“Smaller countries” and macroeconomic stabilisation

Via Matt Yglesias, Ryan Cooper wonders why “why smaller countries are so much better at macroeconomic management“. Cooper suggests that smaller countries have smaller banks that are less able to distort policy debate. Yglesias suggests that larger countries get distracted by “national prestige” projects at the expense of their public.

Between the two of them they provide two short lists of large failures (the US, Japan, Eurozone 1) and small sucesses (Poland, Sweden, Australia, Canada, Israel).

Two thoughts.

The first is the correlation may well be spurious. On almost any metric we’d find most of the top performers are small, but we’d also find the failures are also predominately small – simply because there are far more small countries, especially since if we treat Poland (38M people) as small. For example on the HDI 8 of the top 10 are below 40M people, but so are 9 of the bottom 10.

Likewise with macroeconomic stabilisation, we may have the successes above, but we still have Estonia or indeed Australia of the early 90s as catastrophically bad failures. That there are not more may be sheer randomness.

However, assuming the correlation is valid, I think it may be because a small country is less likely to make morality out of macroeconomics. Greater exposure to the changing climate of international trade year after year is likely to create an understanding that booms and busts are no more a reward for virtue or punishment for vice than real weather.They just happen for reasons beyond your own actions, and you have to deal with them with relevant policy.

A large country that trades within its own borders and is less conscious of the constant chaos of the economic climate becomes accustomed to thinking they are masters of their own destiny. Bad weather, when it comes, is less bad luck than a sanction by the cosmos. So begins a round of soul searching, then forgotten when the sun emerges only to be revived when the clouds gather once again. I think the worst extent is a tendency amongst Japanese to attribute the effects of bad monetary policy on an inherent defect in the character of the people. All this searching for deep reasons for success and failure comes at the expense of the genuine problem at hand.

That said, I still favour the spurious correlation hypothesis.

1 And I guess the UK

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About Richard Tsukamasa Green

Richard Tsukamasa Green is an economist. Public employment means he can't post on policy much anymore. Also found at @RHTGreen on twitter.
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Nicholas Gruen
11 years ago

Large countries also face less elastic demand and supply for exports and imports. So the rewards from realigning their exchange rate are less. That can be a big deal.

David Walker
David Walker
11 years ago

Like Richard, I vote for spurious correlation, an explanation that is wildly under-valued in the social sciences. The discussion cited by Richard seems to me a fine example of an apparently intelligent high-level discussion which is actually just an exercise in torturing some data. It’s nattering about (statistical) noise.

The surprise in this post is that someone – hoorah for Richard Green! – actually cites spurious correlation as the most likely cause of the observed outcome.

Note also that the “outcome” is also a likely victim of the availability fallacy. Right now many people think of the US, Europe and Japan as stability failures. Over other parts of the past few decades they have all at various times been regarded as stability successes. Australia has frequently been regarded as suffering from boom and bust. Just recently, “large economies” – especially the US – have had problems. Their failure is “available”. That doesn’t make the classification right.

On top of that, the specific classification method used is pretty dodgy. European outcomes have been pretty mixed. Germany, a big economy, has been doing OK; Greece has been doing poorly. By treating both of them as “eurozone” you can class them as suffering from macro instability, but it’s a pretty arbitrary categorisation.

Oh, and “small economy” does not mean “trade-exposed economy”. Luxembourg is highly trade-exposed, whereas Australia, the US and Japan are among the world’s least trade-exposed economies. (In Australia’s case, we do however suffer a lot of price variability in our export products.)

OK, I’m sick today, and grumpy. But I keep seeing this statistical nonsense and it needs to be called what it is. Discussions like the Cooper/Yglesias one above seem to me to be almost an elaborate kabuki where intelligent people agree to forget everything they (should) know about data analysis in order to show off their facility with concepts.

People like Ed Leamer, Deidre McCloskey and more recently John Ioannidis have blown the whistle on this many times. Leamer, I find on a quick re-reading of his most famous work, even described the social science data game as one where no-one takes anyone else’s data analyses seriously.

But most people want to keep the kabuki going. So no-one points out the enormous quantity of junk social science happening all around us.

john r walker
11 years ago

” think it may be because a small country is less likely to make morality out of macroeconomics.”
Big countries are sometimes also powerful countries- for a country to pursue bad policy(of whatever kind) for long enough for it to become national folly , that country needs to be powerful enough to deny reality ,for long enough.

David you might be grumpy but for what its worth, I think you are right.

11 years ago

This looks like a case where a story about X (monetary policy) morphed into musings about Y (macro correlations).

11 years ago

I don’t like spurious correlation in this particular case because I thought of a much ‘cooler’ way of putting both Richard and Nick’s hypotheses: the bigger and richer the country you are the easier it is to see the world out of your own arsehole; relative minnows are unable to deny the existence of alternative models.

11 years ago

What does Mediterranean mean? Every culture thinks the world rotates around itself, especially old cultures that have been there and done that. Now, you don’t see Greece and Italy pursuing obviously disastrous policies decade after decade until they are in a hopeless position, do you?

No nation ever calls itself, “the absolute ends of the Earth”, well other than the Dutch of course.