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Economic Resilience and Market Efficiency in Small States. Gordon Cordina University of Malta. April 2007. Background. Vulnerability of small states is well documented Vulnerability is proneness to exogenous shocks
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Economic Resilience and Market Efficiency in Small States Gordon Cordina University of Malta April 2007
Background • Vulnerability of small states is well documented • Vulnerability is proneness to exogenous shocks • Different degree of success of small states can be ascribed to extent of policy-nurtured resilience • Resilience is to ability to withstand and rebound from the effects of adverse shocks • Efficiency of resource allocation is a fundamental element of resilience
Main Themes • Relationship between market efficiency and resilience • Increased incidence of market failure in small economies • Policy intervention and heightened proneness to policy failure in small economies • Imperative of enhanced efficiency and better governance in small economies
The Relationship between Market Efficiency and Economic Resilience
Vulnerability and Resilience • Vulnerability is exposure to exogenous shocks • Effects of shocks are asymmetric, with negative effects outweighing positive ones • Vulnerability can hamper development if not countered by resilience • Resilience is developed through policies which help the economy to: • withstand the effects of negative shocks • rebound quickly from the effects of negative shocks
Resilience and Market Efficiency • Resilience thus requires: • an efficient allocation of resources • an ability to quickly reallocate resources efficiently • For an efficient resource allocation, prices have to reflect the true costs and benefits from production • For an effective reallocation of resources, there needs to be flexibility and mobility of capital, labour, products and services
Resilience and Market Efficiency • Examples of market efficiency and resilience to shocks in small states: • Shocks to tourism demand • Shocks to oil prices • Globalisation, regional integration and international competition
Resilience and Market Efficiency • Market efficiency requires: • private participation • competition between private agents • Public policy is essential to market efficiency and hence economic resilience: • securing legal and property rights • ensuring market access and proper competition • investing in public goods and institutional capacity
Situations of Market Failure • Markets do not achieve allocative efficiency and welfare maximisation in the presence of: • monopolistic conditions • external effects • sluggish market adjustment • missing markets • asymmetric information • uncertainty • socially undesirable distribution of resources
Monopolistic Conditions • Distort price signal through monopolistic rent-seeking • Are prevalent in small states due to: • Small size of markets • Thinness of markets • Indivisibilities in investment expenditure
External Effects • Price signal would be distorted by reflecting only private effects • Are more prevalent in small states due to: • Small land area • High density of population and economic activities • Notable consequences include: • Infringement of property rights and costs of litigation • Limited effects of positive externalities • Vulnerability to global externalities
Sluggish Market Adjustment • Response to price signal would be hampered by immobility of resources • Is more prevalent in small states due to: • High concentration of economic activities in unrelated sectors • Thinness and shallowness of markets
Missing Markets • Not technologically possible to meet demand • Concern mainly capital and insurance markets in small states due to prevalence of shocks • Resource constraints lead to reliance on external markets, with potentially sub-optimal outcomes
Asymmetric Information • Lack of information leads to incorrect: • pricing decisions • interpretation of price signals • More prevalent in small economies due to: • presence of relatively large players in markets • weak bargaining power in international trade arena
Uncertainty • Price signals are distorted or are not followed • More prevalent in small economies due to exposure to exogenous shocks • Consequences include • lower investment • exchange rate volatility
Socially Undesirable Resource Distribution • Market access is restricted to owners of factor inputs • Socially undesirable income distribution more likely in small states due to: • Concentration of economic activities in a few unrelated sectors • Insufficient economic development due to other instances of market failure
Policy Failure • Policy intervention may fail on account of: • mistakes of commission • mistakes of ommission • These may be further amplified into: • Unpredictable changes and costly mistakes • Obfuscated objectives • Implementation errors • High costs of intervention • Stifling of private initiative
Unpredictable changes and costly mistakes • These may be further compounded in small economies due to: • Large size of government • Widespread effects of individual policy interventions
Obfuscated Objectives • Obfuscation between economic, political and social objectives in small economies may be due to: • Proximity of social relationships • Concentration of power within a small group of elite
Implementation Errors • Policy implementation errors may be more widespread in small economies due to: • Insufficient human resources • Inadequate institutional capacity
High Cost of Intervention • Policy intervention may be more costly in small economies due to: • Indivisibilities in the functions of government
Stifling of Private Initiative • Government intervention may have particularly stifling effects on private sector initiative due to: • Culture of dependence on the State of employment and income • Dependence on state for major investment initiatives
Imperative of Better Governance • Enhanced efficiency and better governance is the solution to rectify market failure without incurring policy failure • This is imperative for small economies with higher incidence of both market failure and policy failure
Imperative of Better Governance • There exists no single model of good governance that can be uniformly applied • Small states as a group have widely divergent governance performances • But is it probable that small states could more successfully emulate best practices in other small states with similar problems and constraints
Thank you gordon.cordina@um.edu.mt