CONCEPTUALISING AND MEASURING ECONOMIC VULNERABILITY AND RESILIENCE

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1 Layout CONCEPTUALISING AND MEASURING ECONOMIC VULNERABILITY AND RESILIENCE By Lino Briguglio University of Malta The presentation is organised as follows: 1. Introduction 2. Economic vulnerability 3. Economic resilience 4. Juxtaposing vulnerability and resilience 5. Strengths and weaknesses of this approach 6. Concluding considerations Introduction..1 The economic characteristics of small states are well documented, and include limited ability to exploit economies of scale; lack of natural resource endowments and high import content. Other characteristics relate to limitations of diversification possibilities; dependence on a narrow range of products; limitations on the extent to which domestic competition policy can be applied. Introduction..2 In the case of small island states, a major problem relates to high international transport costs and uncertainties of industrial supplies due to insularity and remoteness. Because of their high exposure to international trade small states a highly exposed to external shocks. These states could counteract or absorb these shocks if they build up their economic resilience. This paper will explore possibility, arguing that small states require support to enable them to build up their resilience against external shocks. Economic..1 There are inherent features associated with small states, which lead to economic vulnerability. Such vulnerability arises from the fact that the economies of small states are, to a large extent, shaped by forces outside their control. Economic..2 Economic vulnerability refers to proneness of an economy to exogenous shocks, lying outside its control Small states tend to be more economically vulnerable than other group of countries as many studies have shown. Manifestations of vulnerability include high degree of fluctuations in GDP and in export earnings 1

2 Economic..3 In spite of their economic vulnerability, many small states manage to generate a relatively high GDP per capita, when compared to other developing countries This has been called the Singapore Paradox referring to the Singapore experience of an economically vulnerable small state, which is economically successful. One can explain this paradox by juxtaposing economic vulnerability with economic resilience Economic resilience refers to the extent to which an economy can withstand or bounce back from the negative effects of external shocks Economic..4 Economic vulnerability indices have been constructed by various authors, including Briguglio (1995, 1997), Briguglio and Galea (2003), Commonwealth Secretariat Atkins et al (2000), United Nations Committee for Development Policy (2006). Various variables have been utilised to measure economic vulnerability. These include variables that are related to exposure to external forces, variables that capture the internal structures that lead to instability and variables that measure that magnitude of shocks/ Economic..5 The main determinants of economic vulnerability in Briguglio and Galea (2003) are: Economic openness Export concentration Dependence on strategic imports Economic..6 The main determinants of the UN Index (2006) are the following seven: population size; Remoteness from world markets; merchandise export concentration; share of agriculture, forestry and fisheries in gross domestic product; homelessness owing to natural disasters; instability of agricultural production; and instability of exports of goods and services. Economic..7 Studies on vulnerability indices generally conclude that small states tend to be more vulnerable than other groups of countries. Economic..1 Meaning of economic resilience (resilire) refers to: the ability of an economy to recover quickly following adverse shocks: shock counteraction The ability of an economy to withstand shocks: shock absorption 2

3 Economic..2 can be measured by an index which refers to what a country is doing to mitigate its inherent vulnerability, such as sound economic governance The combination of the vulnerability and resilience indices would indicate the overall risk of being harmed by external shocks Economic..3 An economic resilience index has been constructed by Briguglio, Cordina, Farrugia and Vella (2006). It includes four variables capturing shock-absorbing and shockcounteracting elements: Macroeconomic stability Microeconomic market efficiency Good political governance Social and environmental conditions Economic..4 Macroeconomic stability is important for shock- Counteraction. Components used in the index : Fiscal deficit to GDP Misery Index: Inflation + unemployment External debt to GDP Economic..5 Market flexibility is required for shock-absorption: Components used in the index: Markets and their efficient operation through the price mechanism is the best way to allocate resources in the economy Regulation of credit, labour and business (Economic Freedom of the World Index) Measures the extent to which markets operate freely, competitively and efficiently Identifies regulatory restraints and bureaucratic procedures on competition and the operation of markets Economic..6 Good political governance is an overarching requisite for good economic management conducive resilience building. Components used in the index (referring to the legal structure and security of property rights (Economic Freedom of the World Index) Judicial independence Impartiality of courts Protection of intellectual property rights Military interference in the rule of law and political system Integrity of the legal system. Economic..7 Social development, leading to well developed social relations and effective social dialogue improve the chances of effectiveness of resilience building policies: Components used in the Index, taken from the HDI: Health (life expectancy at birth) Education (adult literacy rate and school enrolment ratios) 3

