Building Resilience for Building Resilience for Sustainable Development in Sustainable Development in

Small Island EconomiesSmall Island Economies

Robert Read Robert Read

Lancaster University Lancaster University Management School UKManagement School UK

Key Elements of the Size-Growth Key Elements of the Size-Growth RelationshipRelationship

Key economic characteristics of small size:Key economic characteristics of small size:

• Small populationsSmall populations – diseconomies of scale/higher costs; – diseconomies of scale/higher costs; limits on developing large-scale industries, limits on developing large-scale industries, agglomeration and firm clusters; limited competition.agglomeration and firm clusters; limited competition.

• Limited ResourcesLimited Resources – limited natural resources and – limited natural resources and labour supply – reliance on human capital-intensive labour supply – reliance on human capital-intensive activities instead of large-scale labour-intensive activities instead of large-scale labour-intensive industrialisation.industrialisation.

• Constrained diversificationConstrained diversification – a high degree of – a high degree of specialisation in production and exports.specialisation in production and exports.

• Openness to tradeOpenness to trade – ‘structural’ trade openness, – ‘structural’ trade openness, exposure to exogenous shocks, constrained domestic exposure to exogenous shocks, constrained domestic policy-making.policy-making.

Key Growth Sectors in Small Key Growth Sectors in Small EconomiesEconomies

Empirical analyses of the growth of small Empirical analyses of the growth of small economies, notably by economies, notably by Armstrong & ReadArmstrong & Read, , consistently find that three sectors are key to consistently find that three sectors are key to economic growth and high incomes:economic growth and high incomes:• TourismTourism• Financial ServicesFinancial Services• Natural ResourcesNatural Resources

The contribution of The contribution of ManufacturingManufacturing appears to appears to be consistently insignificant while be consistently insignificant while AgricultureAgriculture is is associated with lower growth and incomes. associated with lower growth and incomes.

‘‘Structural’ Openness to Trade in Structural’ Openness to Trade in Small EconomiesSmall Economies

Small economies are highly open to international trade because Small economies are highly open to international trade because of their limited ability to produce a broad range of goods and of their limited ability to produce a broad range of goods and services domestically. This ‘structural’ openness has important services domestically. This ‘structural’ openness has important implications:implications:

• Economic growthEconomic growth: trade openness has strong positive growth : trade openness has strong positive growth effects based upon underlying comparative advantage.effects based upon underlying comparative advantage.

• Growth volatilityGrowth volatility: more open economies are exposed to : more open economies are exposed to greater volatility in their growth – need for greater resilience.greater volatility in their growth – need for greater resilience.

• Domestic policy-makingDomestic policy-making: openness limits policy autonomy, : openness limits policy autonomy, particularly with respect to the exchange rate.particularly with respect to the exchange rate.

for domestic policy-making as well as comparative advantage and for domestic policy-making as well as comparative advantage and exposure to exogenous (external) terms of trade shocks.exposure to exogenous (external) terms of trade shocks.

The Impact of Growth VolatilityThe Impact of Growth Volatility

Large-scale studies of the impact of growth Large-scale studies of the impact of growth volatility all find that it tends to reduce the long-volatility all find that it tends to reduce the long-run average rate of growth. These adverse run average rate of growth. These adverse growth effects of volatility tend to be greatest growth effects of volatility tend to be greatest for:for:

• Low income countries (limited resilience Low income countries (limited resilience capacity).capacity).

• Countries with weak institutional structures Countries with weak institutional structures and poor governance.and poor governance.

Trade Openness & Growth Trade Openness & Growth Volatility in Small EconomiesVolatility in Small Economies

Analyses of the impact of growth volatility on small economies Analyses of the impact of growth volatility on small economies is more limited but the available evidence (notably, is more limited but the available evidence (notably, Easterly & Easterly & Kraay, 2000; Cavallo, 2007Kraay, 2000; Cavallo, 2007) suggests that:) suggests that:

• Greater trade openness gives rise to greater exposure to Greater trade openness gives rise to greater exposure to destabilising terms of trade shocks.destabilising terms of trade shocks.

• Greater trade openness enhances their growth.Greater trade openness enhances their growth.• The stabilising effects of integration with the global The stabilising effects of integration with the global

economy economy more than compensates formore than compensates for the destabilising the destabilising effects of terms of trade shocks.effects of terms of trade shocks.

• Reducing openness to limit growth volatility can therefore Reducing openness to limit growth volatility can therefore be expected to be expected to reduce growth and incomesreduce growth and incomes..

Growth & Resilience in Small Growth & Resilience in Small EconomiesEconomies

Resilience refers to the resource capacity of economies to Resilience refers to the resource capacity of economies to deal with and ameliorate the impact of their vulnerability deal with and ameliorate the impact of their vulnerability to economic and natural shocks:to economic and natural shocks:

• Exposure to growth volatility is expected to be greatest Exposure to growth volatility is expected to be greatest for economies that have achieved the greatest growth for economies that have achieved the greatest growth success.success.

