Journal Issue

Small island economies

International Monetary Fund. External Relations Dept.
Published Date:
June 1984
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Benito Legarda

There are a host of characteristics that help define small economies, and since a sizable number of the so-called small economies are islands or archipelagoes, most of these characteristics apply also to small island economies. The two accompanying articles by Barend de Vries and Vicente Galbis discuss some of the conditions that hold in the economies of small countries or territories. In brief, these conditions cover both the geographic and the economic aspects of smallness. Apart from smallness of population, land area, and gross national product, small economies and small island economies share other characteristics, including:

• Geographic isolation;

• Narrow production bases, often one or two primary products or industries, mainly producing for export;

• Diseconomies of scale, translated through factor indivisibilities into higher unit costs of infrastructure, investment, and production;

• Restricted number of export markets and import suppliers;

• High vulnerability to natural hazards and global market fluctuations.

In 1980, there were 21 independent, small island economies, of which 17 were members of the Fund—small here referring to countries of less than one million people (but excluding Cyprus, Iceland, and Malta). The Fund members were situated in the Caribbean and Western Atlantic (Antigua and Barbuda, the Bahamas, Barbados, Dominica, Grenada, St. Lucia, and St. Vincent), off Africa and in the Indian Ocean (Cape Verde, the Comoros, Maldives, Mauritius, Sao Tome and Principe, and Seychelles), and in the Pacific (Fiji, Solomon Islands, Vanuatu, and Western Samoa). The nonmember countries, all in the Pacific, were Kiribati, Nauru, Tonga, and Tuvalu. In addition, there were another 17 island economies that were either associated with or dependent upon other economies. Seven of these were in the Caribbean and Western Atlantic, one in the Indian Ocean, and nine in the Pacific.

The politically independent island economies varied tremendously in terms of geography, demographics, and economic size, and per capita income. They ranged in land area from 25 to 28,446 square kilometers, and had populations ranging from 8,000 to 958,000 in 1980. Their per capita GNP also varied widely, from $260 to almost $24,000. The smallest, Nauru, had a GNP higher than 16 other independent islands and the highest per capita GNP, while the largest island country, the Solomon Islands, was in sixth place in order of GNP and was eighteenth in order of per capita GNP. The nonindependent island economies were equally diverse in their economic characteristics, with their GNP and per capita GNP affected by either economic ties to major economies or by proximity to larger, more prosperous countries.

In assessing their economic situation and the policy options available to them, the questions that must be posed are whether a small island economy faces a particular set of problems that are different from other small economies or whether the effects of the same conditions are especially acute for the small island economies. Much of the literature skirts these issues, but where the questions are addressed, more often than not the answer in each case is that there are no significant differences. It is pointed out that smallness, remoteness, dependence, peripherality, the decline in self-reliance, insufficient economic diversification, and weak bargaining positions vis-à-vis foreign investors and transport operators are all problems faced by small remote mainland countries and even by peripheral regions with larger countries.

Why they are different

However, some justification for putting small island developing countries in a special category emerges out of the consequences of the transportation revolution of the last two decades or so. The rapid development of the container and the cellular container vessel has led to the centralization of trade and the elimination or marginalization of small operators. The container technologies developed for large, high-wage, continental countries with road-based transportation systems have completely changed the nature of sea traffic from an independent mode of transport to a mere extension of the land transportation system. Increasingly, large vessels carry much heavier cargoes to fewer ports with container-handling equipment. Air traffic compounds the plight of conventional shipping by drawing away passengers. Modern air traffic also tends to burden small economies, since long-range jumbo jets require fewer stops for refueling and larger, costlier, airport facilities.

Small islands, because they have often been bypassed by the larger ships and by international air traffic, are at a disadvantage. For archipelagic countries—a number of the independent island economies fall into this group—the effect is compounded by domestic fragmentation: the outer islands are, in turn, increasingly left out of the economic mainstream. Official and unofficial accounts tell of the decline and sometimes disappearance of cutter boat services in the Pacific and of schooner traffic in the Caribbean.

These consequences have probably been accommodated more readily by the larger island economies. But they have serious implications for the small island economies since they hinder the trading activities of these countries, thus laying the basis for treating them as a separate category.

