Escaping Regulation, Escaping Convention - SSRN

Escaping Regulation, Escaping Convention Development strategies in small economies Naren Prasad

Introduction The academic community tends to give more importance to bigger countries than to smaller ones. In general, there seems to be a fascination for bigness over smallness. Henrikson (2001, p. 51) quite rightly attributed this bias to the world’s system of sovereign states which favors bigness over smallness. But small states have many lessons to offer the world community and other developing countries, especially in the field of development strategies and international relations. It is often thought that small countries are ‘uninteresting’, ‘unimportant’, ‘of diminishing importance’ and/or have little to offer to other countries. It is true that they often play a minor role or no role at all in the international system. However, some major powers have started to pay more attention to these countries, for geo-strategic reasons and in order to win votes in international forums.1 Country size has been a paradox in classical economic theory. Smallness implies a lack of economies of scale, which poses a veritable handicap for any significant industry seeking to develop and operate profitably. Small countries also have small domestic markets, which can be considered an Naren Prasad is Assistant Programme Specialist in the Social and Human Sciences sector in UNESCO’s Asia Pacific Regional Office, Bangkok. The views expressed in this paper are entirely the author’s and should not be attributed to UNESCO. The author is particularly grateful to Professor Godfrey Baldacchino and Professor Claude Albagli for their valuable comments on the first draft of the paper. 1

As seen from the coalition building in the lead-up to the Iraq war, or even for finding short-term solutions to the refugee problem: Australia for example, offered to pay Nauru US$10 million to take an initial 700 refugees, plus US$5 million worth of diesel fuel to alleviate Nauru’s chronic power blackouts.

WORLD ECONOMICS • Vol. 5 • No. 1 • January–March 2004

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obstacle to development. However, in pure trade theory, smallness is considered an asset. A well-known theorem argues in terms of ‘the importance of being unimportant’; it claims that small trading countries can benefit from being small precisely because they can maximize gains of trade if and when they specialize and exchange according to comparative advantage (Salvatore 1995, pp. 43, 64–65). While some small countries and territories have indeed benefited from niche products in services such as tourism and the hosting of offshore financial centers, they have been unsuccessful in commanding influence in many of these products because of their small product range, value or volume in the international economy (Baldacchino 1993, p. 38). Some small states are able to use their sovereignty and political status more than their economic influence to advance their cause. Here, they often resort to non-market solutions or non-orthodox approaches, such as their power to negotiate aid, to provide an emigration outlet for their population, or to ask for derogations in international systems. As Baldacchino (1993, pp. 37–38) neatly puts it, “the history of economics in the real world is, after all, none other than a continual attempt to distort and usurp the free market to one’s perceived advantage”. Economic textbooks preach that, because they have a small proportion of total trade at the global level, small states can avoid retaliation if they break trading rules. This paper demonstrates that, behind the rhetoric of increased globalization and free trade, small states are able to manipulate the global system in their favor. Small states would be the first victims if they were to abide by the trading rules of the WTO. I also argue that, although small countries—often island territories—are considered vulnerable,2 implying that they are highly exposed to geographic, environmental and economic factors beyond their control, they have nonetheless succeeded in adopting unconventional, yet effective, development strategies to overcome such vulnerabilities. For example, they have effectively designed schemes to earn foreign currencies to finance their growing imports. This paper shows that small states are experts in finding loopholes in the international system, seeking leniency and special arrangements or derogations with developed or metropolitan countries. Indeed, small countries use their 2 Briguglio (1995) and the Commonwealth Secretariat (1985, 1997) have been instrumental in developing the vulnerability index for small countries.

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Escaping Regulation, Escaping Convention

‘smallness’ very effectively, especially by playing the game of the ‘importance of being unimportant’ or the ‘power of being powerless’. After defining the category of small states, I show that such states are violators of global trading rules. The final section analyzes how the major development strategies pursued by small islands—such as the use of Export Processing Zones (EPZs), offshore financial centers, remittances, aid and rent-seeking and deriving other unconventional sources of income—go against mainstream thinking in economics.

Definitions Population, economy, environment and physical size—separately or in combination —are the primary, interrelated, criteria used to define a ‘small’ island state. In this paper the size of the resident population is the key criterion distinguishing a small state from a large one. In accordance with common practice, a country with less than 1.5 million people is considered ‘small’. There is also some consensus that ‘islands’ are bodies of land completely surrounded by water, although it is problematic to distinguish small islands from large ones. Whether or not the category of ‘island’ is substantively different from that of any state of comparable size is contentious, especially in economic terms. Statehood is interpreted in terms of political sovereignty, in the sense that most states today are members of the United Nations. Of the 191 member states in the United Nations, 46 have a population of less than 1.5 million; 30 of these are islands or archipelagos, of which 25 are identified as small island developing states (see Table 1). Even if other composite indicators (population, land area, total income of a country) were used, as proposed by Crowards (2002), these 25 island states would still qualify. In the next section we analyze how the different development strategies pursued by small islands contradict mainstream thinking in economics.

