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Undersized Could Greenland Be the New Iceland

Undersized Could Greenland Be the New Iceland

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Published by Johnni M Poulsen

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Published by: Johnni M Poulsen on Sep 24, 2010
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09/19/2014

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Undersized: Could Greenland be the newIceland? Should it be?
Anne Sibert10 August 2009
 
 
 As Greenland moves away from Denmark and acquires more autonomy, this column asks whether it might be too small. In assessing the relationship between country size and economic performance, it warns that  small states have more volatile GDP, more volatile consumption, and more incompetent civil servants.
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 marinemammals. 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 parliamentgranted 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 onseal 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. TheDanish queen attended a celebration at the parliament in Nuuk, and Greenlandic became the country’sofficial language.
Can a country be too small?
Although it is not yet heavily involved in international banking, Greenland’s progression towardindependent statehood is strikingly reminiscent of Iceland’s experience (especially its desire to maintain itsown culture and protect its natural resources at the cost of isolation from the rest of the world and its wish tolimit its economic relationship with Europe). This raises questions – does the recent experience of Icelandsuggest that a country can be
too
small to be a nation state, and what are the costs and benefits of beingisolated from the rest of the world?The answer to these questions is relevant not only for Iceland and Greenland but also other tiny countriesthat have gained sovereignty in recent decades; since 1990, 33 new countries have been formed and, as seenin 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 besignificant costs. I also argue that Iceland’s small size was probably a key factor in Iceland’s failure to stopits financial crisis.
Do smaller countries enact better economic policiesand grow faster?
It is usually claimed that the benefit to small size is social homogeneity which leads to cohesion and anability to build a consensus. This may promote flexibility in the face of changing circumstances and make iteasier to enact policies that promote growth. Indeed, some small economies such as New Zealand, and, inmany respects, Iceland are widely viewed as paragons of economic virtue. Formal empirical evidencelinking small size to growth-promoting policies appears to be lacking, however.Easterlyand Levine(1997) find a strong negative correlation between ethnic diversity and indicators of growth-promoting public goodssuch as the number of telephones and paved roads and the amount of schooling. However, Easterly andKraay (1999) assert that a lack of consistent data makes it hard to test whether small size is associated withgrowth-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 adiscussion of this literature.
 
Smaller countries have more volatile output
The recent experience of Iceland suggests that, while there is no clear evidence that small countriesexperience
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 seemsclear. 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 holdinga 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 adverseshocks 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 itsconsumption – borrowing in states where output is low and lending in states where it is high. Unfortunately,

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