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ECONOMIC
VULNERABILITY AND
RESILIENCE WITH
SPECIAL REFERENCE
TO SMALL ISLAND
DEVELOPING STATES
Prepared by
LINO BRIGUGLIO,
Small States Network for Economic Development
for the
BRUSSELS POLICY BRIEFING NO. 27
4th April 2012
1
Layout
The presentation is organised as follows:

Economic Vulnerability

Economic Resilience

Juxtaposing economic vulnerability and resilience

Results of the
categorisation

Policy Implications and concluding considerations
resilience
index
and
country
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ECONOMIC VULNERABILITY
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Meaning of Economic Vulnerability
Economic vulnerability refers to inherent proneness of an
economy to harmful exogenous shocks.
In the case of small states, such vulnerability arises from
the fact that the economies of these states are, to a large
extent, shaped by forces outside their control.
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Studies on Economic Vulnerability
Studies on economic vulnerability so far have focused on
measuring the phenomenon by proxying exposure to shocks.
The so-called UNCDP index, used for the graduation from
LDC status also attempts to factor-in structural factors.
What follows is based on the Economic Vulnerability Index
developed by the University of Malta.
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Studies on Economic Vulnerability
The research carried out by the University of Malta focuses on
inherent (as against policy induced) factors that lead to
exposure to external shocks, and is measured by:
 Openness to international trade
 Export concentration
 Dependence on strategic imports.
The studies carried out by the University of Malta (Briguglio,
1995; Briguglio and Galea, 2003) conclude, like many other
studies, that small states tend to be more economically
vulnerable than other group of countries
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What causes Economic Vulnerability?
 Trade
openness, measured by Exports + Imports/2 as a
ratio of GDP, arises because (a) small states import a high
proportion of their final expenditure due to limited natural
resource endowments and (b) export a high proportion of their
output mainly due to the limited size of the domestic market
and to meet import expenditure.
 Export concentration (i.e. reliance on a few items of
exports of goods and services) is relatively high in small states
because of their limited diversification possibilities. This leads
to the risk of having too many eggs in one basket.
 High dependence on strategic imports (food, fuel and
industrial supplies) leads to high exposure to shocks. These
imports are characterised by low price and income elasticity of
demand and therefore have a high impact on small states
when the prices of these imports change.
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Success In Spite of and Not because of
Economic Vulnerability
►
►
►
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’
One can explain this paradox by juxtaposing economic
vulnerability with economic resilience.
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ECONOMIC RESILIENCE
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Meaning of 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 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
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Economic Resilience Index
The University of Malta has also undertaken research to
explain why, in spite of their vulnerability, some small
states like Malta, manage to attain economic success.
The policy framework that was investigated towards this
end was labelled “resilience building”. The measurement of
such policies was labelled “resilience index”.
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What helps to Build Economic Resilience?
A framework for the measurement of economic resilience
was developed by Briguglio, Cordina, Vella and Farrugia
(2006; 2009) who constructed a resilience index,consisting
of the following components:
► macroeconomic stability;
► market efficiency;
► good governance; and
► social development.
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Macroeconomic stability
Macroeconomic stability relates to the interaction between
an economy’s aggregate demand and aggregate supply. If
aggregate expenditure in an economy moves in equilibrium
with aggregate supply, the economy would be
characterised by internal balance, as manifested in a
sustainable fiscal position, low price inflation and an
unemployment rate close to the natural rate, as well as by
external balance, as reflected in the international current
account position or by the level of external debt.
These can be all considered to be variables which are
highly influenced by economic policy and which could act
as good indicators of an economy’s resilience in facing
adverse shocks.
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Macroeconomic stability
The macroeconomic stability component of the resilience
index proposed in this study consists of three variables,
namely
 the fiscal deficit to GDP ratio;
 the sum of the unemployment and inflation rates; and
 the external debt to GDP ratio.
Good performance in these variables indicate that the
country will have room for manoeuvre when being affected
by shocks.
The variables are available for a reasonably wide set of
countries spread over a spectrum of stages of
development, size and geographical characteristics.