Rule bending: a strategy for small islands? Small island countries seldom conform to the orthodox prescriptions of economic development (Baldacchino 1998); they are, or can become, experts in “slipping subtly through the nets of conformity” (Baldacchino


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Table 1: Population, area, size of economy and GDP per capita in small islands, 1999 Country Pacific Fiji Marshall Islands Kiribati Micronesia Nauru Palau Samoa Solomon Islands Tonga Tuvalu Vanuatu Caribbean Antigua & Barbuda Barbados Dominica Grenada St Kitts & Nevis St Lucia St Vincent & Grenadines Trinidad &Tobago West Africa Cape Verde Sao Tome & Principe Indian Ocean Comoros Maldives Mauritius Seychelles

Population (‘000)

Area (‘000 km²)

GDP (US$ million)

GDP per capita (US$)

806 62 82 116 11 19 169 430 98 11 186

18,274 181 726 702 21 459 2831 28,896 650 26 12,189

1830.3 96.9 51.3 229.9 33.7 126.1 238.3 346.3 155.4 15.6 228.8

2275 1920 627 1922 2830 6722 1505 801 1574 1556 1193

67 267 71 93 39 152 112 1289

442 430 751 344 261 539 388 5130

645.1 2500.2 266.8 307.2 309.0 658.3 339.7 6596.1

9979 9380 3778 3295 7974 4505 3018 5119

418 144

4033 964

584.4 34.8

1400 257

676 278 1174 80

2235 298 2040 455

192.7 390.1 4192.1 619.6

281 1382 3638 7804

Source: United Nations (2001) (CD-ROM).

and Milne 2000, p. 238). Baldacchino argues that successful microstate economies include those that can oblige or manipulate larger countries (or regional blocs) to create a local advantage for themselves. I will show that most of the development strategies pursued by small islands are at odds

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with mainstream thinking, which considers the economic success of island countries to be an exception (Sachs 2002b), whereas I regard this condition as normal. I demonstrate first that most small islands distort international trade rules, and second, that most of these successful strategies are based on rent-seeking activities which are generally considered unconventional. International trade and preferential trading agreements One of the best known rules of international trade policy (mostly regarding imports and exports of goods and services) is that small countries should not intervene in trade (meaning that they should not erect trade barriers) and should pursue free trade. Using an econometric model, Wacziarg et al. (2002) demonstrate that in a free trade regime small countries can enjoy more prosperity than larger countries. In other words, the benefits of trade openness and economic integration increase as the size of the country decreases. Therefore small countries have a particularly strong interest in free trade, since much of their economy depends on international markets. Sachs (2002b) puts this very well, saying that it is a lifesaving right for small economies to demand completely open markets for their goods and services, and that free trade is their lifeboat. This is because small countries by definition cannot influence world prices and the terms of trade. The central theoretical conclusion of international economics is that free trade is the best policy for most countries most of the time (Milner 1999, p. 92). However, most of the strategies pursued by small islands are based on the bending of global trade rules. For example, small islands rely heavily on international trade, but this form of trade is generally based on preferential access to developed country markets (see Table 2). I will later show that small islands that host offshore financial centers are operating at the limits of acceptable global rules of international relations. Small islands relying on remittances defy the principle of investing in productive activities. All the small island countries in our study except the Maldives are ACP (Africa, Caribbean, Pacific) member states and enjoy privileged market access to the European Union. ACP preferences constitute a one-way trade preference for 71 countries in Africa, the Caribbean and the Pacific—47 countries from south of the Sahara in Africa, 16 island nations from the Caribbean and 8 islands from the Pacific, of which 39 of the ACP


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Table 2: Preferential Trade Agreements in small island developing states3 Country

ACP/Cotonou

Antigua & Barbuda Barbados Cape Verde Comoros Dominica Fiji Grenada Kiribati Maldives Marshall Islands Mauritius Micronesia Nauru Palau Samoa Sao Tome & Principe Seychelles Solomon Islands St Kitts & Nevis St Lucia St Vincent & Grenadines Tonga Trinidad & Tobago Tuvalu Vanuatu ACP AGOA CARIBCAN CARICOM CBI COMSEA EBA ECOWAS GSP IOC LDC MSG O OECS RPTA SAARC SPARTECA WTO

X X X X X X X X X X X X X X X X X X X X X X X X

LDC

X X

X X

X

X

X X

RPTA

WTO

CARICOM, OECS CARICOM ECOWAS CBI, IOC, COMESA CARICOM, OECS MSG, SPARTECA CARICOM, OECS SPARTECA SAARC SPARTECA CBI, IOC, SADC, COMESA SPARTECA

X X O

SPARTECA CBI, IOC, SADC MSG, SPARTECA CARICOM, OECS CARICOM, OECS CARICOM SPARTECA CARICOM

O O O X X X X O X

MSG, SPARTECA

O

X X X X X

Africa, Caribbean and Pacific countries African Growth Opportunity Act Caribbean Canada Caribbean Community and Common Market Cross Border Initiative Common Market for Eastern and Southern Africa Everything-But-Arms Initiative Economic Community of West African States Generalized System of Preferences Indian Ocean Commission Least Developed Country Melanesian Spearhead Group Observer Organization of Eastern Caribbean States Regional Preferential Trading Agreements South-Asian Association of Regional Cooperation South Pacific Regional Trade and Economic Cooperation Agreement World Trade Organization

Source: Schiff (2002b).

3 Other agreements enjoyed by certain small island countries include the AGOA (Cape Verde, Sao Tome & Principe, Mauritius, and Seychelles), GSP for European, American, and Japanese markets, EBA for LDCs, Caribbean Basin Initiative for the American markets, CARIBCAN for Caribbean and Canada, the compacts for Free Association with United States and Micronesia, Marshall Islands and Palau, among others.

