in the Pacific, high transport costs make it harder for them to turn to world markets to compensate for the drawbacks of the small size of their domestic markets. And small domestic markets combine with large distances from other markets to reduce competition and its spur to efficiency and innovation.

• Openness. A high degree of openness to the rest of the world brings benefits. But it also means that small economies are heavily exposed to events in global markets, and developments in the global trade regime, over which they have little if any influence. They also tend to rely more heavily on taxing imports as a source of revenue, leading to difficulties as tariffs are reduced.

• Susceptibility to natural disasters and environmental change. Most small states are in regions susceptible to natural disasters such as hurricanes, cyclones, droughts, and volcanic eruptions, which typically affect the entire population and economy. Some are threatened by global environmental developments. Since most of such adverse events affect the entire population, risk pooling at the national level is not feasible.

• Limited diversification. Because of their small domestic markets, many small states are necessarily relatively undiversified in their production and exports. Where one dominant activity has declined, it has tended to be replaced with another. This adds to vulnerability to changes in the external environment.

• Poverty. There is some evidence that poverty levels tend to be higher and income distribution more uneven in smaller states. Where this is so, income volatility can create additional hardship as the poor are less able to weather negative shocks to their incomes.

• Limited capacity. While weaknesses in both public and private sector capacity are a key problem for most developing countries, smallness of size adds a further dimension to the challenge. This is compounded in states, like the Pacific islands, where the internal distances are large and the population is scattered. In the public sector, small states face diseconomies of small size in providing public services and in carrying out the business of government, and tend to have relatively larger public sectors than other developing countries. In the context of globalization, small states also find they do not have sufficient institutional capacity to participate fully in international finance and trade negotiations—the outcomes of which can profoundly affect their economies. In the private sector, lack of diversification and domestic competition can hold back successful development.

Many of these factors combine to make small states’ economies especially vulnerable; in particular they affect incomes and access to capital.

• Income volatility. Overall, the range of per capita income and rate of growth is not significantly different in small and large developing countries. However, the residents of small states experience higher volatility of their incomes—the standard deviation of annual real per capita growth in small states is about 25 percent higher than in large states. This reflects several of the factors listed above—their high levels of exports and imports and low diversification in production and trade, which leaves them exposed to fluctuations in world markets, as well as their susceptibility to natural disasters.

• Access to external capital. Access to global capital markets is important for small states, and is one way to compensate for adverse shocks and income volatility. But the evidence is that private markets tend to see small states as more risky than larger states; hence spreads are higher and market access more difficult.

Excerpt from the report, Small States: Meeting Challenges in the Global Economy. 2000. Commonwealth Secretariat/World Bank Joint Task Force on Small States, Washington, DC: World Bank.