The extent and structure of international outsourcing in very small countries

It has been shown in Chapter 3 that there is a relatively solid and non-negligible disadvantage for smaller and very small countries with regard to the size of the public sector, in the sense that smaller countries on average exhibit larger public sectors. In brief, we detected a negative size effect, i.e. a negative relationship between country size and public sector size (measured in public expenditure), which has become even more aggravated in the course of the last decades. Theoretically, a large part of this negative size effect must be attributed to diseconomies of scale in the provision of publicly provided goods.

Chapter 4 builds on this important result and is designed to shed some light on the public good provision process in VSC, given the fin-dings of Chapter 3. Contrary to the empirical part of Chapter 3, which is an overall assessment on a highly aggregated level, Chapter 4 follows a case study approach. Based on the presumption that diseconomies of

scale are a major determinant of the size disadvantage, a theoretical framework of organizational choice of the provision of public goods is developed. The main idea is to take borderline cases with regard to two characteristics in order to be able to learn more about how the provision of public goods is organized in a difficult environment. These two cha-racteristics are country size – we take only very small countries, where the negative size effect is expected to be most pronounced – and the ex-tent of diseconomies of scale – we analyze the provision of public goods, which are associated with (very) high levels of economies of scale. We hence would expect VSC to have considerable problems in providing these public goods, and we are, therefore, interested in how they pro vide these goods. Of course, the basic question is whether VSC provide these goods at all.

A comprehensive theory of organizational choice in the provision of public goods is beyond the scope of this study. Such a theory is, moreover, not really necessary for the question underlying Chapter 4.

Since we focus on publicly provided goods with a considerable level of economies of scale, hence a high degree of publicness, outsourcing to private agents as organizational choice is, e.g., very unlikely. Strictly speak ing, there are only three main possibilities for VSC to cope with the size disadvantage in the provision of those goods: VSC can, first, simply abstain from providing such goods (which theoretically might re-sult in lower happiness or utility of citizens); second, provide them irre-spective of the high costs (and bear these higher costs); or third, try to source out production internationally. The empirical part of Chapter 4 is designed to analyze the organizational choice for several public goods in 21 VSC. Our focus is especially on the extent and constraints of interna-tional outsourcing, a hitherto widely neglected organizainterna-tional choice in public economics, which is particularly advantageous for VSC. We speak of international outsourcing when a foreign country provides a public good that is «consumed» by the citizens of the VSC, where one can distinguish between two possibilities: First, the VSC has to pay a certain amount for the provision; second, the VSC acts as free-rider, and the providing country accepts this arrangement. In both cases there may be a formal contract or treaty, or only an informal agreement or tacit unterstanding.

There are a few results of Chapter 4 worth repeating and summari-zing here. First of all, it is astonishing that there are a lot of public goods

which are simply not provided or which are internationally sourced out in VSC. It is even more puzzling that especially the nonprovision op -tion does not seem to reduce happiness or welfare in VSC, although hard facts or comparable data on this issue are very scarce. Although international outsourcing has been largely neglected in economics, it doubtless -ly plays an important role for VSC. Note that the economics of international outsourcing is intimately related with the economics of integra tion, but the point of view is different, since the economics of integra -tion focuses on the private sector and generally deals with countries of equal size. On the contrary, the concept of international outsourcing in this chapter concentrates on the public sector and analyzes the possibil -ities and constraints of international outsourcing from a VSC to one or more larger (adjacent) countries.

Based on the selection of public goods with (very) high economies of scale in Table 4.3, Section 4.3 investigates the organizational choice of the 21 VSC for those publicly provided goods for which data were avail -able for all countries. T-able 4.12 presents the results of the case studies at a glance. Note that for every group of publicly provided goods in Table 4.3 we have at least one empirical example in Table 4.12. Seven public goods could not be analyzed due to lack of data, but there is no sign that the results for them would not comply with the overall picture in Table 4.12.⁹⁴

One can conclude that international outsourcing in VSC is wide-spread. It is also an organizational option for publicly provided goods with a high emotional value for a country’s citizens, like having an own currency or running a full university. Note that it seems that VSC citi-zens do not perceive those public goods, which are generally ascribed a high emotional value, as indispensable. Infrastructure is highly dependent on geographic circumstance, which makes it less useful for an ana -l y sis of organizationa-l choice. One can however easi-ly discern from the analysis that VSC try to avoid costs associated with expensive infra-structure whenever possible. International outsourcing approaches its constraints when the security of the VSC is at stake. More VSC than ex-pected maintain their own army, although many of these armies are not

94 These «missing» publicly provided goods are namely: courts and judicial branch, le-gal system, secondary education, hospitals, social security, highways, tax levy.

really designed to fight in a war with a larger adjacent country. Foreign policy is another example for the constraints of international outsourc -ing. Nearly all VSC are members of the most important international or-ganizations, most of which give preference to VSC in relying on the

«one country one vote»-principle for many decisions. Although these memberships are relatively expensive (permanent missions, data provi-sion obligations, etc.), VSC bear the costs, as they also do for embassies in, for them, important countries.