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countries are classified as LDCs. Because these preferences are neither available to all developing countries nor restricted to least developed countries, they violate WTO rules. However, WTO members have granted waivers to the ACP accord (known as the Cotonou accord) until December 2007.4 Because of stricter WTO discipline, the European Union has proposed regional economic partnership zones from 2008, which will become free trade agreements between the EU and the subregions of the ACP group (Africa, Caribbean, Pacific) (Langhammer and Lucke 2001). The EU ACP preferences, the US Caribbean Basin Initiative and Africa Growth Opportunity Act all introduce favorable discrimination to small island developing states. Preferential trading agreements (PTAs) impose lower tariffs on goods produced in the member countries than on goods produced outside (Panagariya 2000b). In other words, PTAs are agreements made outside the multilateral trading system. According to the Development Assistance Committee’s Annual Report (DAC 2002, p. 39), preferential trading arrangements pose many problems and complications to free trade. Preferences divert trade and create vested interests. Preferential agreements threaten the multilateral trading system (see Bagwell and Staiger 2001; Crawford and Laird 2001; Bhagwati 1992; Krueger 1995) and their expansion detracts from global free trade. The multilateral trading system represents the global effort to achieve trade liberalization across all countries, under the aegis of the WTO. PTAs are clearly inferior to a multilateral trading arrangement in reducing barriers to trade on a global scale and are a second-best means of promoting trade liberalization (ADB 2002a, p. 161). In most cases, PTAs involve a small home country with a large partner (Michaely 1998). Also, most PTAs exist between countries linked by contiguity or a former imperial relationship (Ludema 2002). Indeed, so strong is the relationship between proximity and PTAs that few economists bother to distinguish between preferential trade and ‘regionalism’. I have demonstrated that the cost of transporting goods is one component of the cost of delivering a product to a foreign market. Therefore, ceteris paribus, contiguous countries will deliver goods to each other at lower costs than countries distant from one another. 4

Panagariya (2002a); see also WTO (2001).


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Fears that PTAs may undermine the multilateral process led to the creation of a WTO Committee on Regional Trade Agreements in February 1996 (Grether and Olarreaga 1998).5 The WTO stressed that countries should join the WTO without bending the rules of the multilateral trading system.6 However, the WTO recognizes the special problems facing ‘small economies’. First, the Doha Ministerial Declaration proposed the establishment of a program of work on small economies ((WT/MIN(01)/DEC/1) para. 35); this was reaffirmed by the General Council of the WTO (WT/L/447, March 5, 2002). The proposal ran short of creating a ‘sub-category’ of small economies, but attempted to integrate these economies into the multilateral trading system. The creation of a sub-category would have allowed small islands to be treated as special cases, given ‘special and differential treatment’ in the global trading system, similar to that for LDCs. The neoclassical theory of international trade, as propounded by the WTO, does not want to encourage special cases, preferring a homogeneous liberal trading system based on one set of rules for all (Milner 1999). However, Armstrong and Read (1998, pp. 572; 2002b, p. 79) argue that multilateral trade liberalization under WTO/ GATT has been advantageous to small countries because they can seek trade concessions from industrialized countries. Their small size gives them scope for more free-riding (‘the importance of being unimportant’, or res nihili). Export processing zones Some island countries such as Mauritius, Barbados and Fiji have succeeded in establishing a viable manufacturing industry through Export Processing Zones (EPZs). For example, through an EPZ manufacturing activities (textiles in particular) in Mauritius have led to impressive levels of development, as measured by economic growth, the human development index and low poverty levels (Prasad 2003). 5 The mandate of the CRTA is to carry out an examination of agreements referred to it by the Council for Trade in Goods (CTG). Non-discrimination among members of WTO is the foundation of WTO agreement. Under the WTO’s charter, MFN treatment requires that any member granting any advantage, favor or privilege affecting customs duties, charges, rules and procedures to another member shall extend unconditionally such advantages to all members. According to Grether and Olarreaga (1998), 42% of world trade was based on preferential trade for 1993–97 and 40% for 1988–92. Others, such as Serra Puche (1998), put it even higher at 53%. 6 Mike Moore, Director General of WTO at the WTO/FORSEC Trade Policy Course for Pacific island countries, Fiji, 5–9 March 2001: http://esa.un.org/ffd/PolicyTexts.

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The strategy of EPZs clearly violates the principles of free trade since it creates artificial incentives to attract investors. For example, the textile industry (dominant in an EPZ) is badly distorted by quota systems, which create a false sense of development in countries that cannot truly compete on price, quality or delivery times. Middlemen and manufacturers circumvent these quota systems by sending textile and factory workers to the countries that have quotas to export to the USA or to Europe.7 According to a Handbook on Development, Trade and the WTO, published by the World Bank (Hoekman et al. 2002, pp. 165–166), EPZs are enclaves within which governments attempt to provide a policy environment and infrastructure conducive to investors seeking to produce for export. EPZs are second-best solutions compared with generalized economywide reforms (Hoekman et al. 2002) and are not defined or referred to in the WTO agreements. To the extent that subsidies are provided through EPZs, however, the rules of the Agreement on Subsidies and Countervailing Measures apply. Restrictions on export subsidies could impinge on countries’ abilities to deploy EPZs. This is especially true for countries with income per capita of more than US$1,000. Lower tax rates, special credit facilities and publicly provided infrastructure (all typical of EPZs) could, in principle, be contested, to the extent that they represent subsidies to companies that are required to export most, if not all, of their output. World Bank economists warn that countries relying on EPZs would do well to seek clarification on their compatibility with WTO rules (Hoekman et al. 2002). Much of the success of EPZs depends upon market access to developed countries through preferential agreements. However, in light of the WTO agreement on the Most Favored Nations (MFN) Clause, large countries may prove less willing to make concessions to smaller ones, since they must extend such concessions to a large volume of trade (Horn and Mavroidis 2001). Offshore financial centers Some islands have embarked on the setting up of offshore financial centers as a development strategy. This has shown positive results, but recent international efforts to curb money-laundering have led many countries to 7

Newsweek, 12 August 2002, p. 20.


