This document discusses key challenges facing small island developing economies (SILDEs) related to trade, climate change, and building resilience. It identifies that SILDEs have small populations and limited resources, making them highly open to trade but also vulnerable to external shocks. The document outlines policy options for SILDEs to enhance resilience, such as export and market diversification, improving infrastructure and technological capacity, strengthening domestic and foreign business linkages, investing in human capital, and ensuring good social and political institutions. The conclusion is that while SILDEs face significant challenges, many have achieved growth, and policies can help build resilience if properly implemented.

1. Building Resilience in SIDS for
Trade & Climate Change Policies
Robert Read
Lancaster University Management School, UK

2. Key Elements of the Size-Growth
Relationship
Key economic characteristics of small size:
• Small populations – diseconomies of scale/higher costs; limits
on developing large-scale industries, agglomeration and firm
clusters; limited competition.
• Limited Resources – limited natural resources and labour supply
– reliance on human capital-intensive activities instead of
large-scale labour-intensive industrialisation.
• Constrained diversification – a high degree of specialisation in
production and exports.
• Openness to trade – ‘structural’ trade openness, exposure to
exogenous shocks, constrained domestic policy-making.

3. Key Growth Sectors in Small Economies
Empirical analyses of the growth of small economies, notably by
Armstrong & Read, consistently find that three sectors are key to
economic growth success and higher incomes:
• Tourism
• Financial Services
• Natural Resources
The contribution of Manufacturing is consistently insignificant
while a greater dependence upon Agriculture is associated with
significantly lower growth and incomes.

4. ‘Structural’ Openness to Trade in Small
Economies
Small economies are highly open to international trade because
of their limited ability to produce a broad range of goods and
services domestically. This ‘structural’ openness has important
implications:
• Economic growth: trade 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.
• Domestic policy-making: openness limits policy autonomy,
particularly with respect to the exchange rate.

5. Structural Sources of Growth Volatility
Openness to trade gives rise to several structural sources of
growth volatility in small economies:
• Export concentration: the high reliance on limited range of
exported goods and services.
• Exposure to export price and earnings volatility: greater
exposure to trade shocks in export prices and earnings.
• Geographic export concentration: reliance on a few key
trading partners with exposure to specific trade shocks.
• Strategic import dependence: high dependency upon
strategic imports and exposure to specific trade shocks.
• Remoteness: greater risk of supply disruption exacerbating
co-ordination and effects of trade shocks.

6. The Impact of Growth Volatility
Large-scale studies of the impact of growth volatility, irrespective
of its causes, find that volatility tends to reduce the long-run
average rate of economic growth, notably because of the
‘negative ratchet’ effect. The adverse growth effects of volatility
tend to be greatest for:
• Low income countries (limited resilience capacity).
• Countries with weak institutional structures and poor
governance.
There is also some degree of correlation between low incomes
and weak institutions/poor governance.

7. Trade Openness & Growth Volatility in
Small Economies
Analyses of the impact of growth volatility on small economies is
more limited but the available evidence (notably, Easterly &
Kraay, 2000; Cavallo, 2007) suggests that:
• Greater trade openness gives rise to greater exposure to
destabilising terms of trade shocks.
• Greater trade openness enhances their growth.
• The stabilising effects of integration with the global economy
more than compensates for the destabilising effects of terms
of trade shocks.
• Reducing openness to limit growth volatility can therefore be
expected to reduce growth and incomes.

8. Policy Remedies for Structural Growth
Volatility
• Export diversification: standard solution to export
concentration and export price and earnings volatility but
highly constrained in small economies. Niche income elastic
exports often have lower price and earnings volatility.
• Export market diversification: improving market
knowledge, marketing and distribution logistics, possibly
aided by inflows of FDI.
• Strategic production and inter-temporal management:
output almost regardless of cost together with effective
supply management (smoothing using stocks).
• Improved infrastructural co-ordination: national or
regional co-operation in transportation logistics.

9. Environmental Vulnerability in Small Island
& Littoral Developing Economies (SILDEs)
Small island and littoral economies are among the most
vulnerable environments to the effects of natural disasters and
the long-term effects of climate change because of their size,
location and topography. Further, developing ones (SILDEs)
probably have the least resource capacity (resilience) to deal with
their consequences. In addition, they tend to specialise in sectors
particularly affected by long-term climate change: agriculture,
fisheries and tourism.
Although it is conceptually difficult to quantify environmental
vulnerability, it is very clear that additional resilience capacity and
policy strategies are required for SILDEs, over and above those
for dealing with economic volatility.

10. The Environmental Vulnerability Index
(EVI), SIDS & SILDEs
The EVI has environmental vulnerability data for 235 states
(www.vulnerability.index.net), classifying them as Extremely Vulnerable
(EV), Highly Vulnerable (HV), Vulnerable (V), At Risk (AR) and
Resilient (R).
• SIDS comprise 20% of states but almost 50% (17/35) classed
as Extremely Vulnerable and 27% (17/62) as Highly Vulnerable.
• SILDEs comprise 19% of states but 29% are Extremely
Vulnerable and 21% Highly Vulnerable.
(SIDS comprise several non-sovereign states included in the
EVI and which tend to be smaller and even more vulnerable.)

11. Regional Patterns of Environmental
Vulnerability in SILDEs
The EVI has three components – Hazards, Risks and Resilience –
only the latter is state-specific. Therefore expect some semblance
of a regional pattern of geology and climatic conditions.
• East Asia & Pacific: 13 states; 5-EV, 4-HV, 3-V, 1-AR.
• Indian Ocean: 4 states; 1-EV; 3-HV.
• Caribbean: 16 states; 4-EV, 6-HV, 1-V, 3-AR, 2-R.
• Sub-Saharan Africa: 11 states; 5-V, 3-AR, 3-R.
This exercise using EVI data suggests that SILDEs in the
Indian and Pacific Oceans are more vulnerable/less resilient
than those in the Caribbean or Sub-Saharan Africa.

