Small States, Small Problems?

Abstract

Small states, no different from large states in income and growth, should receive the same policy advice large states do. Because of their greater openness, they may be more vulnerable to volatility in terms-of-trade shocks - but their openness pays off in growth. Small states have attracted a good deal of research. Easterly and Kraay test whether microstates are any different from other states in income, growth, and volatility.

They find that, controlling for location, smaller states are actually richer than other states in per capita GDP. This income advantage largely reflects a productivity advantage - evidence against the idea that microstates are unable to exploit increasing returns to scale. Small states do not have different per capita growth rates, with or without controls.

Their annual growth rates are more volatile, partly because of their greater volatility in responses to terms-of-trade shocks - to which they are exposed because of their greater openness. But on balance their greater openness pays off positively in growth. Easterly and Kraay do recommend that small states diversify their risk by opening up more to international capital markets, although the benefits of doing so are still unresolved in the literature. In general, they conclude, small states are no different from large states and should receive the same policy advice large states do.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to study the needs of small states. The authors may be contacted at [e-mail] or [e-mail].