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review the strategy. Studying Barbados, Prasad (2003) found that financial centers alone do not ensure economic development, without the prior development of other related sectors such as tourism. Offshore financial centers are considered by bigger countries to be illegitimate or questionable activities with “capital-distorting effects” or tantamount to “economic piracy”, since they manipulate tax competition (Baldacchino and Milne 2000, p. 6). Small countries have a comparative advantage in tax competition (Fuest and Huber 2001) because, having less market power in the international capital market, they prefer to have a lower capital tax regime. They therefore have a more capital-intensive production and higher per capita output than larger countries. Others argue that small jurisdictions have the right to compete in the global financial services sector precisely because they have a comparative advantage (Sanders 2002, p. 345).8 Smaller countries use their sovereignty to set up these centers—the “commercialization of state sovereignty” as Palan (2002, p. 151) puts it. Offshore financial centers work by unbundling sovereignty, allowing local regulatory authorities to establish the local regulatory environment, while encouraging multinational banks to make use of their jurisdiction (Hudson 1998). In other words, the authorities sell some powers over their space. The main characteristic of an offshore financial center is the ability to offer a regulatory environment that is different and legally separate from that available onshore in other countries (hence ‘offshore’). The authorities provide a different set of rules for the financial sector, with total security, secrecy and no or low taxes. The existence of a strong tourism sector appears to be a pre-condition (causa sine qua non) for a country becoming an offshore financial center (McCarthy 1979; Hampton and Christensen 2002).9 Tourism and offshore finance require the same services, e.g. rapid air transport links, hotels, restaurants, shops and attractive climates. Typically, the country first becomes a destination for wealthy individuals; some of these then invest and establish residence. Bankers and accounting firms bring their knowledge and experience, adding to the virtuous circle. 8 Well educated computer-literate populations, lower levels of business cost, good telecommunications infrastructure, low levels of tax, etc. 9 Although in some countries that provide offshore financial services, such as Nauru and Vanuatu, the tourism sector is not effectively developed.

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Remittances, aid and rent-seeking Another important source of funds for many small islands is remittances from family members who have emigrated. Remittances provide crucial revenue and contribute to the balance of payments in small countries, but lead to the formation of a consumption society, where productive economic activities hardly exist, as in the case of Samoa. Prasad (2003) found that there was a negative correlation between the importance of remittances and GDP per capita. According to the World Bank (2003), remittances from foreign workers constitutes the second largest source of external funding for developing countries, after foreign direct investment. In 2001 remittances to developing countries represented over US$72 billion, exceeding by far the total official development assistance. For the small island countries remittance per capita is quite significant. According to Gammeltoft (2002), Antigua received close to US$4,000 per habitant between 1995 and 1999, followed by Jordan with $1714, then Jamaica ($1393), Samoa ($1305), Barbados ($1212) and Cape Verde ($1105). Other countries, such as Tonga, Tuvalu, Kiribati and Comoros, also rely heavily on remittances to sustain their consumption. Reliance on remittances is discouraged by mainstream economists, who define economic development in terms of the output produced by the resident population. For many island economies, however, development means capitalizing on economic opportunities across a wider international arena. In addition, the usual benchmark statistics used to rank economies is GDP per capita. For many small island countries, the statistical concepts underlying GDP are less applicable than for large developing countries, because of the importance of external sources of income and the extent to which modern-sector economic activity has moved offshore to metropolitan economies (Kose and Prasad 2002). Conventional emphasis on GDP as the key economic growth indicator is based on the mainstream thinking that expenditure can be sustained only on the basis of local output (Bertram 1999a). Labor is just another good, and therefore the welfare gains from emigration are just a particular case of the welfare gains from trade liberalization (Poirine 1998). Standard international trade theory suggests indifference between free trade and free migration. However, Schiff (2002a) demonstrates that the movement of people differs from the movement of goods