12. Growth & Resilience in Small Economies
Resilience refers to the resource capacity of economies to deal
with and ameliorate the impact of their vulnerability to economic
and natural shocks:
• Exposure to growth volatility is expected to be greatest for
economies that have achieved the greatest growth success.
• Specialisation in high growth sectors appears to reduce the
impact of growth volatility.
• Growth success increases resilience capacity.
Growth volatility and resilience capacity is therefore primarily a
critical challenge for poorer less well-managed small economies.

13. Enhancing Resilience:
Improving Technological Capacity
Resilience can be enhanced by developing local capabilities to
close the ‘knowledge gap’ to aid diversification, improve
productivity and increase value added. In the context of climate
change, this includes the incorporation of adaptation and
mitigation technologies into domestic productive activities.
• Specialisation in SILDEs implies a need for only a narrow
range of climate-change related technologies.
• A strong services bias means that SILDEs are generally more
amenable to carbon reduction requirements and climate
change adaptation.

14. Improving Local Technological Capacity
The challenge of enhancing resilience by improving local
technological capacity in small economies is daunting:
• They generally lack critical mass to generate domestic R&D
and their human capital has limited absorptive capacity.
• They primarily rely upon external sources of technology.
• Issue of whether the private sector can perform this role
alone – FDI is a critical potential source of advanced
technology.
• Public/private support: co-operation and transfer of ‘best-
practice’ technology; active government policy to upgrade
technology.

15. Improving Technological Capacity in
Services
Services provides a relatively scale neutral means for
diversification in small economies. A critical distinction needs to
be made between the environmental implication of activities
within the service sector:
• Financial services, data processing and other ICT-based
activities are relatively ‘clean’. They offer high growth
potential and have a high local ‘carrying capacity’, dependent
upon local human capital and support infrastructure (e.g.,
optical fibre links and capacity).
• Tourism – mass tourism in particular – is a prime cause of
environmental degradation and threatens social development
owing to limited ‘carrying capacity’.

16. Enhancing Resilience:
Improving Domestic Linkages
Growth, international competitiveness and resilience can be
enhanced by improving the depth and quality of domestic
linkages – up- and down-stream – to develop local supply chains:
• Raise domestic productivity.
• Increase domestic value added.
• Reduce import dependence.
• Improve the balance of payments position.
• Generate new high value product/export niches.
• Reduce food mileages.

17. Improving Domestic Linkages in
Small Economies
Narrow/shallow economic structures and a lack of absorptive
capacity can severely constrain linkage development in small
economies. Many have also failed to maximise potential linkages,
reflecting institutional and/or policy weaknesses. 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 organic production.
• Tourism: often highly import dependent with low levels of
local (retained) value added. The greatest potential linkages
are in local sourcing of food, support services and niche
(handicraft) manufacturing.

18. Enhancing Resilience:
Openness, FDI & Local Linkages
Foreign direct investment (FDI) offers an important additional
means to enhance supply-side capabilities and resilience in small
economies because inflows embody technology, know-how and
market access.
Inflows of FDI to small economies are unexpectedly high given
their size, primarily because of their high openness to trade –
openness to trade and FDI inflows are strongly related. Evidence
suggests that the fundamental policy issue for small economies is
not attracting FDI inflows but rather maximising their local
growth effects.

19. Enhancing Resilience:
Promoting Human Capital Formation
People are small economies’ most important asset. 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. Many
small economies have invested heavily in their human capital but
several critical issues arise:
• 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.

20. Enhancing Resilience:
Improving Social Capital & Governance
Good governance and social capital are key to optimal policy-
making and building resilience capacity generally. Khan (2007)
identifies three key institutional-building and objectives:
• Facilitating rapid and effective market and non-market
transfers of assets and resources to more productive sectors.
• Managing incentives and needs for achieving rapid and
effective productivity improvements through technological
acquisition (innovation or up-grading), enhanced learning and
knowledge absorption.
• Maintaining political stability in a context of rapid social and
economic transformation.

21. Social Capital & Governance in
Small Economies
Arguably, small economies are well-placed with respect to their
social capital and good governance:
• They have a strong sense of identity.
• Many have achieved very high HDI scores.
• Their policy-makers and constituents are in close proximity.
• They must be highly flexible in responding to external growth
opportunities and threats.
• They have limited scope to implement/sustain mis-specified
growth policies.
Small economies however, are not homogenous and some suffer
from internal strife.

22. Achieving Sustainable Growth in
Small Economies
On the plus side is their sectoral structure, generally reliant –with
the exception of some natural resource processing activities – on
‘cleaner’ technologies. This includes crop rather than large-scale
livestock production in agriculture, small manufacturing sectors
and large service sectors although attention needs to be paid to
the ‘carrying capacity’ for tourism. To this can be added bio-
diversity which is a natural resource asset in its own right.
On the negative side are the pressures of social and economic
development on fragile environments susceptible to the long-
term effects of climate change.

23. Concluding Comments
• Small economies face a range of challenges but many have
achieved growth and high incomes.
• Their high ‘structural’ openness to trade and vulnerability to
natural disasters exposes them to greater growth volatility.
• Trade is critical to growth and building resilience capacity.
• Reducing trade openness will reduce growth, incomes and
resilience capacity but increase growth volatility.
• A range of policies may enhance growth, reduce growth
volatility and build resilience capacity, particularly with
respect to environmental vulnerability
• Sustainable development is dependent upon effective policy-
making founded upon social capital and good governance.