Table 4.12: Summary of results of Chapter 4 with regard to international outsourcing

Public good Costs in FPUBL Operationalization

«very high» costs:

monetary system very low money

defense very low army

foreign policy very low international organizations

embassies

legislative branch implausible parliament: no. of chambers

parliament: no. of members

executive branch implausible ministers

«high» costs:

higher education low full universities

rail infrastruc-ture low railway infrastructure

ports and airports very low airports

general health care implausible performance

costs

general administration implausible federal levels

Abbreviations: FPBUL = foreign public agency; no. = number; intern. = international; outs. = outsourcing Sources: Tables in this Chapter and in the Appendix.

We did not find comprehensive outsourcing for those public goods, for which we presupposed that international outsourcing is implausible.

It is however noteworthy that one general impression also holds for these public goods. Whenever possible, VSC «tailor» the public goods provided to the size of the country. There are fewer members of parlia-ment or fewer ministers on average in VSC than in larger countries. The only exception to that result is the number of federal levels, which seems to be quite similar to larger countries.

Organizational Choice Remarks

in-house: 7 intern. outs.: 14 some of the 14 are part of a monetary union in-house: 14 intern. outs.: 7 some of the 14 armies are more like police forces

fewer memberships, but nearly all VSC are members of the most important intern. organizations partly outsourced to larger fewer foreign embassies;

adjacent countries only in important countries

14 out of 21 have only one chamber

significantly fewer members than in larger countries

party system no apparent difference between VSC and larger countries

4 to 14 ministers VSC; on average fewer than in larger countries

in-house: 5 intern. outs.: 16

in-house: 7 no: 14 result is also dependent on geographic circumstances in-house: 17 no: 4 only 1 airport in a landlocked European VSC; result is of course also dependent on geographic circum-stances

no difference between VSC and larger countries no difference between VSC and larger countries

financing more public provision

mostly two levels, which means that there is no difference between VSC and larger countries

One can therefore draw the overall conclusion that VSC use all three possibilities to keep costs low in the public sector. On the one hand, they try to source out the provision of public goods international-ly whenever feasible. On the other hand, they simpinternational-ly do not provide pub lic goods or «tailor» them to the country size. It is fact that the pub -lic sector of VSC are examples of integration measures within deeply integrated areas, although this finding has hardly been recognized hitherto in the scientific discussion. Take the EU integration, where – with the exception of Luxembourg – only larger countries are involved, as proof. The idea of a common currency, of common embassies in less important countries outside the EU or of a common defense and exter-nal policy are not qualitatively different from internatioexter-nal outsourcing performed by VSC. On a larger scale, one can more easily understand the differences between public goods with different levels of publicness.

Whereas there are no attempts to create common universities (all coun-tries – with the possible exception of Luxembourg – are large enough to operate full universities nationally), the efforts to create and introduce a common currency were serious. Contrary to the monetary system, uni-versities are far from being a pure public good; a fact which explains the different treatment in EU integration.

Finally note that there are of course further criteria involved in or-ganizational choice, some of which are mentioned in Section 4.2. We do not go into detail here with regard to these criteria, because we wanted to focus on international outsourcing.

Is a VSC an optimal unit to provide public goods? Although Chapter 4 has shown that there are several widely used options to re duce the negative size effect, the more general result of Chapter 3 prevails of course. One therefore has to conclude that VSC are not optimal units for the provision of public goods from a cost point of view. Higher prefe-rence adequacy and other intangible advantages of VSC may level out this disadvantage, but it is very difficult to quantify the according argu-ments. VSC can however lower costs by organizational options. These options, the associated costs and their constraints have been analyzed in Chapter 4 in detail.

To date we still do not know why the number of VSC has been in-creasing during the last decades despite the obvious public sector disad-vantage. The growing number of secessions of countries cannot be explained by the results in the previous chapters. Even more

significant-ly, if we regard only the public sector, we would have had to predict a fall in the number of countries. In the following chapter, the concept of sovereignty and its benefits will be offered as one promising explanation for this puzzling development. Furthermore, we will analyze the effects of international outsourcing on sovereignty and on the perception of sovereignty.