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and services because people create attachments to those with whom they share social capital—norms, languages, customs, values and culture. In this respect, barriers to migration are easier for islanders to overcome than barriers to export markets, and remittance flows have been more sustained and stable than export proceeds (Bertram 1999a). The private-sector-led activities are rendered unprofitable because of high wages and transport costs. In certain respects, the strategy of relying on remittances is considered rent-seeking. Rent-seeking includes profitable activities that do not directly result in real output but have the potential for ultimately yielding benefits (Kakazu 1994, p. 55). Most small economies that rely on remittances have a commercial deficit, implying that domestic demand cannot be met by the country’s own productive resources.10 Therefore its consumption level is sustained by continuous inflows of rent generated abroad. As Kakazu (1994, p. 57) puts it, “rent is an integral part of the international transfer of resources from a ‘surplus’ country to a ‘deficit’ country”. What could be considered another form of rent-seeking is the ability of small islands to attract huge sums of foreign aid. According to the Development Assistance Committee (DAC 2002), average annual per capita aid going to the Pacific between 1995 and 1999 amounted to $220, followed by the Caribbean with $34, and sub-Saharan Africa with $22. The Pacific region has received almost US$50 billion of aid in 1998 dollars (A$100 billion) since 1970, representing by a large margin the highest developing country aid inflows per capita in the world. Rent-seeking activities are an alternative way for small islands to use their economic and non-economic resources, their advantages such as political ties, strategic location, international security, and their goodwill and jurisdiction as an economic resource (Baldacchino 2000; Baldacchino and Milne 2000). Kakazu (1994) suggests that rent-seeking activities need not be considered merely as generating unproductive resource transfer, but as an economically logical way for small island economies to shift their 10

Most islands, especially in the Pacific, have balance of payments deficits of 50% to over 100% of imports, meaning that more than half the imports are financed through current transfers (remittances, aid) or by capital inflow (borrowing, FDI). Apart from remittances and aid as current-account transfers, it should be noted that certain island states (Kiribati, Nauru, Tuvalu) earn interest and dividends on financial assets held overseas (Bertram, 1999a). These are sources of disposable income that do not arise directly from the sale of commodities.

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limited resources from producing uncompetitive products to rent-seeking activities where there are opportunities for income gain. From the above, we have seen that preferential agreements are instruments that divert trade and include a grant element (like aid), which gives rise to a ‘clientelist donor–recipient’ relationship of rent-seeking. We have also seen that small island countries have a different economic logic and subscribe to “unorthodox, yet effective” strategies and policies (Rodrik 2001, p. 21). These results contradict the results obtained by Easterly and Kraay (2000), who argue that small countries are no different from larger countries and therefore should receive the same policy advice.

Other unconventional strategies Apart from the classic strategies mentioned above, there are other sources of income for small island states. Many such countries may be too small and remote for commercial investment and may, therefore, have to look beyond orthodox strategies and the usual service economies such as tourism. The difficulties posed by smallness in achieving economic development in many small islands have led some islands to choose ‘somewhat unusual development strategies’. Selling sovereignty In this era of increased globalization, many small island states sell their sovereignty to other countries in order to finance their budget or to get foreign aid. According to Greenpeace (2002), Japan has given more than US$323 million of ‘aid’ in exchange for votes in the International Whaling Commission to reverse the global whaling ban through its fisheries grant aid.11 Some small countries benefited from the rivalry during the Cold War era, when East and West competed to gain geo-strategic access to remote islands in the Pacific, the Indian Ocean and the Caribbean. Similarly, the current China–Taiwan relationship benefits some small islands. Taiwan provides ample foreign aid benefits to small nations that choose to 11

Some of the countries supporting Japan’s position in exchange for aid are: St Lucia, Antigua & Barbuda, Dominica, Grenada, St Kitts & Nevis, St Vincent & Grenadines, and the Solomon Islands; and other countries include Panama, Morocco, Guinea, Namibia and Gabon. Japan is using overseas aid to persuade poorer nations, with no direct interest in whaling, to support Japan’s pro-whaling stance at the International Whaling Commission.


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recognize it officially.12 Small island nations have used their not-insubstantial leverage of diplomatic recognition, along with an implied favorable UN vote on issues of concern to both Chinas, to win economic favors from each of the two claimants to Chinese rule. Therefore, sovereignty has been an important asset in allowing small islands to structure their international linkages. In addition, in exchange for their votes, small states gain considerable opportunities for rent-seeking in the international institutions such as the United Nations (Armstrong and Read 2002b, p. 78). Military bases Other small island countries provide strategic military bases for developed countries (or sites for weapons testing, including nuclear tests). For example, Palau and the United States negotiated a Compact of Free Association in the 1980s. This agreement gives the US military rights in Palau for 50 years, in exchange for some $627 million paid over the agreement’s first 15 years. The compact took effect in 1994, the same year Palau gained independence and joined the United Nations. The following year, the new nation received nearly $250 million in frontloaded compact payments, though the allocation fell to about $120 million in 1996, and to some $15 million in 1997, with similar annual income set for the following 12 years (Nero et al. 2000). The Marshall Islands have a similar agreement with the United States. Fishing rights The Exclusive Economic Zone (EEZ) for each country reserves exclusive rights to exploit, develop, manage and conserve natural resources in and under the sea within 200 miles (320 kilometers) of its shore (including fishing, oil, gas and minerals). Most small islands have given the rights to other countries with domestic processing industries (Japan, USA, Taiwan, China, and South Korea) to fish their waters and receive access fees. For example, 50% of Tuvalu’s government revenue comes from fishing license access fees. In 2000 there were 949 tuna fishing vessels in the EEZ of the Pacific. Currently, the access fee for each country ranges from 2.2% to 10% 12

Taiwan has full diplomatic ties with 28 countries: the Solomon Islands; Marshall Islands; Tuvalu; Nauru; Vatican City; Belize; Costa Rica; Dominica; the Dominican Republic; El Salvador; Grenada; Guatemala; Haiti; Honduras; Nicaragua; Palau; Panama; Paraguay; St Kitts and Nevis; St Vincent and the Grenadines; Burkina Faso; Chad; the Gambia; Liberia; Malawi; Sao Tome and Principe; Senegal; and Swaziland. These countries are mostly small and politically weak and do not play any significant role in world affairs.

