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Home > Blogs > Anthony Harrington > Challenges facing small countries and island nations do not get easier

Challenges facing small countries and island nations do not get easier

Challenges facing small countries and island nations do not get easier Anthony Harrington

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The International Monetary Fund (IMF) defines small countries as any state with under 1.5 million people. For the most part, this category is populated by the small island states of the world, but there are a number of countries that also fit into this category and a number of others with larger populations but which face many of the same challenges.

The difficulty posed by small states which get into trouble is analogous to the challenge that banks face in backing not particularly brilliant small-to-medium sized enterprises (SMEs). The ability to service the debt, in many cases, is just not there. In a recent IMF publication, namely a policy briefing entitled, Macroeconomic issues in small states, which complements what is actually quite a significant body of work on small state challenges, the IMF sets out to provide some policy guidelines for its staff when they are faced with evaluating applications for Fund assistance.

The issue is particularly relevant for small states right now since, as the IMF notes, on average, with some brilliant exceptions, small states have seen a more or less continuous decline in their relative macro performance - relative meaning relative to larger economies. It is not so much that they are sinking, according to the IMF, as that they are simply not going forward. Many of them are treading water at best, and others are going somewhat backwards.

Part of the reason for this is the same as that which dogs SMEs, namely the difficulty small states have in securing access to funding:

"Small states have performed reasonably well over an extended period, with per capita income levels and social indicators that are broadly in line with those of their larger comparators. However, despite prolonged policy efforts, they have not shared in the improved economic growth of larger peers since the late 1990s, and also continue to experience relatively high levels of macroeconomic volatility."

One of the burdens most small states share is the twin whammy of indivisible fixed costs and diseconomies of scale. This plays out in both the public and the private sector. In the public sector, governments find themselves constrained by the limited size of the tax take and by the need to keep the tax burden on families and businesses within reasonable bounds. In the private sector, the small scale of the economy results in higher costs and reduced service providers. Transport costs for both people and goods also tends to be much higher.

Although small states can be very different from one another, there are very strong macroeconomic themes that run through many, if not all, of them. In boom times, as in the run up to the global financial crash, they find it easier to borrow and run up substantial fiscal deficits. Fiscal controls tend to be weaker, which allows the run up to take place. Then, when tougher times hit and growth fades, the high levels of public debt impose a huge burden on the economy. Helping smaller states through these kinds of difficulties is very much part of the IMF's mission. Where the debt is unsustainable, smaller states will have little option but to seek to get their creditors to agree to a debt restructuring or a partial debt forgiveness, considered as aid.

Another challenge that small states face is that, unlike their larger brethren, they tend not to have a fully developed financial services sector. This means that their financial sectors are not really able, as the IMF puts it, to "play their full role in fostering growth".  The IMF policy papery concludes that it needs to work harder at trying to discover how policy advice and program design can help smaller states become more resilient and more resistant to external shocks. The IMF could and should also work at fostering more regional collaboration and closer collaboration with the World Bank and other regional partners. Debt-to-GDP ratios also need close attention and the relative exposure and degree of risk of each small state needs to be taken into account.

In short, the IMF paper suggests that there is no silver bullet to solving small state issues. What is needed is much more analysis and more involvement by IMF staff once the issues are better understood.

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Tags: economic challenges , IMF , island nations , small states , United Nations
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