PULL QUOTE: The report highlights the role of transparency, investor-friendly regulations, flexible institutions and public-private sector cooperation in diversifying the economies of Small Island States.
Small Island States should establish links with nearby economic centres, maximise the benefits of migration and exploit niche markets to ensure future economic viability, the World Bank recommends. The economic prospects of these states are shaped by their market size and geography, the Bank observes in its 2013 World Development Report, titled “Jobs”.

The report, which specifically addresses Caribbean states, points out that since island populations are fragmented – small populations scattered over many territories – their economies cannot reap the benefit of economies of scale or agglomeration, and as such they are characterised by high costs of producing goods and services.

Agglomeration occurs when multiple firms in a related industry situate next to each other which leads to these firms enjoying economies of scale – that is, declining average costs of production – as a result of there being greater division of labour, and multiple competing suppliers.

Also driving up the cost of production in Small Island States are the high transaction costs associated with their geography, the report adds.

“Smallness and fragmentation further raise the costs of public services and infrastructure,” the World Bank posits, explaining: “A road, an energy network, or a government ministry that serves 100,000 people is likely to have a higher cost per user than one serving 10 million people. High fixed costs have to be spread across a smaller number of people, and often across a larger number of locations.”

And this could also explain the high cost of bandwidth in the Caribbean. “Jobs in cities and clusters rely on scale and density to create positive spillovers,” the report notes.

The City of London, with a population of roughly 13 million, had a 2012 Gross Domestic Product (GDP) of US$731.2 billion. Meanwhile, CARICOM,  excluding the mainland states, has a population of approximately 14 million inhabiting 70 different islands and its 2012 GDP stood at a pale US$107 billion.
    

INTEGRATION WITH BIGGER ECONOMIES
The geographic constraints to the economic development of Small Island States are permanent, but they can be offset through integration with bigger economies, the World Bank asserts.

“Tighter political relationships with large economic centrse are found to be associated with higher income levels among small island nations,” the report stresses.  

MIGRATION

Migration is one of the key channels for economic integration, it says, citing the seasonal agricultural worker migrant scheme between Canada and Latin America and the Caribbean as an example.

“As workers move to larger economic centres, they gain access to larger markets, cheaper inputs, and more investment; thus, the labour force is put to more productive use and can earn higher incomes,” the report explains, adding that “in turn, remittances from migrants improve living standards at home.”

Migration also adds to the human capital base, it advises, since the possibility to migrate may promote greater investments in education, which remittances may finance.

It adds that labour migration to larger markets also allows workers and entrepreneurs to interact with more dynamic firms, thus acquiring better and more diversified skills and gaining exposure to new ideas, all of which adds to the domestic human capital stock once the migrants return.

However, migration does not always lead to a win-win situation, the World Bank notes, indicating that brain drain is a short-term issue for countries which experience emigration.

It notes, too, that remittances can contribute to an abundance of foreign exchange in the local economy, thereby leading to an appreciation of the exchange rate. A high exchange rate means that imports are cheaper relative to locally produced goods, and this contributes to a decline in local industries and the onset of a phenomenon economists dub “Dutch disease”.

NICHE OPPORTUNITIES

“When niche opportunities exist, low business costs become less critical for attracting investment,” the report advises, indicating that Small Island States may leverage their natural endowments to promote tourism, fisheries and agriculture.

However, it warns that the reliance on natural resources leaves their economies more vulnerable since these
sectors tend to be more susceptible to natural shocks such as in the Caribbean’s case, hurricanes.

Additionally, jobs exploiting natural resources should not undermine the fragile ecosystem of the islands, the report insists, adding: “When conducted in a sustainable manner, tourism and fisheries have positive environmental impacts.”

LESSONS FROM MAURITIUS

Citing the structural economic transformation of Mauritius, an Indian Ocean island nation, from a poor sugar producer at the time of its independence in 1968 to a hub for light manufacturing, tourism, finance and ICT, the report highlights the role of transparency, investor-friendly regulations, flexible institutions and public-private sector cooperation in diversifying the economies of Small Island States.

Mauritius, which experienced a real GDP growth rate of 5.1 percent per annum between 1977 and 2009, is ranked as the second most competitive country in the Sub-Sahara African region. It is also renowned for low corruption levels.

The report notes that the outward-looking Mauritians focused on trade and foreign direct investments, using export processing zones to target light manufacturing industries.