undersized could greenland be the new iceland

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Undersized: Could Greenland be the newIceland? Should it be?

Anne Sibert10 August 2009

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As Greenland moves away from Denmark and acquires more autonomy, this column asks whether it might be too small. In assessing the relationship between country size and economic performance, it warns that

small states have more volatile GDP, more volatile consumption, and more incompetent civil servants.

Greenlands population of about 60,000 make it as about the same size as Bismarck, North Dakota. It is

blessed with natural resources such as rich deposits of minerals, and oil and gas reserves are believed to lie below its ice cap. It is protective of both its fishing industry and its long tradition of killing appealing marinemammals. Greenlandic, an Eskimo-Aleut language, is spoken by few outside its borders.

On 1 May 1979, this miniscule country began its move toward autonomy when the Danish parliamentgranted Greenland home rule. Greenland swiftly distanced itself from Europe by exiting the EU in 1985 the only country ever to have done so. The goal was to avoid the EUs Common Fishery Policy (the ban onseal skin products also played a role). Greenlanders approved a referendum on greater autonomy on 25

November 2008 and on 21 Jun 2009 Greenland expanded its sovereignty by assuming authority over its judiciary, policing, and natural resources, leaving only finances and foreign affairs in Danish hands. TheDanish queen attended a celebration at the parliament in Nuuk, and Greenlandic became the countrys

official language.

Can a country be too small?Although it is not yet heavily involved in international banking, Greenlands progression towardindependent statehood is strikingly reminiscent of Icelands experience (especially its desire to maintain itsown culture and protect its natural resources at the cost of isolation from the rest of the world and its wish tolimit its economic relationship with Europe). This raises questions does the recent experience of Icelandsuggest that a country can be too small to be a nation state, and what are the costs and benefits of beingisolated from the rest of the world?

The answer to these questions is relevant not only for Iceland and Greenland but also other tiny countriesthat have gained sovereignty in recent decades; since 1990, 33 new countries have been formed and, as seenin Figure 1, many are very small. 1

Figure 1 . Country size (population in millions)
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In this column, I argue that there is little economic justification for preferring small size and that there can besignificant costs. I also argue that Icelands small size was probably a key factor in Icelands failure to stopits financial crisis.

Do smaller countries enact better economic policiesand grow faster?

It is usually claimed that the benefit to small size is social homogeneity which leads to cohesion and anability to build a consensus. This may promote flexibility in the face of changing circumstances and make iteasier to enact policies that promote growth. Indeed, some small economies such as New Zealand, and, inmany respects, Iceland are widely viewed as paragons of economic virtue. Formal empirical evidencelinking small size to growth-promoting policies appears to be lacking, however. Easterly and Levine (1997)find a strong negative correlation between ethnic diversity and indicators of growth-promoting public goodssuch as the number of telephones and paved roads and the amount of schooling. However, Easterly andKraay (1999) assert that a lack of consistent data makes it hard to test whether small size is associated withgrowth-promoting public goods.

While many small economies have grown rapidly, the existing empirical literature finds that the effect of country size on growth is inconclusive. Easterly and Kraay (1999) find that, after controlling for location,small states are wealthier than large states but do not have significantly different growth rates. This may be

because country size has an insignificant effect on growth or it may be due to limited data; there is a lack of consistent data sets that include a large number of small countries. See Armstrong and Read (2002) for adiscussion of this literature.
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Smaller countries have more volatile outputThe recent experience of Iceland suggests that, while there is no clear evidence that small countriesexperience higher average growth rates, they do have more volatile growth rates. As shown in Figure 2

below, Icelands output growth is less smooth than that of either the UK or the US. The reason for this seemsclear. As a small country, Iceland is far less diversified in endowments and production than the much larger UK or US. A shock in the aluminium, fishing, or banking sector has a major effect on Icelandic output;shocks to different sectors in much larger economies tend to average out.

Figure 2. Percentage change in GDP at constant prices

Smaller countries have more volatile consumptionOutput volatility is not necessarily costly; countries care about smoothing consumption, not output.Residents of a country with variable output can smooth their consumption across states of nature by holdinga diversified portfolio of home and foreign equity. However, most countries hold relatively small amounts of net foreign assets. In addition, such risk sharing is partial at best if it is not possible to hedge against adverseshocks to the return to human capital.

If shocks to a countrys output were purely transitory, a country could use its current account to smooth itsconsumption borrowing in states where output is low and lending in states where it is high. Unfortunately,


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from the point-of-view of smoothing consumption, most shocks appear to have a large permanentcomponent. Thus, it seems likely that a country with relatively variable output will have relatively variableconsumption as well.

In a study of 56 countries over the period 1950 1985, Head (1995) finds that the variances of both outputgrowth and consumption growth are indeed negatively correlated with population size. Moreover, this effectis especially pronounced in high-income countries. Figure 3 shows the relationship between population sizeand (detrended) consumption volatility for 20 relatively high-income countries. While some small countrieshave very low consumption volatility (Norway, Luxembourg), many have very high volatility (NewZealand, Trinidad and Tobago, and Iceland) .2

Figure 3 . Consumption volatility and country size (in millions)

Countries included: US, Japan, Germany, France, UK, Italy, Canada, Netherlands, Australia, Belgium,Sweden, Switzerland, Austria, Denmark, Norway, Finland, New Zealand, Trinidad & Tobago, Luxembourg,

Iceland; detrended annual data for 1950-1985. Source: Head (1995).

