## Strategies for Small States

## Source details

**Canonical URL:** [Strategies for Small States](https://www.imf.org/-/media/files/publications/fandd/article/2023/june/book-review-van-selm.pdf)

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### Why small states are different
- Small states are more open and exceptionally vulnerable to external shocks.
- With limited resources, small states are forced to specialize in a few internationally competitive products and services.
- Policies that seek to switch expenditures toward local products are usually not effective.
- In the Caribbean, prices that determine the competitiveness of local industries (tourism, mainly) are set not in local currency but in the currency of a much larger neighbor—the United States. This reduces the effectiveness of exchange rate devaluation or depreciation as a tool of economic adjustment.

### Exchange rate regime and monetary policy
- The author argues that small states are best served by a pegged exchange rate.
  - A fixed exchange rate regime helps contain inflation and lend credibility to the overall economic strategy.
- If a small country is unable to establish a framework and track record for maintaining an exchange rate anchor, the recommended alternative is abolishing local currencies and adopting the dominant currency as legal tender (in the Caribbean, the US dollar).
  - Benefits cited include eliminating a potential source of instability and removing central bank financing of the government that could undermine fiscal discipline.

### Fiscal policy and public sector management
- With limited or no monetary policy, fiscal policy takes center stage.
- Key fiscal areas that must be managed well:
  - Tax policy and administration
  - Expenditure and public wage policy
  - Debt management
  - Management of state-owned enterprises
- Efficient delivery of public services is particularly important and has been a struggle for the Caribbean.
- Budget allocations for health and education should be large enough to boost human development indicators, which would also raise international competitiveness.

### Balance of payments vulnerability and crises
- The bulk of consumption needs are imported, so imprudent fiscal policy tends to spill over into declining international reserves and eventually trigger balance of payments crises—a frequent occurrence in the Caribbean.
- Examples from Barbados:
  - Balance of payments crises in 1991 and 2018 both originated from fiscal policy failures.
  - Both crises were successfully addressed by policies centered on fiscal consolidation while maintaining the exchange rate peg, in the context of an IMF-supported program.

### Author background and perspective
- The analysis draws on the author’s decades of hands-on economic policy experience, both at the IMF and at the Central Bank of Barbados, where he served as governor from 2009 to 2017.
- The reviewer, BERT VAN SELM, was the IMF mission chief for Barbados from 2017 to early 2023.

*Finance & Development | June 2023*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2023/june/book-review-van-selm.pdf_