• Specialisation in high growth sectors appears to Specialisation in high growth sectors appears to reduce the impact of growth volatility.reduce the impact of growth volatility.

• Growth success increases resilience capacity.Growth success increases resilience capacity.

Growth volatility and resilience capacity is therefore Growth volatility and resilience capacity is therefore primarily a critical challenge for primarily a critical challenge for poorer less well-poorer less well-managed small economiesmanaged small economies..

The Environmental Vulnerability The Environmental Vulnerability ofof

Small EconomiesSmall EconomiesSmall island and littoral economies are among the Small island and littoral economies are among the most vulnerable environments to the effects of most vulnerable environments to the effects of natural disasters and the long-term effects of natural disasters and the long-term effects of climate change because of their size, location and climate change because of their size, location and topography. It is conceptually difficult to quantify topography. It is conceptually difficult to quantify environmental vulnerability, particularly with environmental vulnerability, particularly with respect to evaluating the risk, magnitude and respect to evaluating the risk, magnitude and effects of infrequent climatic and geological events.effects of infrequent climatic and geological events.

It is clear however, that environmental vulnerability It is clear however, that environmental vulnerability requires requires additional resilience capacityadditional resilience capacity and policy and policy strategies over and above those for dealing with strategies over and above those for dealing with economic volatility.economic volatility.

Building Resilience Capacity inBuilding Resilience Capacity inSmall EconomiesSmall Economies

To build their resilience capacity, small To build their resilience capacity, small economies therefore need to adopt a range of economies therefore need to adopt a range of policies to stabilise the impact of growth policies to stabilise the impact of growth volatility and deal with the effects of volatility and deal with the effects of environmental vulnerability.environmental vulnerability.

• Export diversification.Export diversification.• Improving domestic linkages.Improving domestic linkages.• Enhancing domestic social capital and Enhancing domestic social capital and

governance.governance.• Insurance.Insurance.

Export Diversification in Small Export Diversification in Small EconomiesEconomies

Small economies have a high degree of Small economies have a high degree of specialisation in output and exports but only very specialisation in output and exports but only very limited scope for diversification (the standard limited scope for diversification (the standard solution). More successful small economies tend solution). More successful small economies tend to be less prone to trade shocks because of their to be less prone to trade shocks because of their individual or aggregate sectoral specialisation.individual or aggregate sectoral specialisation.

A second element is to reduce A second element is to reduce geographic export geographic export concentrationconcentration – the dependence upon a limited – the dependence upon a limited number of markets, often in former metropolitan number of markets, often in former metropolitan countries.countries.

Improving Domestic LinkagesImproving Domestic LinkagesGrowth and international competitiveness can be Growth and international competitiveness can be enhanced by improving the depth and quality of enhanced by improving the depth and quality of linkages, both up- and down-stream, to develop local linkages, both up- and down-stream, to develop local supply chains and increase domestic value added. supply chains and increase domestic value added.

For small economies, this potential is likely to be For small economies, this potential is likely to be confined to key areas of activity, notably natural confined to key areas of activity, notably natural resources and tourism. A particular challenge is the resources and tourism. A particular challenge is the need to develop critical local capabilities to improve need to develop critical local capabilities to improve innovatory and adaptive capacity – indigenous R&D innovatory and adaptive capacity – indigenous R&D is constrained by the lack of critical mass of is constrained by the lack of critical mass of financial and human capital as well as diseconomies financial and human capital as well as diseconomies of scale.of scale.

Openness, FDI & Local LinkagesOpenness, FDI & Local Linkages

Foreign direct investment (FDI) offers an important Foreign direct investment (FDI) offers an important additional means to enhance supply-side capabilities additional means to enhance supply-side capabilities in small economies because inflows embody in small economies because inflows embody technology, know-how and market access. technology, know-how and market access.

Inflows of FDI to small economies are unexpectedly Inflows of FDI to small economies are unexpectedly high given their size, primarily because of their high high given their size, primarily because of their high openness to trade – openness to trade and FDI openness to trade – openness to trade and FDI inflows are strongly related. Evidence suggests that inflows are strongly related. Evidence suggests that the fundamental policy issue for small economies is the fundamental policy issue for small economies is not attracting FDI inflows but rather maximising not attracting FDI inflows but rather maximising their local growth effects.their local growth effects.

