Small states of the EU
Country size is often measured in terms of population size, and in the book Small States of the European: Economic Perspectives, edited recently by myself, small states of the EU are defined as those with a population of about three million people or less. According to this definition seven EU member states qualify for inclusion in this group, namely Cyprus, Estonia, Latvia, Lithuania, Luxembourg, Malta, and Slovenia.
The book also includes two candidates for membership, Macedonia and Montenegro. Iceland is also included in view of the fact that it is highly integrated in the EU. The book will be formally launched in Malta during a public seminar scheduled to be held on October 21 during a seminar at Europa House in Valletta.
Small states face special disadvantages in view of their small domestic market and their economic diversification constraints. Due to these characteristics, they tend to be highly dependent on international trade and are therefore highly exposed to external shocks. In spite of these constraints, the seven small states of the EU registered relatively high GDP per capita and have fitted satisfactorily in the EU family of states, side-by-side with larger states, including Germany, Italy, UK and Spain.
The small EU member states had to transpose EU directives and abide by regulations set for all EU members, large and small. It is well known that small states tend to suffer from the problem of overhead cost indivisibility, due to the fact that such costs cannot generally be downscaled in proportion to the population.
It is therefore to be expected, that the transposition of these directives and regulations into the body of laws of the respective countries results in higher relative costs for these small states.
The populations of the seven EU small states, with the exception of Cyprus, tend to view EU membership favourably, mostly because of free trade access to a single large market, in view of the fact that their domestic market is very small. Most of them also benefit from transfer of funds from the EU.
However, in the case of the Baltic states geopolitical reasons are seen as the major benefits derived from EU membership, in view of their experiences as part of the Soviet Union and their proximity to Russia. Luxembourg, though a net contributor of funds to the EU, benefits greatly by hosting a considerable number of EU institutions.
Malta benefitted greatly from transfer of funds, enabling the island to significantly upgrade its infrastructure. Cyprus stands out as an EU member state where the majority of its people think that the EU did not really help Cyprus in times of need, as evidenced from the responses to the recent eurobarometer surveys.
The economic prospects of the ten small states do not generally appear to be bleak. The Baltic states, namely Estonia, Latvia and Lithuania, geopolitical tensions in that area and the ensuing uncertainty due to Russia’s economic problems, may negatively affect their export performance.
However it appears that Estonia’s economy will continue to grow in the medium term as the country improves its export performance. The country is characterised by solid public finances, with public debt expected to remain below 10 per cent of GDP. In the case of Latvia, growth is also likely to be sustained, mostly by domestic demand, but the country’s sour relations with Russia may have an impact on the domestic economy.
A major problem with Latvia is its shrinking labour force. Lithuania’s economy is also likely to remain on course in the medium term, again with domestic demand likely to be the major contributor to growth. A worrying possible development in these states is that the increases in wages rates, partially caused by the economic recovery itself is likely to increase labour demand, leading to wage increases which could negatively affect the competitiveness of these countries.
The prospects of the two Mediterranean states, namely Malta and Cyprus, are very different. Malta’s economic growth is projected to be sustained in the medium term, driven by strong domestic and external demand, leading to an increase in the number of gainfully employed persons and a reduction in unemployment.
In the case of Cyprus, the effects of the 2013 financial crisis and recession are still being felt, and the chapter on Cyprus in this publication sheds doubt as to whether the structural reforms and austerity measures imposed on it will lead to sustained growth. However, some projections state the Cypriot economy is set to stabilise itself and even expand gradually in 2015-16 after a number of years in recession.
Luxembourg’s economic growth rate is expected to be robust in the coming years, driven by domestic and foreign demand. This country is characterised by solid economic fundamentals, but its reputation was somewhat tarnished by the tax rulings aimed at reducing tax liability through a secret corporate tax avoidance scheme for a large number of multinational companies located Luxembourg.
Economic growth in Slovenia is also expected to be sustained in the medium term but public finances are likely to remain problematic.
The two candidate countries considered in this publication, namely Macedonia and Montenegro, are both likely to remain on the growth path driven by investment, notably in the infrastructure, although both countries may experience public finance constraints.
In the case of Macedonia, the increase in income inequality in recent years is likely to have negative social impacts. In addition, the political crisis that Macedonia has been going through since the end of 2014, could adversely affect all segments of living and undermines the European perspective of the country.
Iceland is still recovering from its devastating 2008 financial crises which led to a severe economic downturn in the following two years and to political unrest. The economy has since then recovered mainly driven by domestic demand and a rapid increase in tourism inflows.
Wage rates in Iceland are relatively high and are likely to be further pushed upwards with increased demand for labour. Problems have also arisen with regard to government debt, although measures are being taken to reduce its ratio to GDP.
The overall impression one obtains from the book is that, in the case of the EU small states, possibly with the exception of Cyprus, there is relatively high degree of economic optimism, but it remains to be seen whether the projections referred to in the book materialise.
Lino Briguglio is professor of economics at the University of Malta.