The predictions of economic theory

As outlined above, the economic consequences of size have not been a major field of research in economics. Especially with regard to publica-tions in core economic journals, the economic problems and (dis-)ad-vantages of nation’s size and economic peculiarities of VSCs’ private and public sectors as well as their macroeconomic performance have not even been a recognized issue. Although VSC have been ignored in core economics, there have always been quite a few economists, often affi -liated with international organizations or located in small countries, working on this subject.

When the benefits of jurisdictional power are not taken into ac-count in an assessment of VSC, then the economic consequences of small size in economic theory are straightforward. It is therefore not surpris -ing that

the papers collected in Robinson (1960) remain the principal sub-stantive contribution to the theoretical analysis of micro-states.

More recent analyses have generally failed to develop further many of the ideas originally contained therein (Armstrong and Read, 1995, p. 1230).

If we are to assess the impact of jurisdictional power properly, it is ne-cessary to present the most important theoretical arguments concerning the economic consequences of a small country size in order to have an appropriate benchmark for comparisons. Most of the relevant theories clearly emphasize the disadvantages of a small country size, and it is much more difficult to assess the advantages of small size with the help of theoretical arguments in economics. As already stated in Chapter 3, given the evidence of an ever-increasing number of small and very small countries in the world, it would be desirable to have some economic

arguments concerning the possible advantages of small size. We will discuss these advantages after having presented the traditional theoreti-cal arguments, which establish a quasi «inferiority» axiom for VSC.

Table 5.1 gives an overview on the most popular arguments in favor of or against VSC.

Obviously, this is a huge list of disadvantages¹⁰¹with a lot of com-mon arguments and based on well-known and empirically tested general economic concepts. It is far beyond the scope of this work to go into the details of the arguments on VSC economic «inferiority». As one can ea-sily detect, the list in Table 5.1 is not much more than an enumeration of the most often quoted arguments against the existence of VSC¹⁰², and we are not able to dwell upon interesting interactions and causalities be -tween some of the arguments in Table 5.1.¹⁰³Note further that there are, of course, ideas, which can appear on both sides of the table depending on institutional frameworks and constitutions. Take for instance social homogeneity, which may either lead to a swifter decision-making pro-cess due to less diverse preferences and opinions or create a system of personal relationships – sometimes called elite connectivity – that may result in clanlike structures, corrupt practices and other adverse beha -vior.

In the previous chapters of this work we concentrated on one of the

«inferiority» arguments, i.e. the problems associated with the public good provision in VSC, where public goods are defined in a relatively broad sense. It is important to note that this issue – although only one of many in Table 5.1 – is one of the most pressing for VSC, and many of the theoretical «inferiority» results in Table 5.1 may be traced back to public sector-related or diseconomies of scale-related questions. To recapitu late our main result, we found that a negative size effect clearly exists, but VSC are more adaptive and innovative than economic theory has been

101 We have the clear impression – given the results of this study – that some of the «in-feriority» arguments concerning VSC are invalid to a certain extent, because they do not seem to be empirically confirmed. Note that most disadvantage arguments are strongly related to the private sector. The important exception is the diseconomies of scaleargument in the provision of public goods.

102 These arguments were the basis of a rather widelyheld scientific opinion that denied the chance of survival of VSC between the two world wars and, especially, after the second.

103 For the interested reader we provide some references in Table 5.1. Good overviews can be found in Armstrong et al. (1998), Robinson (1960) and Waschkuhn (1993).

suggesting in finding ways to reduce the resulting disadvantages (provi-sion of only selected public goods, international outsourcing etc.).

Some of the disadvantages listed in Table 5.1 have also been dis -cussed under the label «vulnerability» (e.g., Briguglio, 1995; Hintjens and Newitt, 1992). Table 5.1 aims to prove that the economic assessment

Disadvantages

• diseconomies of scale in public good provision (Alesina and Wacziarg, 1998; Kocher, 2000; Robinson, 1960)

• small size of the domestic market (diseconomies of scale in private production) (Armstrong et al., 1993; Briguglio, 1995; Kuznets, 1960)

• diseconomies of scale in research, development and technology (Briguglio, 1995;

Jewkes, 1960; Vakil and Brahmananda, 1960)

• less competition on internal markets (Armstrong et al. 1993; Gantner and Eibl, 1999)

• not a large enough home market of considerable size to back export strategies

• poor domestic resource base, both raw materials and knowledge (limited and undiver-sified) (Bhaduri et al., 1982; Kuznets, 1960; Waschkuhn, 1990)

