Small states in a global economy: the role of institutions in managing vulnerability and opportunity in small developing countries

Small states in a global economy: the role of institutions in managing vulnerability and opportunity in small developing countries

The importance of high quality institutions in small states

Paper examines various hypotheses about the reasons for the development performance of small developing countries in the 1960-98 period. It also examines a subgroup of countries that share the same medium-high rank in the Commonwealth Secretariat's 'Composite Vulnerability Index'. Paper argues that although they tend to be equally exposed to the risks and opportunities of globalisation, small states differ internally. In particular, different histories and strategic choices have built different sets of institutions in small countries, and these institutions affect how globalisation is mediated in each country. Paper further seeks to discover whether it is possible to distinguish institutional differences of small countries that are successful at making sure that their citizens benefit from the foreign investment and trade opportunities provided through globalisation, from those that are not.

Primary findings:

  • the differences between small and large countries are real, but concentrated in relatively few variables. Small countries experience more volatile growth rates and are more aid and trade dependent, when controlling for regional location, the initial level of economic development, the rate of growth, and a number of other variables. Small countries are clearly more vulnerable to rapid fluctuations in the fortunes of the global economy
  • there are no significant differences between small and large countries in terms of the quality of their institutions. However, precisely because small countries are more vulnerable, the quality of their institutions matters even more than it does in large countries. Put another way, high quality institutions in small states matters more in terms of managing already high levels of globalisation (i.e. helping to sustain high growth rates and low growth volatility) than in attaining additional levels of global integration. We show that small countries with high quality institutions of conflict management and state capacity have less growth educe underemployment and eliminate poverty volatility, and that those with stronger state capacity in particular are more likely to enjoy higher rates of economic growth

These results have important implications for business groups and the international development community. Small countries have traditionally been highly dependent on trade, but investors seem to be indifferent to the quality of their institutions, which are so important not only in their own right but instrumentally for maintaining economic (and political) stability. Of greater concern is the fact that while aid donors are accurately targeting poor countries, their funds to small countries appear to go to those with institutions that are significantly worse than those who are less aid dependent. While this could be read as a good thing if aid dependence was indicative of funds going for institutional reform, a more plausible-and troubling-explanation is that considerable sums of aid money are being wasted in small poor countries that do not have the institutional infrastructure in place to use it effectively. Closer attention to the institutional environment in small developing countries is likely to help both stabilise and increase growth rates, and thus make an important contribution to poverty reduction and social concerns (such as health and education).

  1. How good is this research?

    Assessing the quality of research can be a tricky business. This blog from our editor offers some tools and tips.