Does size matter? The economy of small countries
Small states worldwide thrive even in hostile environments.
Despite their size limitations, many small countries have proven that they can achieve prosperity and demonstrate above-average economic performance. What is the secret of their success?
A new report by Credit Suisse entitled "Small countries: The way to resilience" explores the factors influencing the relationship between a country's size and its success. The study investigates whether smaller states are at a disadvantage in an increasingly competitive and multipolar world, or, in fact, have been quite successful in utilizing and benefiting from their size limitations.
Does bigger always mean better?
Though large countries seem to enjoy some economic advantages compared to small states (e.g. a bigger internal market and production options), small countries tend to perform better economically.
For example, in the IMD Business School's most recent competitiveness ranking in 2022, three small countries – Denmark, Switzerland and Singapore – occupied the top three positions. Additionally, in the United Nations Human Development Index, which combines income per capita, education and health metrics, 15 of the top 20 places were held by small countries.
Although small economies do face potential challenges (e.g., they lag behind bigger countries in areas such as internal markets), there are some benefits to being a small country, like a less diverse population (which lowers the risk of internal conflicts and makes a "one-size-fits-all" approach more likely to work) or economic openness and, associated with that, a greater degree of specialization.
The circumstances that may impact the prosperity of a country are quite complex, not only because of an abundance of influencing factors, but also because some of them may act as a double-edged sword.
For example, economic and trade openness combined with specialization contributes to the prosperity of small countries. It also increases their vulnerability to negative shocks, such as fluctuations in commodity prices.
Understanding success aspects of small countries
To gain a deeper understanding of the different factors that could affect the prosperity of economies, we have developed two indicators which we applied to 32 countries in our study:
- The Economic Vulnerability Index (EVI), which measures an economy's exposure to shocks and takes into account factors like economic openness, import and export concentration, energy imports and reliance on foreign human capital;
- The Economic Resilience Indicator (ERI), which provides a framework for assessing a country's economic robustness to deal with such shocks, as well as its ability to adapt to changing economic circumstances. Aspects influencing this marker include macroeconomic stability, economic (sector) diversification, infrastructure, governance, and equality and social mobility.
The results of our analysis show that small countries often exhibit a high degree of economic vulnerability as they often rely on foreign human capital as well as international trade.
To counterbalance their susceptibility to economic bumps, many small states have developed strategies to mitigate the challenges posed by their size disadvantages. Strategies fostering economic resilience (high ERI score in areas such as innovation, infrastructure or social protection) have helped many small states, such as Switzerland, to improve their ability to absorb shocks and contributed to their long-term economic success.
And although smallness alone is by no means a ticket to prosperity, our analysis shows that many small countries are quite successful in capitalizing on their size limitations.
It seems that, to be successful, small countries need to be economically open.
However, there are also examples of less successful small countries. Greece, for instance, is relatively vulnerable and not very resilient. The pandemic and current geopolitical tensions, which have hindered economic travel and brought widespread adjustments to value chains, have meant significant challenges for the Greek economy, which is not only dependent on tourism, but also heavily concentrated in the shipping business.
Although they face challenges in terms of vulnerability and sovereignty, small countries should be aware that their authority in law-making and economic decisions is crucial for them to improve resilience and enjoy economic success. Even though the current geopolitical tensions bring the vulnerabilities of small countries to the fore, they also represent an opportunity to learn and grow stronger together.