Small states have a number of characteristics and vulnerabilities that present them with special challenges over and above the normal challenges of development, as they adjust their economies and exploit the opportunities of closer integration into a rapidly changing global economy. This is the main finding of The Report of the Commonwealth Secretariat/World Bank Joint Task Force on Small States, which was issued shortly before the spring 2000 World Bank-IMF meetings in Washington. The product of 18 months of consultation, analysis, and research, the report is addressed both to small states and to the international development community. It sets out a contextual framework and a continuing agenda for action and analysis by the small states and by the international and other organizations that provide external support and influence their development.
Features of small states
The report uses a population cutoff of 1.5 million for small states as a useful starting point only and does not recommend the creation of a special category of small states. It argues that countries should be regarded as lying along a size continuum, with a number of larger states sharing some or all of the same characteristics.
Among the world’s 45 sovereign developing states with populations of less than 1.5 million, 41 are members of the World Bank and the IMF, more than 30 are eligible for Bank Group borrowing, and 29 are members of the Commonwealth. The incomes and stages of development of these states vary widely, from very poor African countries such as Guinea-Bissau (with per capita GNP of $160) to wealthy countries such as Brunei, Cyprus, Malta, and Qatar (with per capita GNP of more than $9,000).
Small states are found in every geographic region, but most countries fall into three main groups: 12 are in the Caribbean, 14 in East Asia and the Pacific, and 12 in Africa. While each small state is unique, and there are also differences between regions, most small states share a number of common characteristics. These include remoteness and isolation, openness, susceptibility to natural disasters and environmental change, limited diversification, limited capacity, income volatility, and limited or difficult access to external capital. In particular, the report found both that most small states are more vulnerable and experience greater income volatility than larger states, and that the sources of this vulnerability are often a result of the external environment.
In these common characteristics of small states, the report finds clear indications of the challenges they face in improving their development prospects. It emphasizes up front that sound domestic policies will be essential to successful development. As with all other countries, policies that bring macroeconomic stability need to be supplemented by good and appropriate structural and social policies that provide the basis for growth, successful transformation of their economies, and poverty reduction. Arguably, such policies are even more important in small states than in larger ones; first, in countries that are vulnerable to external shocks, it is even more important to avoid internally generated instability; and second, in small states, policy mistakes—for example, in using nonrenewable resources or in environmental protection—can have longer-lasting and more pervasive effects than they would in larger states. In effect, one aspect of vulnerability is susceptibility to domestic policy mistakes.
Crucial policy areas
The report details how small states can tackle the challenges they face with a combination of appropriate policies and external support and assistance and identifies a specific list of actions for the future. In particular, the report examines four areas of special relevance to successful development in small states: tackling volatility, vulnerability, and natural disasters; adapting to the changing global trade regime; strengthening production capacity; and meeting key challenges and new opportunities arising from globalization. For each of these areas, the report draws up a work program of actions, analysis, and new initiatives for the states and for the international community.
Among the steps that the international community should consider in addressing the special development problems of small states are
• new approaches to regional cooperation, as a way of tackling limited capacity in small states;
• maintaining a high level of external support and official assistance in cases where the correct policies are in place, to compensate for the perceived riskiness and the difficulty in attracting investment flows;
• improvements, where achievable, in the external environment;
• new mechanisms to address the mitigation of natural disasters (an area in which the World Bank has been active);
• assistance in strengthening capacity in both the private and public sectors;
• helping small states exploit the new opportunities arising from globalization; and
• action, whenever possible, to reduce or remove barriers to the exports of small states and to achieve greater flexibility in the transition to the changing global trade regime.
One area of particular interest singled out in the report is the provision of offshore financial services, which has become an important economic activity for many small states, but is also under much scrutiny by the major industrial countries. The report recognizes the clear need for improvements in financial operating practices and regulatory standards and the need to take action to prevent financial and tax crime and to address concerns about harmful aspects of tax competition. The report sympathizes with the concerns of small states about their lack of representation in the Organization for Economic Cooperation and Development (OECD) and the Financial Stability Forum and lack of adequate consultation on matters of interest and relevance. At a London conference in February 2000, the OECD indicated its willingness to constructively engage small states on tax competition issues and to respond to their call for a multilateral discussion. It is important, the report stresses, that all these issues be considered in international forums where small states have a voice, so that their interests can be taken into account.
