While many small states’ undeveloped natural beauty and remoteness offer unmistakable assets, these same characteristics can constrain small states progress towards the Sustainable Development Goals. Small states are characterized by a small population, limited human capital, and a confined land area. They face labor market and capacity constraints: the limited number of workers and production capacity is often inadequate for local production or export at scale, and few in-country education facilities means a dearth of adequate specialization.
Constrained economic prospects mean relatively few employment opportunities, so skilled labor often migrates to seek an economic livelihood. While this brain drain leaves the country more exposed to labor market shortfalls, it opens the door to remittances and capital inflows. Despite challenges managing remittance income, these flows provide much needed resources.
Private-sector-led growth can be difficult for small states to achieve. The narrow population base means a low demand for goods and services, which limits domestic production and international investment targeted at the local market. Manufactures are primarily for export, but that, too, is constrained by the small workforce. Production costs are generally high because of the lack of economies of scale. The investment climate often needs improvement to ensure appropriate regulations, a level playing field, and good infrastructure.
A diversified economic base can also be difficult to achieve. Geography and demography limit small states’ productive base. The few economic sectors may include fisheries, tourism, commodity exports, or financial services, and opportunities for economic diversification are limited. The narrow range of exports can make such states vulnerable to terms-of-trade shocks and extreme weather events.
Generally, few sources of revenue are available. Less space for land-based economic activity and a constrained pool of human resources limit economic activity and sources of income. Thus the tax base for most small states is small and inadequate to meet the cost of public administration and services. A constrained fiscal envelope makes it hard to manage financial, economic and other forms of volatility. Many small states face endemic debt challenges.
Remoteness adds an economic cost. Many small states are geographically far removed from international trade partners. The Pacific island states are the most remote, situated on average 12,000 kilometers away from the nearest markets. The landlocked African states are similarly cut off from direct access to the sea. The lack of connectivity imposes a tax on trade. External inputs into domestic production are proportionately costlier, while transport expenses make exports less competitive.
Poor IT connectivity affects the service sector. Mauritius and small states in the Caribbean have leveraged their skilled workforce and good IT connectivity to position themselves as service providers. Such a solution is not yet available to small states in the Pacific, given poor Internet broadband and inadequate submarine fiber optic cables, though there are recent efforts to ameliorate the problem.
Providing public services to small scattered populations can be costly. Many small states - notably the Pacific island states - are island archipelagoes with populations dispersed over enormous geographic distances. The prohibitive costs of service delivery across vast swathes of ocean often affect health care, education, social security, and infrastructure services.
Small island states are highly exposed to climate change and natural disasters. This group accounts for two-thirds of the countries that suffer the highest relative losses due to natural disasters (1-9 percent of their GDP each year). The Pacific and Caribbean are frequently hit by storms, earthquakes, volcanic activity, floods, droughts, and landslides.
Recurrent financial, climate, and disaster shocks reduce the fiscal space. With a narrow economic base, small states may have difficulty to spread economic risk across productive sectors. They face more exposure to market shocks that affect income, employment, and expenditure.
Small states therefore rely on international finance to supplement their fiscal envelopes. However, unless they have commodity exports or a service sector geared to the external market, many small states are not sufficiently creditworthy to raise funds in international capital markets. The local financial sector is similarly less developed, given diseconomies of scale. Several small states are forced to rely on concessional finance; others have significant debt as they draw on their natural resources to graduate from low-income status and lose their access to concessional financing.
The small states also face challenges in the area of human development. Although many have made progress on infant mortality, there is still an unfinished agenda of low child immunization rates, the reemergence of vector-borne diseases such as dengue, and the challenge of non-communicable disease (high blood pressure, diabetes, cancer, etc.). In general, small states have achieved gender parity at the lower levels of education, and more girls than boys pursue higher levels of education. However, women’s employment prospects and earnings are significantly worse than men’s.
Despite the systematic constraints identified above, there are small state success stories which can offer some lessons more broadly. For example, Bahrain, Brunei, Estonia, Malta, and Qatar have achieved high incomes, making the most of their specific combinations of fossil fuels, strategic location on the crossroads of trade, a highly educated workforce, strong legal systems, and well-developed financial sectors. However, most small states lack these advantages.
Small states do not easily fit the standard development model where low-income and IDA-eligible countries become medium-income and IBRD states, and then transition to self-sufficiency and graduation. Instead, many small states find themselves caught in a gap between eligibility for concessional financing and self-sufficient capacity to take on sustainable financing at market interest rates. To meet small states’ unique constraints, international development institutions need to develop innovative solutions tailored to address their interrelated development and financing issues.