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Market efficiency
The science of economics views markets and their efficient
operation through the price mechanism as the best way to
allocate resources in the economy. If markets adjust rapidly
to achieve equilibrium, following an external shock, the risk
of being negatively affected by such a shock will be lower
than if market disequilbria tend to persist. Indeed, if with
very slow or non-existent market adjustment, resources will
not be efficiently allocated in the economy, resulting in
welfare costs, manifested, for instance, in unemployed
resources and waste or shortages in the goods markets.
These considerations have important implications for
resilience of the shock absorbing type.
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Market efficiency
The market efficiency indicators used related to:
 the financial market. These indicators assess the extent
to which (a) the banking industry is dominated by private
firms; (b) foreign banks are permitted to compete in the
market; (c) credit is supplied to the private sector; and (d)
interest rates are in line with the workings of the market.
 the labour market. Here the indicators relate to unduly
high unemployment benefits (which could undermine the
incentive to accept employment), dismissal regulations,
minimum wage impositions, centralised wage setting,
extensions of union contracts to non-participating parties
and conscription.
 Bureaucratic control of business activities. This indicator
measures the extent of government interference which is
also thought to inhibit market efficiency.
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Good Governance
Good governance is essential for an economic system to
function properly and hence to be resilient. Governance
relates to issues such as rule of law and property rights.
Without mechanisms of this kind in place, it would be
relatively easy for adverse shocks to result in economic
and social chaos and unrest. Hence the effects of
vulnerability would be exacerbated. On the other hand,
good governance can strengthen an economy’s resilience.
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Good Governance
The Economic Freedom of the World Index (Gw has a
component which focuses on legal structure and security of
property rights. This is considered to be useful in the
context of the present exercise in deriving an index of good
governance. The component covers five sub-components,
namely:
 judicial independence;
 impartiality of courts; (c) the protection of intellectual
property rights;
 military interference in the rule of law; and
 political system and the integrity of the legal system.
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Good Governance
An alternative governance index is presented by the World
Bank (Kaufmann et al., 2006). A Pearson correlation test of
the World Bank governance indicators and the Economic
Freedom of the World's "legal structure and security of
property rights" component yielded a value of 0.92. Thus,
both indices are likely to be measuring a similar
phenomenon. In fact when the Kaufmann Index was used
in the compilation of the resilience index the ranking of
countries only changed marginally.
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Social Development
Social development is another essential component of
economic resilience. This factor indicates the extent to
which relations within a society are properly developed,
enabling an effective functioning of the economic apparatus
without the hindrance of civil unrest. Social development
can also indicate the extent to which effective social
dialogue takes place in an economy, which would in turn
enable collaborative approaches towards the undertaking
of corrective measures in the face of adverse shocks.
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Social Development
Social development can be measured in a number of ways.
The variables chosen for the resilience index werethe
education and health indicators utilised to construct the
UNDP Human Development Index.
 Educational advancement, measured by the adult literacy
rate and school enrolment ratios, is considered to be a
good indicator of social development. In addition, an
improved standard of education could be indicative of an
improved ability to cohere in the face of external shocks—a
condition conducive to economic resilience.
 Life expectancy at birth is considered to be suitable for
measuring the health aspects in society. This in turn is
likely to be related to medical facilities, housing and degree
of proneness to accident or risk of injury.
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JUXTAPOSING
VULNERABILITY AND RESILIENCE
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Juxtaposing Vulnerability and Resilience
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 the following figure.
The figure shows that risk has two elements:
► the first is associated with the inherent vulnerability conditions of the country that expose it shocks, and
► the second is associated with good economic governance
► the risk of being adversely affected by the shock is
therefore the combination of the two elements.
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Juxtaposing Vulnerability and Resilience (cont)
Risk of being harmed by external shocks
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FOUR COUNTRY SCENARIOS
On the basis of this methodology, one can propose 4
scenarios into which countries may be placed according to
