Undersized: Could Greenland be the new

Iceland? Should it be?

Anne Sibert Print Email
10 August 2009 Comment Republish
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 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.
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