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Economic Resilience and Market Efficiency in Small States
Gordon Cordina
University of Malta
April 2007
Background
Vulnerability of small states is well documented Vulnerability is proneness to exogenous shocks Different degree of success of small states can be
ascribed to extent of policy-nurtured resilience Resilience is to ability to withstand and rebound
from the effects of adverse shocks Efficiency of resource allocation is a fundamental
element of resilience
Main Themes
Relationship between market efficiency and resilience
Increased incidence of market failure in small economies
Policy intervention and heightened proneness to policy failure in small economies
Imperative of enhanced efficiency and better governance in small economies
The Relationship between Market Efficiency and Economic Resilience
Vulnerability and Resilience
Vulnerability is exposure to exogenous shocks Effects of shocks are asymmetric, with negative
effects outweighing positive ones Vulnerability can hamper development if not
countered by resilience Resilience is developed through policies which
help the economy to:– withstand the effects of negative shocks– rebound quickly from the effects of negative shocks
Resilience and Market Efficiency
Resilience thus requires:– an efficient allocation of resources– an ability to quickly reallocate resources efficiently
For an efficient resource allocation, prices have to reflect the true costs and benefits from production
For an effective reallocation of resources, there needs to be flexibility and mobility of capital, labour, products and services
Resilience and Market Efficiency
Examples of market efficiency and resilience to shocks in small states:– Shocks to tourism demand– Shocks to oil prices– Globalisation, regional integration and international
competition
Resilience and Market Efficiency
Market efficiency requires:– private participation– competition between private agents
Public policy is essential to market efficiency and hence economic resilience:– securing legal and property rights– ensuring market access and proper competition– investing in public goods and institutional capacity
Market Failure in Small States
Situations of Market Failure
Markets do not achieve allocative efficiency and welfare maximisation in the presence of:– monopolistic conditions– external effects– sluggish market adjustment– missing markets– asymmetric information– uncertainty– socially undesirable distribution of resources
Monopolistic Conditions
Distort price signal through monopolistic rent-seeking
Are prevalent in small states due to:– Small size of markets– Thinness of markets– Indivisibilities in investment expenditure
External Effects
Price signal would be distorted by reflecting only private effects
Are more prevalent in small states due to:– Small land area– High density of population and economic activities
Notable consequences include:– Infringement of property rights and costs of litigation– Limited effects of positive externalities– Vulnerability to global externalities
Sluggish Market Adjustment
Response to price signal would be hampered by immobility of resources
Is more prevalent in small states due to:– High concentration of economic activities in
unrelated sectors– Thinness and shallowness of markets
Missing Markets
Not technologically possible to meet demand Concern mainly capital and insurance markets
in small states due to prevalence of shocks Resource constraints lead to reliance on
external markets, with potentially sub-optimal outcomes
Asymmetric Information
Lack of information leads to incorrect:– pricing decisions– interpretation of price signals
More prevalent in small economies due to:– presence of relatively large players in markets– weak bargaining power in international trade arena
Uncertainty
Price signals are distorted or are not followed
More prevalent in small economies due to exposure to exogenous shocks
Consequences include– lower investment– exchange rate volatility
Socially Undesirable Resource Distribution
Market access is restricted to owners of factor inputs
Socially undesirable income distribution more likely in small states due to:– Concentration of economic activities in a few
unrelated sectors– Insufficient economic development due to other
instances of market failure
Policy Failure in Small Economies
Policy Failure
Policy intervention may fail on account of:– mistakes of commission– mistakes of ommission
These may be further amplified into:– Unpredictable changes and costly mistakes– Obfuscated objectives– Implementation errors– High costs of intervention– Stifling of private initiative
Unpredictable changes and costly mistakes
These may be further compounded in small economies due to:– Large size of government– Widespread effects of individual policy interventions
Obfuscated Objectives
Obfuscation between economic, political and social objectives in small economies may be due to:– Proximity of social relationships– Concentration of power within a small group of elite
Implementation Errors
Policy implementation errors may be more widespread in small economies due to:– Insufficient human resources– Inadequate institutional capacity
High Cost of Intervention
Policy intervention may be more costly in small economies due to:– Indivisibilities in the functions of government
Stifling of Private Initiative
Government intervention may have particularly stifling effects on private sector initiative due to:– Culture of dependence on the State of employment
and income– Dependence on state for major investment
initiatives
Imperative of Better Governance in Small Economies
Imperative of Better Governance
Enhanced efficiency and better governance is the solution to rectify market failure without incurring policy failure
This is imperative for small economies with higher incidence of both market failure and policy failure
Imperative of Better Governance
There exists no single model of good governance that can be uniformly applied
Small states as a group have widely divergent governance performances
But is it probable that small states could more successfully emulate best practices in other small states with similar problems and constraints