Enhancing Social Capital & Enhancing Social Capital & GovernanceGovernance

Good governance and social capital are key to optimal Good governance and social capital are key to optimal policy-making and building resilience capacity policy-making and building resilience capacity generally. generally. KhanKhan ( (20072007) identifies three key institutional-) identifies three key institutional-building and objectives:building and objectives:

• Facilitating rapid and effective market and non-Facilitating rapid and effective market and non-market transfers of assets and resources to more market transfers of assets and resources to more productive sectors.productive sectors.

• Managing incentives and needs for achieving rapid Managing incentives and needs for achieving rapid and effective productivity improvements through and effective productivity improvements through technological acquisition technological acquisition (innovation or up-grading), enhanced learning and knowledge absorption.

• Maintaining political stability in a context of rapid social and economic transformation.

Social Capital & Governance inSocial Capital & Governance inSmall EconomiesSmall Economies

It is argued that small economies are particularly well-It is argued that small economies are particularly well-placed with respect to social capital and good placed with respect to social capital and good governance:governance:

• Small societies have a stronger sense of identity.Small societies have a stronger sense of identity.• The short distance between policy-makers and The short distance between policy-makers and

constituents.constituents.• Their need to be highly flexible in responding to Their need to be highly flexible in responding to

external growth threats and opportunities.external growth threats and opportunities.• Limited scope to implement mis-specified growth Limited scope to implement mis-specified growth

policies.policies.

A note of caution; many small economies are not A note of caution; many small economies are not homogenous and some suffer from internal political strife.homogenous and some suffer from internal political strife.

Insurance & Growth Volatility inInsurance & Growth Volatility inSmall EconomiesSmall Economies

A key policy conclusion with respect to the A key policy conclusion with respect to the incidence of volatility in small economies is that incidence of volatility in small economies is that they should make greater use of available they should make greater use of available insurance markets and products as a growth insurance markets and products as a growth stabilisation strategy (stabilisation strategy (Easterly & Kraay, 2000Easterly & Kraay, 2000). ). The use of insurance is particularly pertinent to The use of insurance is particularly pertinent to environmental vulnerability and the need to hold environmental vulnerability and the need to hold sufficient precautionary reserves (i.e., resilience sufficient precautionary reserves (i.e., resilience capacity) to deal with its effects.capacity) to deal with its effects.

Achieving Sustainable Growth inAchieving Sustainable Growth inSmall EconomiesSmall Economies

Achieving sustainable growth in small economies Achieving sustainable growth in small economies is likely to be the outcome of a combination of is likely to be the outcome of a combination of effective growth policies, resilience capacity and effective growth policies, resilience capacity and ensuring the environmental sustainability of ensuring the environmental sustainability of domestic activities. domestic activities.

Small economies are, to an extent, better Small economies are, to an extent, better prepared to cope with these challenges than prepared to cope with these challenges than many other developing countries although they many other developing countries although they face critical challenges relating to their size and face critical challenges relating to their size and capacity for resilience.capacity for resilience.

Achieving Sustainable Growth inAchieving Sustainable Growth inSmall EconomiesSmall Economies

On the plus side is their sectoral structure, generally On the plus side is their sectoral structure, generally reliant –with the exception of some natural resource reliant –with the exception of some natural resource processing activities – on ‘cleaner’ technologies. This processing activities – on ‘cleaner’ technologies. This includes crop rather than large-scale livestock includes crop rather than large-scale livestock production in agriculture, small manufacturing production in agriculture, small manufacturing sectors and large service sectors although attention sectors and large service sectors although attention needs to be paid to the ‘carrying capacity’ for tourism. needs to be paid to the ‘carrying capacity’ for tourism.

To this can be added bio-diversity which is a To this can be added bio-diversity which is a natural resource asset in its own right.natural resource asset in its own right.

On the negative side are the pressures of social and On the negative side are the pressures of social and economic development on fragile environments economic development on fragile environments susceptible to the long-term effects of climate change.susceptible to the long-term effects of climate change.

Concluding CommentsConcluding Comments

• Small economies face a range of challenges but many have Small economies face a range of challenges but many have achieved growth and high incomes.achieved growth and high incomes.

• Their high ‘structural’ openness to trade and vulnerability Their high ‘structural’ openness to trade and vulnerability to natural disasters exposes them to greater growth to natural disasters exposes them to greater growth volatility.volatility.

• Trade is critical to growth and building resilience capacity.Trade is critical to growth and building resilience capacity.• Reducing trade openness will reduce growth, incomes and Reducing trade openness will reduce growth, incomes and

resilience capacity but increase growth volatility.resilience capacity but increase growth volatility.• A range of policies may enhance growth, reduce growth A range of policies may enhance growth, reduce growth

volatility and build resilience capacity, particularly with volatility and build resilience capacity, particularly with respect to environmental vulnerabilityrespect to environmental vulnerability

• Sustainable development is dependent upon effective Sustainable development is dependent upon effective policy-making founded upon social capital and good policy-making founded upon social capital and good governance.governance.