In the Federalist papers, Alexander Hamilton argued for the proposed U.S. Constitution that gave the federal government great powers because he claimed large countries with strong central governments have freer internal markets, can better deal with foreign aggression, and can raise taxes more easily to pay for needed government services.Yet since 1946, the number of countries has grown from about 76 to almost 200. Some of that growth has been due to countries gaining independence from colonial powers, such as India or Zaire. Others resulted from a subdivision of countries into smaller units, such as the breakups of Czechoslovakia into the Czech Republic and Slovakia, or of Yugoslavia into several independent nations. Agitation to form independent nations continues in all regions of the world.
Has this splintering into smaller nations, often due to nationalistic aspirations, lowered their economic efficiency? My conclusion is that developments in the global economy during the past 50 years have greatly reduced the economic disadvantages of small nations enumerated for his time by Hamilton. In fact, being small now may even have efficiency advantages. This would help explain the splintering of nations along ethnic, religious, linguistic, and geographic lines.
In the past, larger nations generally provided bigger domestic markets with relatively low barriers to movements of goods, services, capital, and labor. By contrast, tariffs, quotas, capital and immigration constraints severely limited the movement of goods, capital, and people across national boundaries. But many of these barriers have come tumbling down as international trade has boomed for the past half century, propelled at first by GATT and then by the World Trade Organization (the WTO). Members of the WTO are forced to have low tariffs and quotas on import of most goods and services, and to some extent, on capital as well. As a result, world imports and exports have grown since 1950 at the remarkable rate of about 10 per cent per year
In other words, small countries can now gain the advantages of large markets through trading with other nations. So it is no surprise that international trade generally constitutes a larger fraction of the GDP of small nations than of large ones. For example, exports in 2004 relative to GDP are about 10 per cent for the United States compared to 37 per cent for Iceland. Most poor nations that experienced rapid economic growth during the past four decades also were extensively involved in international trade. This is true not only of the Asian tigers- South Korea, Taiwan, Japan, Singapore and Hong Kong- but also of Chile and Mauritius. These are all small except for Japan. In addition, much greater use of international trade helped rescue the two giants, China and India, from their long economic sleep.
Smaller nations even have some advantages in a world with much international trade. Their exports are too little to be considered a threat to other nations, so they are not subject to as many barriers as those from large nations, They often specialize in niche markets that are too insignificant, or not accessible, to large nations. For example, the tiny principality of Monte Carlo with about 5000 citizens has become a tax haven and gambling center for rich sports stars and other wealthy individuals. Singapore and Hong Kong have been mainly trading centers for shipments of goods to their much larger neighbors. Mauritius has succeeded by concentrating on textiles and tourism.
Apropos of Hamilton’s other arguments, small nations can now free ride on the military umbrella provided by the United States, NATO, or the United Nations. Small nations may still be at a disadvantage in providing other government services, but powerful groups in large nations often use the economies of scale in raising taxes and dispensing subsidies to exploit weaker ethnic, national, or economic groups. Smaller nations are usually also more homogeneous, so the powerful interests there have fewer other groups to exploit.
Tariffs and quotas on foreign producers impose a relatively big economic cost on small countries since they have little influence over the international prices of imports and exports. This cost reduces the ability of domestic producers to get politicians and voters to go along with their efforts to weaken competition from producers in other countries.
The economic consequences of the reunification of East and West Germany demonstrate some of these advantages of being smaller. East German productivity was much below that in West Germany when the communist government was overthrown. Economists both inside and outside of West Germany warned against the consequences of both exchanging one East German mark for one West German mark, and preventing East German wages from falling much below those in West German. The result not surprisingly has been very high rates of East German unemployment- still around 20 per cent- with the unemployed and others supported by massive financial transfers from West German taxpayers. These transfers more than a decade after reunification still amount to 4 per cent of total German income.
Both Germanies would have been better off economically if East Germany remained independent, and had an agreement with West Germany for free movement of goods, people, and capital across their borders. Wages in the East would then settle at a fraction of those in the West to reflect the lower productivity of East German workers. These low wages would attract companies from Germany and elsewhere to outsource some activities to the East that would provide jobs and raise employment and wages. Unfortunately, the prospects of attracting investments in East German have worsened with the expansion of the EU to include central European nations, like the Czech Republic, Slovakia, and Poland, with much cheaper, and less unionized, labor.
The split into the Czech Republic and Slovakia about a decade ago is also instructive. There was concern then that Slovakia would have trouble going it alone because they received transfers from the richer Czech region, and because many powerful leaders in Slovakia were ex-communists. But economic pressures forced a much more realistic assessment of what they needed, so Slovakia threw the communists out of power, and prospered by reforming rapidly toward a freer market economy.
My conclusion is that economic consequences no longer discourage secessionist movements that are driven by hostility among different religious, ethnic, linguistic, and other groups. This explains the continued secessionist pressure in some countries, such as the recent call by the main leader in the Basque region of Spain for a referendum there on whether they should become more or less completely independent from the rest of Spain. They already have considerable autonomy, so this example shows that giving power to regions is an imperfect substitute for full independence. Political pressure remains strong among French Canadians for Quebec to become independent from the rest of Canada, although this sentiment is weaker than a decade ago as Canadian regions have received greater autonomy. Many Kurds in Iraq, Iran, and Turkey still dream of an independent Kurdistan. The Tamils in Sri Lanka, and different groups in Indonesia continue their fight for independence. And is it any surprise that most Taiwanese do not want to become part of a greater China, despite growing threats from China?
Mainly due to the growth of the global economy and globalized trading, the evidence is overwhelming that small nations can now do very well economically, perhaps better than larger ones. In light of this evidence, it is surprising how many people, including economists, continue to believe that their economies will be ruined if secessionist movements succeed.