Undersized: Could Greenland be the new Iceland? Should it be?

Anne Sibert, 10 August 2009

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Greenland’s 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 marine mammals. 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 parliament granted 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 EU’s Common Fishery Policy (the ban on seal 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. The Danish queen attended a celebration at the parliament in Nuuk, and Greenlandic became the country’s official language.

Can a country be too small?

Although it is not yet heavily involved in international banking, Greenland’s progression toward independent statehood is strikingly reminiscent of Iceland’s experience (especially its desire to maintain its own culture and protect its natural resources at the cost of isolation from the rest of the world and its wish to limit its economic relationship with Europe). This raises questions – does the recent experience of Iceland suggest that a country can be too small to be a nation state, and what are the costs and benefits of being isolated from the rest of the world?

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

Figure 1. Country size (population in millions)

In this column, I argue that there is little economic justification for preferring small size and that there can be significant costs. I also argue that Iceland’s small size was probably a key factor in Iceland’s failure to stop its financial crisis.

Do smaller countries enact better economic policies and grow faster?

It is usually claimed that the benefit to small size is social homogeneity which leads to cohesion and an ability to build a consensus. This may promote flexibility in the face of changing circumstances and make it easier to enact policies that promote growth. Indeed, some small economies such as New Zealand, and, in many respects, Iceland are widely viewed as paragons of economic virtue. Formal empirical evidence linking 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 goods such as the number of telephones and paved roads and the amount of schooling. However, Easterly and Kraay (1999) assert that a lack of consistent data makes it hard to test whether small size is associated with growth-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 a discussion of this literature.

Smaller countries have more volatile output

The recent experience of Iceland suggests that, while there is no clear evidence that small countries experience higher average growth rates, they do have more volatile growth rates. As shown in Figure 2 below, Iceland’s output growth is less smooth than that of either the UK or the US. The reason for this seems clear. 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 consumption

Output 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 holding a 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 adverse shocks to the return to human capital.

If shocks to a country’s output were purely transitory, a country could use its current account to smooth its consumption – borrowing in states where output is low and lending in states where it is high. Unfortunately, from the point-of-view of smoothing consumption, most shocks appear to have a large permanent component. Thus, it seems likely that a country with relatively variable output will have relatively variable consumption as well.

In a study of 56 countries over the period 1950 – 1985, Head (1995) finds that the variances of both output growth and consumption growth are indeed negatively correlated with population size. Moreover, this effect is especially pronounced in high-income countries. Figure 3 shows the relationship between population size and (detrended) consumption volatility for 20 relatively high-income countries. While some small countries have very low consumption volatility (Norway, Luxembourg), many have very high volatility (New Zealand, 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 countries

A small population has other costs; I will mention three here. First, as the provision of many public goods has an important fixed cost component, the per capita cost of public good provision is likely decreasing in country size. Second, it is also likely that the per capita administrative cost of income taxes is decreasing in country size. As a result, smaller countries tend to rely less on relatively efficient income taxation and more on 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 with small geographical size. Many countries are vulnerable to natural disasters and environmental damage and self-insurance against these sorts of shocks is easier for larger countries. If an American city is damaged by a hurricane, residents can move to another American city. If global warming causes sea levels to rise sufficiently, the consequences for the residents of Tuvalu are likely to be less favourable.

Problems for civil servants in small economies

In 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 radio show, 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 appears to have had no expertise in economics and banking and was ineffective at either averting the financial crisis or playing a positive role in its aftermath.

In addition to Oddson’s 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 and ecclesiastical 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 play more roles than he would in a more populous society. Such multi-tasking can be demanding and makes it difficult 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 things getting 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 denying Glitnir a loan in October 2008 and that the Independence Party played an unseemly role in the privatisation of 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 cohesion and the state’s legitimacy.3

A sensible policy solution to the problem of filling sufficiently important posts when there is limited local talent 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 this strategy by hiring a Norwegian expert to be the acting central bank governor and a Norwegian-born French magistrate 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 hire supervisors from abroad – the banks can be taxed to fund them.

Island officials should get out more

Many very small countries are islands, and thus isolated. It is more difficult for senior officials to travel to a neighbouring 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 might not have access to advice that their counterparts abroad might offer. It is thus important that senior officials in out-of-the-way locations make an attempt to attend conferences and other professional gatherings abroad.

Footnotes

1 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 seem somewhat 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 than any other in Northern or Western Europe.”

References

Armstrong, 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 World Bank, 1999.

Easterly, William and Ross Levine, “Africa’s 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,” World Development 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 Development Programme, 2007/2008.

Topics: Europe's nations and regions
Tags: Greenland, Iceland

Comments

The effects of absolute size of a society

Sibert asks the important question of the social effects of the absolute size of a society, which is strangely ignored in social science in general and in Icelandic social science in particular. The latter is a pity, since Iceland is a particularly interesting case being a very small and very highly developed society.

Sibert makes convincing arguments in her field of economics, but less convincing ones when venturing into political science and public administration questions.

Concerning the skill levels of former Central Bank Governor David Oddsson, the comparison with the USA shows immediately that political appointments is not a function of the size of societies, but political tradition. It is actually an interesting political science question, why Iceland took up a widespread tradition of political appointments in its civil and foreign service upon independence from Denmark (which has very few such appointments).

Sibert correctly points out that Icelandic civil servants are faced with a much broad range of topics than their colleagues in larger countries. Iceland as a highly developed country can be expected to be faced with qualitatively the same issues a other highly developed countries, but with much fewer absolute resources. Concerning potential EU presidencies for Iceland, Icelandic civil servants are individually as qualified as their European colleagues to handle this, but there might simply not be enough of them.

The argument by Sibert about a lack of skilled civil servants in a small country is puzzling. Since Iceland is highly developed, the population is well educated. Also, the distribution of giftedness is probably similar to other countries. The only basis for a lack of skilled civil servants would, thus, be based on a relatively higher demand for skilled analysts and decision-makers, which Sibert does not show.

Sibert points out potentially very detrimental isolatedness in a small island nation, but is it empirically the case? This argument reflects an consistent obversation I have made as a Dane living in Iceland, Switzerland, the Netherlands, UK, France and the USA, that countries always perceived relatively smaller countries as less sophisticated and more isolated. This bias is actually quite strange: the smaller the country, the relatively more greater is foreign trade, foreign-language skills and media consumption. Compare the TV-viewing of an average Icelandic and (not recent immigrant) American family.

Based on my own experience in the Danish and Icelandic civil services, the level of foreign-language skills and foreign work and study experiences was significantly higher in Iceland, because they had had to go out for their education. I would be quite confident about the same expectation comparing between Iceland and the UK or USA. At a leading US public policy school, I hardly ever meet senior US policy makers with any foreign educational experience.

If the level of qualifications of the civil service is related to the size of the country and that explains Iceland's predicament today, then how did the USA get itself and the world into to subprime mess and an international financial crisis?

There is one element of the absolute size of Icelandic society and the financial crisis which seems intuitively very important to a non-economist: the size of the domestic market and the 'utras', the foreign expansion of Icelandic business in recent years. If I was an ambitious Icelandic business leader (e.g. bank manager) wanting growth, whereelse should I go than abroad? Today the expansion seems foolish, but what was the alternative business strategy?

Professor of Economics at Birkbeck, University of London and CEPR Research Fellow