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of gross revenue. Small islands in the Pacific received around US$60 million in access fees from foreign fishing activity in 1999, compared with $15 million in 1982 (Gillette et al. 2001, p. 13). Shipping registries Shipping registries and the sale of passports (see next section), both significant revenue earners in several small island states, are contentious when they encroach on the sovereignty of bigger states. For example, the Marshall Islands are a leading ‘flag of convenience’ (FOC), offering maritime registry services to predominately US-owned shipping. It is worth noting that ‘flags of convenience’ represent around 50% of the world fleet (Morris and Klikauer 2001). Ships operating under FOC fly the flag of the country where they are registered (e.g. Panama, Liberia, Marshall Islands, Vanuatu and other small countries that offer open registry services for shipping owners). Vanuatu has about 500 merchant- and fishing vessels currently flying the Vanuatu flag of convenience, representing significant revenue for the government at around $2,500 per ship (February 18, 1999—Radio Australia). Other countries such as Sao Tome & Principe have also ventured into such practices to earn hard currency. Passport sales Islands such as Kiribati, the Federated States of Micronesia, Samoa, Tonga, Grenada, St Lucia, Sao Tome & Principe and Tuvalu have ventured into selling their national passports to rich businessmen. The Kiribati government, for example, has received more than US$5.5 million through its Kiribati Foreign Investor Passport Program for Asian businesspeople. The program encourages rich businesspeople from Asian countries to set up investments that are different from those already in existence in Kiribati (Pacific Islands Report, 5 February 2001). The Marshall Islands also started such schemes from the mid-1990s, selling hundreds of passports to Asians (primarily in China) and earning the country tens of millions of dollars. (Under the Compact of Free Association between the USA and the Marshall Islands, natural born Marshall Islanders can live, study and work in the United States without obtaining a visa.) Tuvalu also has an Investment Passport Scheme which, however, contributes very little to the government’s revenue (ADB 2002b).


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Philately Less controversial is the sale of postage stamps to foreign collectors, which contributes to the revenues of some smaller islands such as Tuvalu and Sao Tome & Principe. In Tuvalu, annual philatelic revenues at one point grew to well over US$500,000. (Government reserve funds totaled less than this amount.) Currently, the philatelic profits amount to around US$50,000 annually. The Tuvalu Philatelic Bureau (TPB) was established after the island’s independence in 1978, and for its first few years it was the country’s major foreign exchange earner. At one stage the TPB was the country’s third largest employer (ADB 2002b). Trust funds Some countries in the Pacific, such as Kiribati, Tuvalu and Nauru, have set up special trust funds to earn interest in order to finance their budget. Tuvalu, for example, established the Tuvalu Trust Fund (TTF) in 1987 principally for overseas donors “to contribute to the long-term financial viability of Tuvalu by providing an additional source of revenue for recurrent expenses of the Government”. In the 1990s, the Fund contributed about 20% of the government’s recurrent revenue. In 1998 the TTF (‘untouchable’ balance) stood at US$17 million. The success of the Fund has been a major step forward in advancing Tuvalu’s sovereignty and ensuring its long-term future. Indeed, it has become a model for advancing financial sustainability, which other Pacific Island nations are now attempting to emulate. While the TTF is not the panacea some had anticipated, it allows Tuvalu to manage its economy in a manner that avoids major budgetary shortfalls and the debt trap that has enveloped some other small island states. The trust fund provides over 21% of the revenue for public expenditure (ADB 2002b). The success of the Fund is just one of Tuvalu’s efforts as a sovereign state to advance its interests globally. Country code Some small countries resort to more controversial measures to raise revenues, including the international telephone routing code. Because small countries have simple three-digit area codes, residents of the USA or Europe can dial these numbers without realizing they are making expensive international calls. In the case of Tuvalu, its country code 688 is used

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by international telephone sex firms, which enables callers paying by credit card to maintain their anonymity. This generated up to US$1 million in revenues per year, and after eight years was contributing approximately 10% of the national budget (ADB 2002b). After strong moral objections from the local churches, the government decided to end this operation by the late 1990s (Pacific Islands Report, 1 November 1997). Other countries in the Pacific, such as Vanuatu, and in the Caribbean, such as Guyana, are also involved in such practices. Domain names Another new source of revenue is the sale of internet domain names. All countries are assigned a two-letter internet Country Code Top-Level Domain (ccTLD), such as .fr for France or .au for Australia. Each sovereign country and overseas territory has its own such ccTLD (there are altogether 243 ccTLDs). Many small states have sold the rights to their domain names to private firms in exchange for money and access to information technology. These corporations then market the domain names to anyone wishing to register them. Tuvalu is a good example. It was given the country domain name extension .tv when Internet addresses were handed out. In 1999 the government of Tuvalu signed a contract with the USA-based DotTV Corporation International to market and manage its ccTLD ‘.tv’ indefinitely. Having learned from past misjudgments, government officials sought legal and technical assistance to negotiate a marketing agreement. In return for the exclusive rights to sell second-level domain addresses, the Tuvalu government would receive US$1 million per quarter for 12.5 years and 20% equity in the company. In mid-2001 the DotTV Corporation ran into financial difficulties, and in December 2001 the company was purchased by VeriSign Inc., the domain administrator for ‘.com’. Tuvalu’s share of the sale amounted to about US$10 million, which was received as a lump sum. The new contract with VeriSign provides Tuvalu with US$2.2 million per annum plus 5% of all revenue exceeding US$20 million sales per year. VeriSign holds the rights to market ‘.tv’ for 15 years (ADB 2002b, p. 10). This money was transferred into the Tuvalu Trust Fund and used to finance the country’s development budget, including the installation of its first street lights and the inaugural tarring of the roadways of Tuvalu’s capital, Funafuti (Pacific Island Business, July 2002), electricity to the outer