4 Economic..8 Juxtaposing and..1 The resilience index was constructed as follows: All observations were standardised to give values from 0 to 1 Index was computed by taking a simple average of the four components: Macroeconomic stability Microeconomic market efficiency Good governance Social development The index was computed for 86 countries in different stages of development and of different sizes. Index Index Juxtaposing and..2 Results produced by Briguglio et al (2006) Juxtaposing and..3 Overall tendencies: countries which fall in the best-case quadrant are mostly the large developed countries; countries which fall in the self-made quadrant include a number of small states with a high vulnerability score; countries which fall in the prodigal-son quadrant include mostly large third world countries; and countries which fall in the worst-case quadrant include a few vulnerable small countries with weak economic governance. Juxtaposing and..4 Regression results indicate that resilience is positively related to GDP per capita and vulnerability is negatively related to GDP per capita Juxtaposing and..5 Creating a methodological framework: By distinguishing between inherent economic vulnerability and nurtured economic resilience, it is possible to create a methodological framework for assessing the risk of being affected by external shocks, as shown in Figure 1. Figure 1 shows that risk has two elements: the first is associated with the inherent vulnerability conditions of the country that is exposed to shocks, and the second associated with good economic governance the risk of being adversely affected by the shock is therefore the combination of the two elements. 4

5 Juxtaposing and..6 Strengths and Weaknesses of the Approach..1 Strengths: This approach could be used to: support decision-making, setting targets and establishing standards monitor and evaluate developments derive quantitative estimates disseminate of information and drawing attention to the issue Quantitative estimation helps to focus the discussion on the essential elements Promote the idea of integrated action Strengths and Weaknesses of the Approach..2 Weaknesses: The methodology requires indices to be applied. This is associated with a number of weaknesses: Subjective choice of variables Problems of measurement Averaging and weighting procedure Lack or shortage or other inadequacies of data Non-homogenous data Concluding Considerations Results of juxtaposing economic vulnerability and resilience permit an assessment of the reasons behind the economic success or failure of small vulnerable countries. is negatively related to economic development due to the effects of negative external shocks. On the other hand, resilience building influences positively economic development as it helps a country to withstand or absort these shocks. Many small states succeed economically not because they are small, but in spite of the small size constraints, due to good economic governance. References Atkins, J., Mazzi, S. and Easter, C. A Commonwealth Index for Developing Countries: The Position of Small States. London: Commonwealth Secretariat (2000). Briguglio, L. Small Island States and their Economic Vulnerabilities, World Development, Vol.23 (9): (1995). Briguglio, L. Alternative Economic Indices for Developing Countries, Report prepared for the Expert Group on Index, United Nations. (1997). Briguglio, L. and Galea, W. Updating the Economic Index. Occasional Papers on Islands and Small States, No Malta: Islands and Small States Institute. (2003). Briguglio, L. Cordina, C. Farrugia, N. and Vella, S. Conceptualizing and Measuring Economic. In Building the Economic of Small States, Edited by L. Briguglio, C. Cordina and E.J. Kisanga, Malta: Islands and Small States Institute and London: Commonwealth Secretariat, United Nations Committee for Development Policy. Overcoming Economic and Creating Employment. Report of the Committee for Development Policy on the Eighth Session (20 24 March 2006), United Nations, New York THANK YOU FOR YOUR ATTENTION! 5