• narrow range of domestic output (Selwyn, 1975)

• limited possibility of import-substitu tion (Selwyn, 1975)

• export and import dependency (Kuznets, 1960)

• unstable export prices may harm VSC economies considerably (MacBean and Nguyen, 1978)

• high proportion of imports in domestic consumption

• geographic export specialization (Kuznets, 1960)

• vulnerability with regard to exogenous shocks (internal balancing mechanisms of shock consequences are limited) (Amstrong et al., 1998)

• internationally «neglected» (little power to pursue (economic) interests internationally)

• special problems (depending on geographic variables): high transport costs, limited ac-cess to international transport networks (highways, railways, harbors), geographic fractionalization etc. (Baldacchino and Milne, 2000)

• elite connectivity (Gantner and Eibl, 1999; Geser, 1993)

Table 5.1: Disadvantages and advantages of VSC

of VSC has been dictated by a rather narrow understanding of econo-mics and therefore resulted in a long list of disadvantages. Most studies briefly refer to a number of advantages¹⁰⁴but do not analyze them ade-quately. An explanation for this fact is straightforward. There is a wide-ly held belief among economists that «the few advantages derived from small size identified in the micro-state literature are generally intangible and therefore impossible to quantify» (Armstrong and Read, 1995, p. 1230). While this statement contains, of course, a bit of an explana tion, it is nevertheless disappointing. A concentration on negative arguments clearly fails to explain why some VSC are overwhelmingly successful. In

104 This is the reason why we abstain from giving more than a few references for argu-ments concerning the advantages.

Advantages

• greater social homogeneity, cohesion and closer coherence (Kohr, 1995)

• less ethnic and linguistic fractionalization

• greater flexibility

• higher decision making efficiency

• necessity of public outsourcing increases efficiency (Gantner and Eibl, 1999)

• greater openness to change

• large gains from international trade (Marcy, 1960; Scitovsky, 1960)

• internationally «neglected» (ability to maintain niche policies)

• possibility to create and protect narrow niche markets

• law-making authority is very effective (economic benefits of sovereignty); legal diffe-rences between VSC and adjacent countries (Gantner and Eibl, 1999)

• smaller «distance» between politics/administration and citizens

• less congestion costs

• less costs from agglomerations and conurbations

the following sections we will, therefore, simply take the disadvantages as given without analyzing them in greater detail – bearing in mind that their extent and impact may have been exaggerated sometimes, especial-ly for land-locked, peaceful and open VSC – and take a closer look at the advantages, which are largely intangible and very difficult to quantify.

However, some of the advantages must enable certain VSC to achieve high levels of living standard; hence, for those VSC the advantages must exceed or at least level out the disadvantages of small size. One of the promising starting points for an analysis of the important determinants of high living standards in VSC is law-making authority, which will be at the heart of our considerations in the following sections.

Before analyzing the sources of welfare in VSC, it is helpful to clarify our understanding of sovereignty again. Possible definitions of so -vereignty have been expounded in Section 2.3.2, but we did not assess the term from an economic view. Apart from legal considerations like inter-national recognition, which will be still useful in distinguishing between very small countries and small autonomous regions, we want to analyze the influence of «effective» sovereignty on economic success. To be spe-cific, we are interested in the degree of «effective» sovereignty that is ne-cessary to ensure that very small countries – which generally exhibit a very low degree of «effective» sovereignty – can pursue niche strategies and can be successful economically?

Law-making authority, which we often refer to, is part of sover-eignty in a broader sense. Soversover-eignty might also include the perceptions of the citizens of a country or intangible assets, like a national anthem or national colors. The latter are apparent signs of sovereignty, but we are rather interested in the transmission mechanisms at work between «ef-fective» sovereignty and economic strategies (sovereignty put to actual use or economically «useful» sovereignty), and have to leave these emo-tional and symbolic manifestations of sovereignty aside in order to make the analysis as straightforward as possible.¹⁰⁵Henceforth, we will there-fore not strictly distinguish between law-making authority and sover-eignty, because the possibility to pass and enforce laws within a limited territory is the most important part of sovereignty for our analysis. Note

105 We know of course that emotional manifestations of sovereignty may have economic consequences or induce economic behavior.

that law-making can be viewed as a public good with a consumption obligation, since nobody can be excluded from its consequences and all citizens have to obey the law. The «producers» of laws normally have a territorial monopoly on passing and enforcing laws or similar legal regulations.