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islands, and extension of Tuvalu’s only airstrip.13 It was also able to pay Tuvalu’s UN membership fee and to provide better services for its inhabitants (Sheehan 2002, p. 12). Other countries have reaped similar benefits from marketing their ccTLDs, such as Moldova (the second smallest of the former Soviet states) whose ccTLD happens to be .md. The Polynesian island Niue’s two-letter ccTLD, .nu, means ‘now’ in several Scandinavian languages (Drezner 2001). By marketing its domain name to those countries, Niue has generated enough revenue to become the only nation providing free internet service to all its residents. Other domain names that are frequently sought include Tonga’s ‘.to’, used to make memorable URLs such as www.go.to; Turkmenistan’s ‘.tm’, used for trademarking; and the Democratic Republic of the Congo’s ‘.cd’, used for promoting music. Satellite business Some small islands have also launched into the satellite business. One of the first was the kingdom of Tonga, which was a bold pioneer in establishing political control over orbital slots and turning that control to economic advantage. Tonga has tried to earn income by claiming orbital satellite slots under international law and then selling them to telecommunications carriers. After initially claiming 27 satellite slots, Tonga received seven, after larger countries and telecommunications companies objected to a small nation snapping up chunks of space (Price 1999). The skies over Tonga represent the last unoccupied stretch of the geo-stationary orbital arc—that very special place, 22,300 miles above the equator, where an orbiting satellite’s forward speed equals the earth’s rotational velocity, so that from the earth’s surface the satellite appears stationary (Omni 1994). These geo-stationary satellites carry international television hookups, telephone communications and data transmissions. Until recent years few nations aside from the USA, the former Soviet Union and some of the European countries had either the capability or the need to launch sophisticated communications satellites.

13

Chris Gaither, New York Times, July 16, 2001.

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Peacekeeping operations One small island country—Fiji—has been supplying troops to the United Nations peacekeeping operations. Fiji gains many benefits from such operations, especially through the creation of employment opportunities for its youth, a boost to government revenue (at one stage supplying UN troops was Fiji’s third largest earner), upgrading of the country’s military skills and enhancement of Fiji’s international image in the global system (Ishizuka 1999). *** Many small island countries have virtually no goods to export; their external balance, as well as their external service balance, is in substantial deficit. However, this trade deficit is more than balanced by income receipts from abroad through some of the original initiatives (outlined above) undertaken by the countries’ governments.

Conclusions Despite being vulnerable and at the mercy of external donors, small economies have invented ingenious systems to overcome the difficulties posed by the very nature of their smallness. The concept of vulnerability has been a political exercise which has brought the smaller economies, particularly small islands, into the limelight in international discussions. This article has shown that small economies pursue development strategies based on preferences that go against the theory of international free trade. Rather than invest in productive activities to finance imports, small islands prefer to be rent-seekers. This is a perfectly logical choice for a small economy, and often not a choice at all. Sovereignty (and its instruments) is considered an important economic asset, enabling many small economies to pursue their ‘development’ in relatively successful, albeit peculiar, ways. In summary, small island economies are at odds with the prescription of economists, since they are champions in breaking and distorting rules. The article has also demonstrated that the importance of being unimportant has allowed many small economies to pursue distinctively national policies seeking favorable deals which concede special advantages. Many small economies behave like ‘modern-day pirates’ in their search for


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exceptions, loopholes, special arrangements and derogations in the world systems. This behavior is not a choice but a necessity for survival in this era of increased globalization. The unconventional strategies can be practiced only by smaller economies, because of the very nature of their smallness, and may not be an option for larger countries. Seen from the small economies’ perspectives, globalization is not homogeneous, uniform or equal, but rather “pluralistic, messy and often richly asymmetrical”, consisting of “derogations, exceptions, and special arrangements” (Baldacchino and Milne 2000, p. 239). Wise and intrepid, the leaders of small islands try to make the most of global opportunities while engaging the forces of globalization on its own terms. References Armstrong, H. W. and Read, R. (1998). Trade and growth in small states: the impact of global liberalization, World Economy, 21(7), 563–585. Armstrong, H. W. and Read, R. (2002a). The phantom of liberty? Economic growth and the vulnerability of small states, Journal of International Development, 14(4), 435–458. Armstrong, H. W. and Read, R. (2002b). The importance of being unimportant: the political economy of trade and growth in small states. In S. M. Murshed (ed.), Issues in Positive Political Economy. London: Routledge, 71–88. Asian Development Bank (ADB) (2002a). Asian Development Outlook 2002: Preferential Trade Agreements in Asia and the Pacific. New York: Oxford University Press. Asian Development Bank (ADB) (2002b). Tuvalu: 2002 Economic and Public Sector Review. Manila: ADB. Bagwell, K. and Staiger, R.W. (2001). Reciprocity, non-discrimination and preferential agreements in the multilateral trading system, European Journal of Political Economy, 17(2), 281–325. Baldacchino, G. (1993). Bursting the bubble: the pseudo-development strategies of micro-states, Development and Change, 24(1), 29–51. Baldacchino, G. (1998). The other way round: manufacturing as an extension of services in small island states, Asia Pacific Viewpoint, 39(3), 267–279.

