The Vulnerabilities of Small Countries - Part 3 of 3

This is the third post in my three part series, where I discuss why the model of small, urban, export-oriented countries/city states is under threat. You can read the first and second parts here and here.

In the first part, how polities made for a "Just in Time" world - think of small export-oriented countries/city states - thrived in a globalized world as nodal links on trade routes between different countries. And why that advantage risks being lost in a "Just in Case" world where there are increasing restrictions on the lengths of value chains from being spread globally - either in the name of economic development or in the guise of national security.

The second part talked about how these dynamics have squeezed the terms of trade advantage that these states have enjoyed and have exposed the vulnerabilities they have due to being overly dependent on large, natural resource rich states for food and fuel.

In this section, I conclude, by highlighting two more points of weakness, especially for modern small states. 1. They place a natural growth limit for start-ups/new companies founded there 2. They remain uniquely at risk and unprepared- fiscally, infrastructurally and culturally - for the new immigrants calling them their home in the recent past.

This is something about Small Countries that we keep telling our clients as investment bankers….

There are some long standing vulnerabilities with these countries which have become more salient in the light of other risks. The equity market microstructure for these countries (except Hong Kong), contrary to expectations, isn’t very robust. As of end 2023, in Denmark, Novo Nordisk made up 54% of the listed equity market cap, Equinor in Norway took away almost 25% and Nestle in Switzerland around 15%. Comparatively, the? respective largest companies in developed market and BRIC cohorts make up 7.4% and 8.3% of the listed equity market cap respectively.?

At the aggregate market level too, there hasn’t been much creative destruction either -winners have continued to remain winners for the past three decades. The lack of large tech businesses in the benchmark indices , except for Singapore, also tells a story of a venture capital market that lags far behind that of larger countries .

This is concerning for two reasons. One, it indicates that while getting initial access to capital to start a business might be easier in these countries, ultimately newer firms have to live under an unyielding canopy of legacy businesses that have dominated the equity markets. Second, having a relatively weak domestic VC sector means having fewer institutions with an appetite to burn risk capital. Few in smaller countries seem to be willing to take big bold bets to create the disruptive equivalent of the Venetian Fleet of the Middle Ages.?

What is your shared origin story?

All nations are essentially a social contract based on a shared value/ origin story. The successful small countries in our sample have a significantly high share of immigrants (~15-30%) relative to the global average. The period from 1980-2010 saw a steady economic migration into these countries from emerging markets. However, it brought in people who had already been in a state of gradual assimilation with their destination country.

Via the usual vectors of quicker assimilation - common language, similar political systems, shared concepts of social organization and similarities in business culture, long standing trade and investment flows- they had been primed to the idea of the nation they were immigrating to. The benefits from these immigrants - new ideas, enterprise and a welcome increase in overall productive years- helped these countries maintain their vitality.

However, since 2012, Low grade conflict, economic collapses and full-blown wars have been the rising source of immigrants - particularly in the Successful Small Countries of Europe.

Though undeniably necessary on humanitarian grounds, managing such flows is far more challenging for these countries than what they had seen in the preceding three decades. A rapid increase in migrants from fragile states, without a corresponding increase in housing and formal jobs, creates fertile conditions for social isolation and vulnerability to crime -something that even larger countries like Canada are witnessing. Add to that the fact that migrants from these countries are likely to be significantly different from economic migrants on almost all the dimensions of homogeneity - language, politics, social and religious values and business culture.

Creating a new narrative and identity for a country, which balances the political, economic and social concerns of both immigrants and citizens does not lend itself well to such a sudden increase in migration. In these circumstances, Homogeneity, that secret sauce which turned small countries into efficient economies and reduced the costs of governance, is likely to be the trade off.?

All of this is not to say that we will see these Successful Small Countries disappear in our lifetimes. Or that the lessons they impart in investing in human capital, keeping oneself open to global talents and best practices and creating urban clusters of growth and innovation are useless. Nor are the natural advantages they enjoy by the virtue of being geographically tight knit, culturally homogenous and politically less contentious.

The catch is - the world is deglobalizing and the fundamental limit of economic organization is changing from being the world to being a specific country. If you are a car-maker, you don’t make for the world anymore from a single hub. You are more like accounting majors (E&Y, KPMG, Deloitte, PWC), each running a very different business in a country and for the country. The case for connecting hubs - the so-called “Centers of Excellence” - in some city state in a convenient time-zone and on the trade route to a major economy gets weaker by the year. Its not just the manufacturing that is being in-shored, it is data protection laws, accounting standards and laws too. It is tough being a player acting as an intermediary between two large economic regions if they don’t talk to one another.

In the 21st Century, we might still have Singapores, Hong Kongs, Dubais and Switzerlands - but they are more likely to be regions within the nations rather than independent states.

Finally, a request.

I don't know how LinkedIn will evolve. But I suspect that deeper, original writing is more likely to get lost in the mass produced content from creators on this platform too.

I have a day job, which pays me good enough. And a work life balance that gives me time to reflect. My motivation to write is to become a better thinker. If you like these pieces, consider subscribing to my Substack here.