Guan’s blog


Country size

16 Sep 2014

In a post on Scottish independence, Felix writes:

In terms of economics, bigger is nearly always better. On purely economic terms, Ireland would probably be better off it was part of the UK; Canada would be better off if it were part of the US; in Europe, it would make perfect economic sense for the Netherlands to merge with Luxembourg and Flanders, while Wallonia joined up with France. But no one in any of those countries actually wants those things to happen. These days, countries don’t merge (the reunification of Germany being the main exception): they break apart, like the Soviet Union, or Czechoslovakia, or Yugoslavia. Or, quite possibly, if Scotland becomes independent, Spain.

This lead to some discussion on Twitter. I pulled data from the Penn World Table and plotted GDP per capita in 2010 (the last year for which data is available) against a country’s population.

The relationship between country size and GDP per capita is not statistically significant, with a p-value of 0.34. This correlation doesn’t tell us that much: as Evan Jenkins points out, the fact that a small country is rich may help it stay independent. The point estimate is slightly negative because of a few rich small countries, mostly in Northern Europe, and a few large poor countries in Asia.

This is not exactly Felix’s point, however: he is making claims about specific counterfactuals. Ireland is doing quite well outside the UK now, but his claim is that they would be even better off if they were part of the UK. He later brought up the fact that Hong Kong has done quite well as part of China.

There are actually two types of counterfactuals we could set up. It’s almost certain that Hong Kong would not have be richer than it is today if the city had been part of China since 1949. It is very plausible that they would have been no better off if they had not joined China in 1997. Similarly, you could either ask if Ireland should have always stayed part of the UK, or if Ireland should join the UK now, and you might get different answers. It’s clear that Ireland has done very well as an independent country, and we have a nice control group for that.

How might it help if a country is larger? At very small sizes, there are immediate economies of scale. A country needs a central government (but large countries may need larger governments at lower tiers), laws, a supreme court, a UN mission, a network of embassies, a country code top level domain, etc. The World Bank sets the threshold for a “small state” at 1.5 million people.

Beyond that viability threshold, a large country can benefit from larger markets, a single language or at least a lingua franca, and tighter integration through both labor mobility and fiscal transfers which can help with shocks: if one region is experiencing a negative economic shock, for example an agricultural region experiencing a drought or a regional natural disaster, then the other regions will help. Workers can also move from poor regions to rich regions.

Larger countries may be better able to help its less fortunate citizens or regions, but they may also be less willing to due to lower political cohesion and dimished solidarity. If transfers to a particular region continue indefinitely, for whatever reason, that can in itself create new political tensions or make existing ones worse. That is particularly true for political tensions created by the fact that the state is an amalgamation of existing countries. You may be willing to indefinitely subsidize an area that feels like part of the same country—all countries do that—but will you be willing to subsidize an area that feels like a different country?

Indefinite transfers to a region can also reduce the pressure for structural reforms when they are necessary. Since a region of a country will usually not have its own currency, you cannot make adjustments through the exchange rate.

Large countries also tend to have hard to resolve tensions between the central government and the regions. You can let regional governments have a great deal of autonomy, and taxing and borrowing power (tiny Denmark lets its 98 municipalities tax income and borrow), but then you need to keep them in check and you could end up with the same difficulties with debt and potential bailouts that a currency union brings. If you centralize everything, like in Britain and particularly England, you get other problems.

Some, but not all, of the economic benefits of large countries can be realized through trade agreements and tighter regional cooperation such as NAFTA and the European Union.

My quick takes on some plausible reconfigurations of countries:

  1. Would Ireland be better off in the UK? No.
  2. Is the Mezzogiorno better off in Italy? It’s poorer than Greece! Probably not.
  3. Is Hong Kong better off in China? Yes.
  4. Would the Nordic countries be better off as a single country? No, it’s a wash. They’re rich and integrated enough.
  5. Would the Baltic countries be better off as a single country? Yes.
  6. Would Portugal be better off in Spain? Yes.
  7. Would Singapore be better off in Malaysia? No.