Growth Challenges for Small
Economies: Issues & Prospects for
Lancaster University Management School, UK
The Growth Performance of Small Economies
In spite of the many growth challenges that they face, small
economies are disproportionately represented in the World
Bank’s two highest income categories – High and Upper Middle
Income. This demonstrates that, regardless of these challenges,
many have been highly successful in delivering growth and
incomes to their citizens.
Small economies in the Caribbean Region rank 2nd behind those
in Western Europe in terms of their growth performance and
Determinants of Growth in Small Economies
The principal factors in the success of small economies (growth
rates and income levels) are:
• Openness of economies to trade, capital and labour flows.
• International competitiveness founded strongly on domestic
comparative advantage, notably human capital as well as
• Sectoral specialisation – tourism, financial services and natural
• Location: Proximity to dynamic global regions (e.g., US and
Sectoral Specialisation in Small Economies
Three sectors are key to economic growth success and higher
incomes. All are present in the Caribbean (to varying extents):
• Tourism: limited value added (low wages) but high
• Financial Services: high value added (high wages) and
• Natural Resources: high value added (high wages) but
limited employment effects.
Manufacturing makes a limited contribution except in ‘larger’
economies while greater dependence upon Agriculture has
lower growth and income effects.
Three Types of Caribbean Economies
Type 1 (High Growth/High Income):
• Strong tourism (US-oriented) and financial services sectors,
with little agriculture. High levels of private investment and
low inflation rates. Worst hit by the global downturn.
Type 2 (Moderate Growth/High Income):
• More reliant upon tourism (Europe-oriented) but with much
less financial services.
Type 3 (High Growth/Lower Income)
• Larger, generally more remote with a greater dependence on
manufacturing and agriculture. Best performance since the
Openness & Growth Volatility in Small
Small size necessitates (‘structural’) openness to the global
economy but has important implications:
• Economic growth: openness has strong positive growth effects
based upon underlying comparative advantage.
• Growth volatility: more open economies are exposed to greater
volatility in their growth – need for greater resilience.
• Integration with the global economy more than compensates
for the destabilising effects of external shocks.
• Domestic policy-making: openness limits policy autonomy,
particularly with respect to the exchange rate. Reducing
openness however, is likely to reduce growth and incomes.
Growth Strategies & Resilience
in Small Economies
Resilience is the resource capacity to deal with the impact of
external shocks (economic and natural):
• Exposure to growth volatility is expected to be greatest for
economies that have achieved the most growth success.
• Specialisation in high growth sectors tends to reduce the
impact of growth volatility (but still affected by the global
crisis – tourism and financial services).
• Growth success increases resilience capacity.
Growth volatility and a lack of resilience are therefore primarily a
key challenge for poorer less well-managed small economies.
Improving Economic Performance
in Small Economies
Growth, international competitiveness and resilience capacity
can be enhanced by improving domestic economic performance:
Raising domestic productivity.
Increasing domestic value added.
Generating additional high value product/export niches.
Improving local supply linkages/reduce import dependence.
Diversifying export markets.
Creating a sovereign ‘Resilience Fund’.
Diversifying Export Markets
There is limited potential in small economies to diversify their
income generating activity so as to reduce their heavy reliance
upon key sectors and the impact of external shocks. Further,
many are very reliant upon ‘traditional’ export markets, primarily
A key path forward is to secure new export markets for existing
products and services. This offers growth potential as well as
reducing exposure to market-specific (but not sectoral-specific)
Improving Local Supply Linkages
The development of local supply linkages in small economies is
constrained by narrow/shallow economic structures and a lack
of absorptive capacity. Linkage creation is likely to be confined
to specific sectors, notably:
• Agriculture: the development of downstream processing to
improve employment and value added. Also diversification
into certified niche products, such as organics.
• Tourism: generally highly import dependent with low levels
of local value added. Potential for improved linkages in local
sourcing of food, handicrafts and support services –
including the local or Caribbean ‘experience’.
Openness, FDI & Local Linkages
Foreign direct investment (FDI) offers an important additional
means to enhance local supply-side capabilities and resilience in
small economies because inflows bring technology, know-how
enhanced value added, greater competitiveness and market
Inflows of FDI to small economies are unexpectedly high given
their size, primarily because of their high level of openness. A
fundamental policy issue for small economies however, is not
attracting inflows but rather maximising the local growth effects
Enhancing Growth & Resilience Capacity :
Promoting Human Capital Formation
The most important asset of small economies are their people:
they are the principal determinant of their international
competitiveness and a key component in building resilience.
Human capital formation through education and training is
essential to improve absorptive capacity and facilitate the
assimilation of new technologies. Several critical issues:
• High levels of migratory outflows, particularly of key skills.
• High dependence upon worker remittances.
• Need to create appropriate local employment opportunities
to match skill creation to reverse ‘brain drain’ .
• Climate change pressure for further out-migration.
• Small economies face a range of challenges but many have
achieved growth and high incomes. The Caribbean is a success
• Openness to trade and vulnerability to natural disasters
exposes them to greater growth volatility.
• Openness critical to growth and building resilience capacity.
• Growth-enhancing policies (diversification, improved local
linkages etc.) should reduce growth volatility and build
• Need to build up reserves/reduce debt to improve resilience
capacity to deal with future economic and natural shocks.