Is Small Always Beautiful?

Published: 31 May 2018
The recent report by the Growth Commission contains some interesting ideas, says Michael Keating, but also makes some problematic assumptions. 
The report of the Sustainable Growth Commission is a weighty contribution to the debate on the economics of Scottish independence, intended to face those difficult questions that were often swept aside in 2014, about the fiscal deficit and the currency. It contains a lot of good ideas about economic management, especially on the micro side, many of which could be put into effect using existing devolved powers. As a vision for Scotland’s future, however, it is perhaps less than the sum of its parts and hangs uneasily between hard-headed analysis and advocacy.
Advocacy approaches to policy learning typically select examples of success and seek to adapt them to the case at hand. Management consultants, eager to bring good news, are prone to this. Academic analyses, by contrast, look at both successes and failures and seek to identify the key differences. Only in this way can we learn what really works.
The Commission has picked up on a literature from the early 2000s about small states, largely of the advocacy type, purporting to show that they were more prosperous, socially cohesive and generally superior on all the performance indicators. 
A more recent wave of research (including our work in the Centre on Constitutional Change*) has questioned these simple associations and generalizations and focused on the differences among small state themselves. Smallness is not an absolute but relative and can refer to population, land area or peripherality in world markets. However defined, small states face both vulnerabilities and opportunities. They can succeed but need (a) an external shelter such as a free trade regime and (b) an internal buffer, or means of responding to economic shocks. They provide these in very different ways and there tends to be an internal coherence in successful cases.
The Commission’s approach is to take twelve successful small countries and ten large countries and make general comparisons. There are some basic methodological problems in doing this type of comparison. One is to make sure that the difference in the average values in each group (the mean or median) is not greater than the difference within each group (the variance). Yet several of the Commission’s figures show massive within-group differences (on outward investment; on inward investment; on multinationals). In other cases (such as R & D investment and innovation) there is little difference between the groups. 
Another classic problem is that of the outlier. So large countries only have average larger debt because of Japan and Italy. In other words, this tells us something about those two countries, not about large countries.
The growth recipes for the small countries are also so different as to make generalizations difficult. Some are based on productivity enhancement, others on population growth, as the Commission itself notes. Ireland has a massive direct inward investment sector, which is in many ways detached from the rest of the economy and has given rise to highly uneven development. Hong Kong and Singapore have such radically different social structures and international trading positions that one has to wonder about their relevance for Scotland although they are often cited by neo-liberal Brexiters for inspiration.
The Commission does recognize that there are different types of small states, taking as models Ireland and Singapore; the Nordic Countries; and New Zealand. However, it then seeks to pick and mix elements of each. This is a mistake which Ireland has made in the past.  Successful cases have an internal coherence in which one element supports the others. The Nordic model in particular relies on a series of virtuous circles in which social cohesion and growth support each other, based on strong institutions, although there are significant differences among the Nordic states. One lesson that can be learnt is that the connections among economic growth, labour market policy and welfare are crucial. The Commission pays little attention to these linkages.
It is a cliché in Scotland that we are a small society in which everyone seems to know everyone else. As the Commission notes, this can help decision making and flexible and rapid response to change. The comparative literature, however, shows that it can also make for group-think, veto points and stasis. One reason for the drift of Ireland to the financial disaster of a few years ago was the way in which most people bought into the wishful thinking around an economic model that was unsustainable. 
The Commission picks up on the claim made by Alesina and Spoloare’s, The Size of Nations, that small states are more likely to emerge at times of free trade. This is simply historically false. New states that emerged in the late nineteenth century had differing trading strategies. The explosion of new states after the First World War coincided with a fragmentation of markets, followed by the collapse of the international trade system into national protectionism. The collapse of the Soviet Union and Yugoslavia was not caused by their breakaway republics seeking free trade (with the possible exceptions of the Baltic States and Slovenia). What is true is that small states face particular challenges and opportunities within free trade regimes. The issue of how Scotland would work within the European Union deserves more attention, as there are examples of small state failure and success. So would the future economic relationship with the United Kingdom. The suggestion that ‘The UK Government would have a strong interest in maintaining a trading relationship with Scotland that is as open and frictionless as possible’ recalls the wishful thinking among Brexiters (even to the idea of frictionless trade). 
The Commission is right to note that small countries cannot afford to maintain large budget deficits and debt over the long term and are usually able to balance their books. The recommendation to reduce the Scottish deficit and keep it down is surely wise, as no state has managed to maintain a full-service welfare state by continual borrowing. What does not follow is the conclusion that ‘The core lesson from other small advanced economies is that the most effective way to reduce the deficit would be to control spending growth to no more than GDP growth.’ The Scandinavian welfare states combine fiscal responsibility with generous public expenditure because they have high taxes. Public services are not considered a drag on the productive economy but as a form of social investment, enhancing economic growth as well as social welfare. 
Demographic pressures are putting ever more demands on our squeezed public services. Even the Conservative Party may be moving towards higher taxes (however packaged) to fund health and social care. There is both and economic and a social case for expanded health care. As the Commission notes, inequalities of wealth and income are massive. Independent or not, Scotland will have to have a serious debate about taxation.
Michael Keating is Professor of Politics at the University of Aberdeen and Director of the Centre on Constitutional Change. 
*CCC publications on small states include Michael Keating and Malcolm Harvey, Small States in a Big World. What Scotland Can Learn, Luath, 2014; Harald Baldersheim and Michael Keating (eds), Small States in the Modern World, Edward Elgar, 2015; and Michael Keating (ed), A Wealthier, Fairer Scotland, Edinburgh University Press, 2017.

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