their vulnerability and resilience characteristics. These
scenarios are termed “best-case”, “worst-case”, “selfmade”, and “prodigal-son”.
► Countries classified as “self-made” are those that take
steps to mitigate their inherent vulnerability by building their
economic resilience, thereby reducing the risks associated
with exposure to shocks.
► Countries falling within the “prodigal-son” scenario are
those with a relatively low degree of inherent economic
vulnerability but which adopt policies that expose them to
the adverse effects of exogenous shocks.
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FOUR COUNTRY SCENARIOS (cont)
►
►
The “best-case” scenario applies to countries that are
not inherently highly vulnerable and which at the same
time adopt resilience-building policies.
Conversely, the “worst-case” scenario refers to
countries that are inherently highly vulnerable but make
matters worse by adopting policies that exacerbate the
negative effects of their vulnerability.
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FOUR COUNTRY SCENARIOS (cont)
►
►
These four scenarios or cases are depicted in the
following figure, where the axes measure inherent
economic vulnerability and nurtured resilience,
respectively.In this scheme the best situation in
economic terms falls in quadrant IV.
The vulnerable small island states that have adopted
resilience-building policies are likely to fall in quadrant II.
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Vulnerability Index
FOUR COUNTRY SCENARIOS (cont)
Resilience Index
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RESULTS OF THE
RESILIENCE INDEX AND
COUNTRY
CATEGORISATION
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Results of the V&R Juxtaposition
Results produced by Briguglio et al (2006)
Malta
Singapore
Jamaica
Trinidad &
Tobago
Resilience
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Results of the V&R Juxtaposition (cont)
The overall tendencies that emerged from the study:
► 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,
including Malta;
Vulnerability
► 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.
Resilience
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CONCLUDING
CONSIDERATIONS
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Concluding Considerations
Main Implications
► The main implication of this presentation is that
vulnerability has negative connotations on economic
development due to the effects of negative external
shocks.
► On the other hand, resilience building has a positive
influence on economic development as it helps a country
to withstand or absorb these shocks.
► Also, economic resilience building is associated with good
economic governance.
► Many small states succeed economically in spite of the
small size constraints, due to good economic governance.
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Concluding Considerations (cont)
Usefulness for policy
► The juxtaposition of economic vulnerability and resilience
permits an assessment of the reasons behind the
economic success or failure of small vulnerable countries.
► This approach was utilised in a recent ESCAP study
(ESCAP, ABD, UNDP, 2010).
► A number of policy implications emerge from this
presentation, but the most important one is the small states
should give major importance to resilience building by:
- reducing instability,
- improving the workings of the market,
- enhancing political governance, and
- promoting social development.
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Concluding Considerations (cont)
Usefulness for country profiling
► For the purposes of policy formulation and implementation,
it is useful to undertake in-depth investigation of issues
within the specific context of the country and its
circumstances
► This was done by the Commonwealth Secretariat in
collaboration with the University of Malta through profiling
exercises. These exercises have enabled a number of
small island states to carry out a self-examination in order
to identify gaps in their policy framework. Visit:
http://publications.thecommonwealth.org/Uploaded/Product
s/ProductInfoPDF/Profiling%20Vulnerability%20and%20Re
silience841.pdf
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REFERENCES
► Briguglio, L. (1995). “Small Island States and their Economic Vulnerabilities,”
World Development, Vol.23 (9): 1615-1632.
► Briguglio, L. Cordina, C. Farrugia, N. and Vella, S. (2006). “Conceptualizing and
Measuring Economic Resilience.” In Building the Economic Resilience of Small
States, Edited by L. Briguglio, C. Cordina and E.J. Kisanga, Malta: Islands and
Small States Institute and London: Commonwealth Secretariat.
► Briguglio, L. Cordina, C. Farrugia, N. and Vella, S. (2009). “Economic
Vulnerability and Resilience: Concepts and Measurements.” Oxford Development
Studies,Vol. 37 (3): 229- 247
► Briguglio, L. and Galea, W. “Updating the Economic Vulnerability Index.”
Occasional Papers on Islands and Small States, No. 2003-4. Malta: Islands and
Small States Institute. (2003).
► Briguglio, L., Cordina, C. Vella, S. and Vigilance, C. (2010). Profiling Economic
Vulnerability and Resilience: A Small States Manual. London: Commonwealth
Secretariat.
► ESCAP, UNDP, ADB (2010). Achieving the Millennium Development Goals in an
Era of Global Uncertainty. Asia-Pacific Regional Report 2009/10 (Annex 3)
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THANK YOU FOR YOUR ATTENTION
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