Other problems in small countriesA small population has other costs; I will mention three here. First, as the provision of many public goodshas an important fixed cost component, the per capita cost of public good provision is likely decreasing incountry size. Second, it is also likely that the per capita administrative cost of income taxes is decreasing incountry size. As a result, smaller countries tend to rely less on relatively efficient income taxation and moreon relatively inefficient taxes, such as customs taxes (see Easterly and Rebelo 1993). Third, a lack of competition in the provision of non-traded goods in small countries can lead to inefficiency.

I have focused on costs associated with small populations, but there is also an important cost associated withsmall geographical size. Many countries are vulnerable to natural disasters and environmental damage andself-insurance against these sorts of shocks is easier for larger countries. If an American city is damaged by ahurricane, residents can move to another American city. If global warming causes sea levels to rise
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sufficiently, the consequences for the residents of Tuvalu are likely to be less favourable.

Problems for civil servants in small economiesIn October 2005, David Oddsson was appointed chairman of the board of governors of the Icelandic central

bank. The multi-talented Oddsson had studied law, been a theatre director, the producer of a comedy radioshow, a political commentator, and the co-author of several plays. He had previously been the mayor of Reykjavik, a long-time prime minister and, for a brief period, the foreign minister. Unfortunately, he appearsto have had no expertise in economics and banking and was ineffective at either averting the financial crisisor playing a positive role in its aftermath.

In addition to Oddsons apparent acquiescence in the face of looming disaster, neither the prime minister,

nor the finance minister or financial regulator seems to have made any serious attempt to stem the growth of the Icelandic banks. This suggests that a significant cost of small size is the burden that it places on senior government officials.

Despite its miniscule size, Iceland has ministries of business affairs, communications, science and culture,environment, finance, fisheries and agriculture, foreign affairs, health, industry and tourism, justice andecclesiastical affairs, social affairs, and social security. This causes two problems. First, it is difficult for such a small country to find enough talented civil servants, and second, each civil servant is forced to playmore roles than he would in a more populous society. Such multi-tasking can be demanding and makes itdifficult to build up expertise in a particular area.

In an interesting article, Farrugia (1993) suggests that very small countries may also suffer because of their high degree of interpersonal relations. In a tiny nation, everyone knows everyone. This can facilitate thingsgetting done quickly, but it has its costs. Farrugia comments that, Many necessary decisions and actions can

be modified, adjusted and sometimes totally neutralised by personal interventions and community pressures.In extreme cases, close personal and family connections lead to nepotism and corruption.

In Iceland, it has been alleged that personal animosity may have played a role in the central bank denyingGlitnir a loan in October 2008 and that the Independence Party played an unseemly role in the privatisationof Landsbanki with agreements made to offer plum executive positions to Independence Party members.Even if such suspicions are untrue, the widely held belief that they might be is damaging to social cohesionand the states legitimacy. 3

A sensible policy solution to the problem of filling sufficiently important posts when there is limited localtalent or to filling a politically sensitive post where the independence and impartiality that is required cannot

be found at home is to hire foreigners. Prime Minister Johanna Sigurdardottir has already adopted thisstrategy by hiring a Norwegian expert to be the acting central bank governor and a Norwegian-born Frenchmagistrate to investigate the possibility of criminal activities by Icelandic banks. In the long run, if supervising the banking system requires more expertise than can be acquired locally, Iceland should hiresupervisors from abroad the banks can be taxed to fund them.

Island officials should get out more
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Many very small countries are islands, and thus isolated. It is more difficult for senior officials to travel to aneighbouring country if they live on a remote island than if they live in Luxembourg. This leads to a danger that policymakers in small and far away locations might become insular in their thinking and that they mightnot have access to advice that their counterparts abroad might offer. It is thus important that senior officialsin out-of-the-way locations make an attempt to attend conferences and other professional gatherings abroad.

Footnotes1 At least Pitcairn Island with its 48 inhabitants remains a non-self-governing territory.

2 A caveat is that the extreme variances for some small countries in the sample make matters seemsomewhat worse than they are as the consumption data includes durable goods.

3 Gylfason (2009) comments that, Iceland is a clan-based society more heavily permeated by politics thanany other in Northern or Western Europe.

ReferencesArmstrong, Harvey and Robert Read, The Phantom of Liberty?: Economic Growth and the Vulnerability of Small States , Journal of International Development 14, 2002, 435-458.

Danielsson, Joh, Iceland applies for EU Membership, the Outcome is Uncertain , VoxEU.org, 21 July

2009.

Easterly, William and Aart Kray, Small States, Small Problems? Policy Research Paper 2139, The WorldBank, 1999.

Easterly, William and Ross Levine, Africas Growth Tragedy: Policies and Ethnic Divisions , Quarterly Journal of Economics 112, 1997, 1203-1250.

Easterly, William and Sergio Rebelo, Fiscal Policy and Economic Growth: and Empirical Investigation , Journal of Monetary Economics 32, 1993, 417-57.

Farrugia, Charles, The Special Working Environment of Senior Administrators in Small States , WorldDevelopment 21, 1993, 221-226.

Gylfason, Thorvaldor, Iceland Warms to Europe , VoxEU.org, 21 July 2009.

Head, Allen C., Country Size, Aggregate Fluctuations, and International Risk Sharing , Canadian Journal of Economics 28, 1995, 1096-1119.

United Nations, Human Development Report , published for the United Nations Human DevelopmentProgramme, 2007/2008.
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