Stanford GSB: Stanford Business February 2001

More than half
of the world's countries have
fewer people than the state of Massachusetts.

THE WORLD BE CAME A CROWDED PLACE during the 20th century, and not just by population count. There was also an explosion in the number of new countries, many of them small. Tiny nations are nothing new, of course. Luxembourg has been around since 1839 and Monaco has been sovereign since 1419. But what about Sri Lanka, Cambodia, and Pakistan in the 1940s? Know much about Togo, Burundi, Comoros, Djibouti? They all came of age in the 1960s and 1970s, mostly as a result of decolonization. Not to mention a flock of new nations created in the 1990s by the bust-up of the Soviet Union.

Why are so many new countries forming and surviving? Stanford Business School's Romain Wacziarg, assistant professor of economics, explains that free trade makes small countries economically viable. And you can probably expect to see more new countries. Along with Wacziarg, research coauthors Alberto Alesina of Harvard and Enrico Spolaore of Brown argue that the globalization of markets goes hand in hand with political separatism.

Reviewing a half-century's worth of nation building, the researchers found that the number of countries in the world nearly tripled from 74 in 1946 to 192 in 1995. Eighty-seven countries had fewer than 5 million inhabitants, 58 had fewer than 2.5 million, and 35 had fewer than 500,000. "More than half of the world's countries have fewer people than the state of Massachusetts," says Wacziarg. What gets economically interesting is that in the same five decades, the volume of imports and exports as a share of world GDP increased by roughly 40 percent in a sample of 61 countries.

Looking at the political and economic landscape between 1870 and the present, the economists uncovered a strong association between the number of countries in the world and free trade. They also found the reverse was true during periods of protectionism. For example, tariff rates slowly increased between 1870 and the 1920s while the number of countries was stable or decreased.

After World War I, there was a global economic depression. Countries became isolationist, throwing up trade barriers to shut out the contagion of recession spreading around the world. That only led to more impoverishment, international turmoil, and a second world war. At the same time, the number of countries remained constant.

After World War II, tariff rates declined dramatically, and the number of countries rapidly rose. Many nations realized how misguided protectionist policies had been. International trade agreements, such as the General Agreement on Tariffs and Trade, were signed. It became feasible for colonial powers to let go of their overseas sources of raw material. Many of them developed trade treaties with their former colonies that provided some degree of market access to the fledgling nations.

Essentially, free trade made it possible for a small country to exist and even thrive because a country no longer needed to have every resource within its own borders. It could be politically independent while depending on trade for its economic needs.

Wacziarg and his colleagues developed two economic models, one of which shows that the economic benefits of country size depend on just how open trade is. In a trade-restricted world, political boundaries influence the size of a country's market and its productivity level. On the other hand, free trade makes country size irrelevant to the size of markets and has less of a bearing on productivity for open countries.

A second model shows that the trade environment influences the history of nation-state creation and secession. The decision to secede appears to result from a tradeoff between the economic benefits of size versus the costs of heterogeneity (such as infighting over resources) that result from large and diverse populations. Since the economic benefits of size are smaller when the world enjoys a period of relative free trade, the number of countries can be expected to rise.

The researchers' work suggests that as economic globalization progresses, political separatism will persist. In a world of global markets, larger centralized nation-states increasingly will be threatened from below by regional separatism and from above by the growth of "supranational" institutions akin to the European Union that try to capture the economic advantages of scale. Indeed, recent regionalism already has shown its head in Canada's Quebec, France's Brittany, and Spain's Catalonia, to name a few.

Economic Integration and Political Disintegration, Alberto Alesina, Enrico Spolaore, and Romain Wacziarg, American Economic Review, December 2000

Globalization