Min ZhuBy Min Zhu

The economies of small states have unique features. They have relatively higher costs, higher public spending needs, and more volatile economies. And their growth has not matched the improved economic performance of the rest of the world since the late 1990s, despite their many efforts over the years. We wanted a better grasp of why this is so we can better tailor our advice and support. Here is what we found.

Small can be complicated

More than a fifth of IMF members are countries with populations of under 1.5 million. Three out of four small states are islands or widely dispersed multi-island states; others are landlocked, and some are located far from major markets. These small states are a diverse group representing all income categories, but all of them face size-related constraints.

The smallest of these, known as microstates, have populations below 200,000 and face a fairly unique and at times more difficult economic circumstances.

The Pacific Island nation of Tuvalu, for example, has a land area of 10 square miles, roughly one-seventh the size of Washington, D.C., which makes it difficult to produce agricultural goods. Administration is particularly difficult in the neighboring island of Kiribati, whose population of 100,000 people is spread over 3.5 million square kilometers of ocean—an area about the size of the Indian subcontinent.

Why size matters

Small states share a number of intrinsic characteristics that have translated into a common set of development challenges. Because of their small size, they have higher fixed and variable costs of providing public goods, with little scope to exploit economies of scale.

In the private sector, higher costs have led to concentrated markets with less competition. Very high shares of imports and exports in most small states help them to overcome weak competition and to invigorate growth. But this high degree of openness has heavily exposed them to external shocks in global markets.

Small size also hinders these countries from diversifying into a wide range of activities, making them more vulnerable to shocks. Domestic financial markets in small states tend to be shallow. They have less favorable access to global capital as investors often perceive them to be more risky.

To make matters worse, most small states are prone to natural disasters and some are particularly susceptible to climate change. Micro states in the Caribbean and the Pacific suffer annual costs equivalent to some 3 to 5 percent of GDP because of natural disasters. And the United Nations Intergovernmental Panel on Climate Change expects Kiribati to be the first country to see its entire territory disappear underwater as a result of global climate change.

Make the most of what you’ve got

Given these vulnerabilities, are small states doomed to lag behind their larger peers?

Actually, the longer-term economic performance of small states has been generally good. Per capita income levels and social indicators broadly match those of their larger peers.

Some small states have been able to overcome certain size-related challenges by achieving higher levels of such growth determinants as openness, education, and financial development. The key to achieving economic success may be to pursue policies that exploit their advantages and offset their disadvantages.

One way of offsetting the size disadvantage is through regional integration and cooperation. For example, the Eastern Caribbean Currency Union’s Regional Government Securities Market aims to integrate existing national securities markets into a single regional market, helping to exploit economies of scale in financial markets.

Since the late 1990s, however, most small states have experienced slower and more volatile growth than larger peers. With higher public spending, a number of small states now face high debt burdens.

In light of these developments, we have stepped up our engagement with small states. The heightened interest began when several of the IMF’s Executive Board members created an informal working group on economic issues in small states. Internally, collaboration has increased since a small islands group was formed to facilitate the sharing of insights and lessons learned by staff working on small states.

To weather natural disasters and other external shocks, small states have used a number of IMF financing instruments—including the Rapid Credit Facility, a type of emergency assistance.

Delivery of technical assistance and training, particularly through our regional technical centers, plays a vital role in building small states’ capacities. Staff exchanges involving national governments, regional entities, and the IMF and other international organizations may also help to strengthen small states’ institutions. And we are collaborating closely with other international institutions and development partners to meet small states’ needs and learn from their experiences.

We plan to pursue analytical work on issues affecting small states, maintain an active dialogue with country and regional officials, and continue to help build their capacity. Over time, these efforts should help reduce small states’ vulnerability and increase their resilience.