The Size of Nations - Small Countries Fare Well

http://www.scoop.co.nz/stories/BU0502/S00021.htm

The Size of Nations [ & the Trend towards Devolution]

Roger Kerr, New Zealand Business Roundtable

... A brief glance around the world today confirms that many small countries are faring very well. The richest member of the Organisation for Economic Cooperation and Development is Luxembourg with a per capita income estimated by the OECD of around US$50,000, more than twice that of New Zealand. It could be argued that Luxembourg is hardly a country, merely a small region within the giant European Union economy. But Norway, Ireland, Switzerland, Denmark, Austria, Belgium, Sweden and Finland, all OECD countries with a population of around 10 million or less, have an average per capita income above the OECD average, while tiny Iceland, with a population of a mere 300,000, is in 10th place in the 30-member OECD.

Outside the OECD, Hong Kong and Singapore are of course well known cases of small, successful countries. In Africa, Botswana is a country with a growth record that has far exceeded much larger countries like South Africa and Nigeria in recent decades. Tiny Mauritius, with its remote location in the Indian Ocean, is another strong performer.

An even more extreme case is Bermuda. Its population is only 60,000, it is a barren island in the mid-Atlantic, and it has no valuable natural resources. Yet its per capita income is above that of the United States and nearly twice that of New Zealand. . .

Of the ten countries with populations over 100 million, only the United States and Japan are prosperous. Gary Becker, a Nobel laureate in economics, has noted that since 1950 real per capita GDP has risen somewhat faster in smaller nations than it has in bigger ones. . .

[As] the debate on the economic effects of smallness and remoteness continues ... economists Alberto Alesina and Enrico Spolaore [in their book] The Size of Nations ... remind us ... that globalisation has been accompanied by a substantial increase in the number of countries. Since 1945 the number of independent countries has more than doubled, from 74 to 193. More than half have fewer people than the US state of Massachusetts, which has 6 million inhabitants. Relatively speaking, New Zealand is not as small as it once was.

Why do we need reminding that the number of countries has been rapidly growing under our noses? Because we are used to thinking that globalisation eliminates national borders. In 1990, a book was published titled The Borderless World: Power and Strategy in the Interlinked Economy. Its author, Kenichi Ohmae, viewed the expanding multinational networks as having ever less attachment to any home base, so making national borders increasingly irrelevant. That is the direction in which many people have imagined a globalising world to be moving. And yet, since Ohmae’s book appeared, many thousands of kilometres have been added to the total length of international borders in our so-called borderless world.

The great increase over the last 50 years in the number of countries, and their falling average size, has mostly followed the break-up of empires. Decolonisation of the old European empires added several new countries to the world list, especially in Africa. The collapse of the Soviet Union added 15 more. The continuing demise of communism in Europe led the federation of Yugoslavia to fall bloodily apart, whereas Czechs and Slovaks arranged an amicable divorce. Against the trend, Yemen reunified, and so did Germany. But ... showered as they have been with largesse by their rich Western relations, they have done far worse than their Polish and Czech neighbours, who had no choice but to sort themselves out as independent countries. This is also the lesson of foreign aid: at best it is a minor factor in helping countries to develop .... At worst it helps prop up corrupt and ineffective governments and holds development back.

The growing number and falling size of nations has often been accompanied by devolution, even within old and well-established countries. In response to growing regional sentiment, Spain has adopted a system of regional government. In the United Kingdom, Scotland and Wales, as well as Northern Ireland, now have their own assemblies. . .

All these trends share an underlying logic that Alesina and Spolaore articulate in their book. Part of that logic is globalisation: free trade in goods, services and capital makes small countries viable. ...

[In most countries, there seems to be a trade-off between size and diversity. The more diverse a country, the greater the costs of size are likely to be.] The big apparent exception ... is the United States, which is not just the world’s most successful large economy and society but also very diverse while also being highly democratic. No trade-off between size and diversity seems to operate there. The obvious answer to the riddle is federalism: a form of devolution that has enabled the United States to enjoy the benefits of size while allowing considerable leeway for the expression and realisation of diverse preferences. The country would not otherwise stay together.

Besides Spain and the United Kingdom, several other European counties adopted devolution in the 1970s and 1980s in response to taxpayer dissatisfaction with the standard of government services. They include the relatively small countries of Denmark and Sweden. Half of Denmark’s 14 counties have fewer than 10,000 people, yet they collectively control two-thirds of Danish public spending and run transport, secondary schools, hospitals and other health services. A system of what we might call ‘competitive localism’ operates whereby patients can choose a hospital in another county. Subordinate municipalities run primary education. Sweden too has a devolved system, with nearly half of all taxes going to local government. Service standards diverge widely, as do policy models. Under devolution such divergence can be controversial and open to the charge of inequity. However, in Sweden the central government redistributes from richer to poorer municipalities by block grants, and in any case people are free to move among localities to obtain their preferred mix of local taxes and benefits.

The best example of the potential for devolution is Switzerland, another small and rich country and a miracle of diversity with its four language groups. The central government collects less than a third of tax revenues; most services are provided by the cantons. Any system of substantial devolution generates a good deal of local politics; in Switzerland this includes the widespread use of the citizen initiative and referenda, which are also used in some central government policy areas. . .

The popularity of devolution in continental Europe can be contrasted with widespread dissatisfaction with government services in the United Kingdom, which over the last two decades has gone against the European trend and increasingly centralised the funding and control of public services. Britain has the best-performing economy of the big European ones, but its public services are notoriously poor: its public transport is a shambles, its health system mediocre, its school system slowly disintegrating, and its clear-up rates for crime low and falling. No wonder: service providers are tormented by a permanent drizzle of performance targets issued from the centre. As under the old Soviet system of central planning, such targets can be met only in devious ways that actually reduce service standards and that cause bureaucracies to grow out of control. In New Zealand we have recently seen similar trends towards re-centralisation of services such as health and education, and similar levels of community dissatisfaction.

...

In theory, if there are no barriers to trade between countries with similar endowments, and if all products are tradable, wages and returns to other factors of production would equalise across countries, even if some factors of production (like land) are immobile. ... Only higher transport and communication costs would limit returns to a producer in a small, distant economy and to be competitive, other costs in that economy – such as the costs of land, natural resources and non-traded inputs – would have to be lower to compensate. It is easy to see the same pattern within a country: a farmer on remote land may do as well as an equally competent farmer on better located land, but the price of the remote land may be lower to offset the costs associated with distance. If we could put an outboard motor on New Zealand and push it up to the coast of California, we might all be a bit better off. However, with domestic and international transport and communication costs continuing to fall, the gap between actual and potential incomes and asset values is shrinking all the time.

Let me summarise the implications of what I have said and draw some general conclusions.

First, Alesina and Spolaore’s analysis of the optimal size of nations crucially turns on the optimal size of jurisdictions, and that depends on the kind of service being provided. Many such services can best be supplied in small, local jurisdictions. ... At the local government level, our experience suggests bigger is typically not better: smaller councils tend to be more efficient and more responsive to local preferences. Where economies of scale matter, such as in defence and infrastructure, for example, better solutions than larger jurisdictions are supranational organisations and international alliances on the one hand and commercial structures, joint ventures and private sector participation on the other.

Secondly, the evidence is clear that small economies tend to perform at least as well as large economies, if not better. Moreover, the economic penalty for remoteness allied to smallness seems to be small and reducing. To see why geography is usually relatively unimportant, just think of the relative levels of prosperity of tiny Bermuda and giant Brazil, or of Canada and Mexico, just north and south of the US border.