Another disadvantage of small islands is remoteness, which has both geographic and economic aspects that contribute to the peculiar economic circumstances of these countries. In its most obvious meaning, remoteness refers to geographic distance, with implications for transport costs and delivery time, giving the advantage in the export trade to those countries that are located close to the rich markets of the more developed countries. But there is another aspect of remoteness that may enter the picture even when physical distance is not that great. For even if a small island country is located near its potential markets, if it does not have the facilities to take advantage of that proximity—that is, if it does not have harbors or airports equipped to receive the large carriers of the modern tourist trade—then it can be said to be economically remote.

Similarly, peripherality—that is, the distant relationship between a small island economy and an economic center—affects the ability of such countries to keep up with the pace and direction of developments at the center. This may be a function of socioeconomic systems, cultural biases, or the state of communications. The most successful island countries are those that have best been able to adapt to economic changes at the center, largely through the development of human resources and entrepreneurial skills.

The problems facing small island economies therefore appear to arise from several distinct but often related factors that affect most small economies, but perhaps more so the island countries. As mentioned earlier, these factors include small populations; limited land area, natural resources, and skilled manpower; geographical and geopolitical isolation; and high per capita costs. How, then, should these countries cope with an ever changing and competitive global economy?

Options available

Because of the diseconomies of scale for major industry and agriculture, small island economies could profit from developing primarily their light manufacturing and services sectors. This would include light manufacturing for export, creating export processing zones, attracting foreign investment and multinationals, developing tourism, encouraging migration of excess labor (including work on foreign ships), and the setting up of offshore financial centers. Another sector that could be profitably developed is fisheries. But the diversification into these dynamic sectors has its costs, such as the need to create trade infrastructure, that is, credit systems, information and marketing networks, shipping arrangements, and so on. Not all these countries have the capability of going into the major growth sectors, because of location, labor, and other factors.

A review by the author of the 17 small island countries that were Fund members in 1980 identified a characteristic of these economies that could be exploited: the importance of invisible receipts. Of these, tourism alone was larger, for the group as a whole, than commodity exports. It has been responsible for dramatic increases in per capita incomes in several small island countries, but many islands were not developing tourism because of cultural, political, or environmental reasons. Next in importance among invisibles were transfers (private and official), which for at least three countries surpassed not only other invisibles but also commodity exports. Offshore banking revenues made a noticeable impact in only two countries, and the amounts involved were quite modest. Studies distinguish between “paper” centers, which record deposit and lending transactions that actually take place elsewhere, and “functional” centers, that physically host banks that raise, invest, and lend funds largely on their own initiative. While many countries are capable of hosting “paper” operations, only a few have the potential to become “functional” centers, and most of the countries that had real potential to establish themselves as successful offshore centers have already done so.

Fisheries hold great promise for island economies, especially since the recent introduction of the 200-mile exclusive economic zone. But it is of quantitative importance in only three countries. The problems affecting this sector include the migratory nature of offshore species, the costs associated with smallness and remoteness, and the constraints of scale economies. Fuel costs are high and fishing boats are expensive. Cooperation with neighboring states, preferably on a regional basis, could help alleviate these problems.

As for light industries for export, some Caribbean and Indian Ocean island countries have had some success in this line. One possible discouraging feature is the modest retained-value ratio, which, for cases where figures are available, is less than 30 percent. Another, and possibly more serious, drawback is the chilling influence of protectionism in the developed industrial economies, which are the markets for the output of these smaller countries. In any program aimed at helping small island countries, the lowering of protectionist barriers by the developed countries probably would rank as high as any other policy prescription.


The small island countries have open economies with severe constraints on their material and labor inputs, because of their limited land area and small populations. These constraints preclude economies of scale for a wide range of products and lead to high unit costs of production. Compounding the disadvantages are high transport costs arising from their remoteness, isolation, and fragmentation (in the case of archipelagic countries). Long-range modern aircraft and ships which bypass them have heightened the transportation problems of these countries. Finally, they are dependent on a few primary exports which makes them vulnerable to natural hazards and to wide cyclical fluctuations that affect these products.

To overcome their disadvantages, these countries must diversify into dynamic sectors where economies of scale play little part, or where they have a resource advantage. The main avenues for this diversification include tourism, fisheries, and light manufactures for export. Subsidiary sectors include produce for regional markets and products with low bulk weight to value ratio, like certain nuts and craft timbers. Not all small island countries can move into all these sectors, but many of them could go into one or more. For many small island countries—namely, the more disadvantaged among them—the development effort will be a lengthy process and will require external assistance.

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