Another area of interest relates to trade liberalization, which the report views as an integral part of a sound overall economic development strategy. However, in view of the potential fiscal consequences of liberalization, the report urges the IMF to continue to take a pragmatic approach to the advice it gives to small states that risk losing a major source of fiscal revenue as tariffs fall. The report recognizes that for some small open economies, low flat-rate tariffs may be one component of an efficient tax system.
Eleven international agencies, including the World Bank, the Commonwealth Secretariat, and the IMF, submitted specific work programs or frameworks to the task force in the course of the preparation of the report.
The World Bank framework centers on helping small states develop and implement effective strategies to reduce poverty, developing programs to support private sector development, exploring new approaches to Bank support for risk pooling and disaster insurance, and emphasizing a flexible approach to graduation policy. The World Bank framework also takes into account the special circumstances of small states to ensure that none is graduated prematurely.
The framework of the European Union includes, among other things, financing an African, Caribbean, and Pacific countries office in Geneva to assist member countries in their dealings with the World Trade Organization, and supporting transition of the most banana-dependent economies by improving competitiveness of the banana sector, creating new activities to replace traditional banana production, financing new infrastructure, and retraining labor.
IMF activities with small states
The IMF’s framework focuses on the provision of support to member countries (large as well as small) through policy advice and financial and technical assistance. It emphasizes that advice and assistance are tailored to each country’s specific circumstances and needs, including special factors related to size.
On surveillance—the main channel for the IMF’s policy advice—the report notes that for slightly more than half of its small member states, the IMF maintains a close dialogue through annual consultations. Other small member states, including most of those in the Asia and Pacific region, are on a 24-month cycle for such consultations (18-month in one case). For these countries, the IMF maintains continuity in its surveillance activities through interim staff visits. Small states have also availed themselves of staff-monitored programs with the IMF, which can play an important role as a catalyst for aid and private capital flows. These various bilateral discussions are supplemented by discussions with the regional authorities of those small member states that participate in a monetary union (namely, the Eastern Caribbean Currency Union, the West African Economic and Monetary Union, and the Central African Economic and Monetary Community).
On financial assistance, the IMF framework notes that, like all member countries, small states that face balance of payments difficulties are eligible for all of the IMF’s financial facilities and loans and that all programs take into account country-specific circumstances, including size. Thus, small states that are vulnerable to natural disasters or have a higher degree of export concentration have opportunities to avail themselves of emergency assistance for natural disasters and the Compensatory Financing Facility. Small states that have low per capita income are eligible for the IMF’s concessional loan facility, the Poverty Reduction and Growth Facility (PRGF). Eligibility for the use of PRGF resources has tended to follow closely the World Bank’s decisions on eligibility for loans under the International Development Association. Of the 19 small states eligible for PRGF (or its predecessor, Enhanced Structural Adjustment Facility) financing, 8 have used these concessional resources to date (some more than once) and 2 are currently in a PRGF arrangement with the IMF.
Photo Credits: Denio Zara, Padraic Hughes, Pedro Márquez, and Michael Spilotro for the IMF.
Finally, the IMF framework emphasizes the wide array of technical assistance programs provided through the Fiscal Affairs, Monetary and Exchange Affairs, Statistics, and Legal departments, and the training courses and seminars offered by the IMF Institute to member government officials both in Washington and outside. The provision of technical assistance to the small states of the South Pacific (by the IMF and the United Nations Development Program (UNDP)) has benefited from the establishment of a regional center in Fiji in 1993, whose activities are coordinated by the IMF and financially supported by the Asian Development Bank, Australia, and New Zealand.
The IMF is currently working with the UNDP and other multilateral and bilateral donor agencies to establish a similar center in the Caribbean. The proposed Caribbean Technical Assistance Center would involve the posting of a core team of three or four experts in the region—working in collaboration with an IMF coordinator—to provide technical assistance in specified fields (statistics, bank supervision and regulation, and fiscal management) on a peripatetic basis. The center in the Pacific has demonstrated the many benefits of this approach to providing technical assistance. The assignment of experts for two or three years allows sufficient time to initiate a project in a country and assist in the execution and follow-up in subsequent visits. The approach contributes significantly to the building of local expertise and facilitates arrangements for in-country training courses, workshops, and special consultancy arrangements.
The technical assistance project is part of a wider “Caribbean initiative,” which includes expanding surveillance, deepening research on regional issues, and establishing closer collaboration between the IMF and the regional institutions [see IMF Survey, March 6, page 65]. In this regard, the IMF and the Caribbean Development Bank were joint sponsors of a high-level seminar held in Barbados in February 2000, which centered on the Caribbean’s adaptation to globalization.