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Escaping Regulation, Escaping Convention Baldacchino, G. (2000). The challenge of hypothermia: a six-proposition manifesto for small island territories, The Round Table, 353(1), 65–79. Baldacchino, G. and Milne, D. (eds.) (2000). Lessons from the Political Economy of Small Islands: The Resourcefulness of Jurisdiction. London: Palgrave Macmillan. Bertram, G. (1999a). Economy. In M. Rapaport (ed.), The Pacific Islands: Environment and Society. Honolulu: Bess Press, 337–352. Bertram, G. (1999b). The MIRAB model twelve years on, The Contemporary Pacific, 11(1), 105–138. Bhagwati, J. (1992). Regionalism versus multilateralism. The World Economy, 15(5), 535–555. Briguglio, L. (1995). Small island developing countries and their economic vulnerabilities, World Development, 23(9), 1615–1632. Commonwealth Secretariat (1985). Vulnerability: Small States in the Global Society, Report of a Commonwealth Consultative Group. London: Commonwealth Secretariat. Commonwealth Secretariat (1997). A Future for Small States: Overcoming Vulnerability, Report by a Commonwealth Advisory Group. London: Commonwealth Secretariat. Commonwealth Secretariat/World Bank Joint Task Force on Small States (2000). Small States: Meeting Challenges in the Global Economy, Report of the Task Force, Washington, DC: World Bank. http://www.worldbank.org/ Crawford, J. A. and Laird S. (2001). Regional trade agreements and the WTO, North American Journal of Economics and Finance, 12(2), 193–211. Crowards, T. (2002). Defining the category of ‘small’ states, Journal of International Development, 14(2), 143–179. Development Assistance Committee (DAC) (2002). Annual Report, DAC Journal for Development Co-operation. Paris: OECD. Drezner, D.W. (2001). Sovereignty for sale, Foreign Affairs, September/October, 76–77. Easter, C. (1999). Small states development: a Commonwealth Vulnerability Index, The Round Table, 351(1), 403–422. Easterly, W. and Kraay, A. (2000). Small states, small problems? Income, growth and volatility in small states, World Development, 28(11), 2013–2027.


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Naren Prasad Rodrik, D. (2001). The Global Governance of Trade: As If Development Really Mattered. New York: UNDP. (www.undp.org) Sachs, J. (2002a). The growth performance of small economies. Paper presented at the ‘Conference on Iceland and the World Economy: Small Island Economies in the Era of Globalization’, Center for International Development, Harvard University, May 20, 2002. Sachs, J. (2002b). Keynote remarks at the 2002 Small States Forum, September 30, 2002, Washington, DC. Salvatore, D. (1995). International Economics, 6th Ed. Englewood Cliffs, NJ: Prentice-Hall. Sanders, R. (2002). The fight against fiscal colonialism: the OECD and small jurisdictions, The Round Table, 365(1), 325–348. Schiff, M. (2002a). Love thy neighbor: trade, migration, and social capital, European Journal of Political Economy, 18(1), 87–107. Schiff, M. (2002b). Regional Integration and Development in Small States, Working Paper No. 2797. Washington, DC: World Bank Scollay, R. (2001). Regional trade agreements and developing countries: the case for the Pacific Islands’ proposed free trade agreement, Policy Issues in International Trade and Commodities, Study Series No. 10, UNCTAD. Serra Puche, J. (1998). Regionalism and the WTO. Paper presented at the WTO symposium ‘Fifty Years: Looking Forward’, 30 April, Geneva. Sheehan, G. (2002). Tuvalu little, Tuvalu late: a country goes under, Harvard International Review, 24(1), 11–12. Tisdell, C. (2002). Globalisation, development and poverty in the Pacific Islands, International Journal of Social Economics, 29(12), 902–922. Viner, J. (1950). The Customs Union Issue, New York: Carnegie Endowment for International Peace. Wacziarg, R. T., Spolaore, E. and Alesian, A. F. (2002). Trade, Growth and the Size of Countries, Institute Research Working Paper No. 1995, Institute of Economic Research, Harvard University. World Bank (2003). Global development finance: striving for stability in development finance, Washington, DC: World Bank.

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Escaping Regulation, Escaping Convention World Trade Organization (WTO) (1999). Problems of small economies: the case of Mauritius. Communication presented to the Committee of Trade and Development, WT/COMTD/W/55, Geneva, WTO. World Trade Organization (WTO) (2001). European Communities: the ACP–EC Partnership Agreement, WT/MIN(01)/15. World Trade Organization (WTO) (2002). Trade and economic performance: the role of economic size. Committee on Trade and Development Dedicated Session, WT/COMTD/SE/W/5.

Major data sources Asian Development Bank (ADB), Key Indicators of Developing Asian and Pacific Countries, various issues. Economist Intelligence Unit (EIU), Country Profile, various issues. Economist Intelligence Unit (EIU), Country Report, various issues. United Nations, Statistical Yearbook, 2001 (CD-ROM). UNCTAD, Handbook of Statistics, 2002 (CD-ROM). World Bank, World Development Indicators, 2002 (CD-ROM).


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