The Flotilla Effect. Europe’s small economies through the eye of the storm

André Gide, the great French novelist, was reported to have declared on his deathbed: “I believe in the virtue of small nations. I believe in the virtue of small numbers. The world will be saved by the few.”1 During the time of the Great Moderation, the long lingering worldwide economic boom of the nineties and the 2000s, those words seemed to develop an almost prophetic air. Small and nimble open economies like Ireland, Iceland and the Baltic States became the poster-boys of globalisation, much as the Asian tigers had been a generation before. Countries the size of Norway and Iceland topped virtually every virtuous league table in existence from GDP per capita to indices of wellbeing and peacefulness.

Now, as the economic conditions have turned, so too has the tide of ideas. The travails of small countries have made big headlines worldwide. The sovereign debt crisis in Greece, the banking collapse in Iceland, the property crash in Dubai and Ireland‟s fall from “Celtic Tiger” grace have cumulatively led to a shift in the intellectual terms of trade. This was perhaps best summed up by an epithet attributed to Paul Volcker, the former Federal Reserve Chairman (with a sideways nod to Roy Schneider‟s character in the movie Jaws): “In turbulent times it‟s better to be on the bigger boat.”

Can the small survive and thrive through the present storm? This is no small matter for any of us. We live in a world of small states: approximately two thirds of the voting power in the UN and the EU belong to countries with less than 15 million citizens. And in Europe there is no shortage of candidates to join their ranks: Scotland, Wales, the Basque Country, Catalonia and Flanders, to name a few. If small countries are thought to founder on the overhanging rocks of economies of scale, then independence, for some, will remain a risk not worth taking.

In this short report, we seek then to ask a simple question: how does country size affect economic output? Section one gives an overview of the literature of the economics of country size. We use a standard tool of econometrics: a cross-country regression of population size versus real GDP growth, both before and during the recent crisis, to ascertain the relationship, if any, between them. Section two provides commentary on the policy implications of the recent economic crisis as it has particularly affected small countries. Finally, in section three, we seek to draw out the implications of the above for Europe in general, for existing small countries and for those candidate countries for Europe‟s “internal enlargement”.