The relationship between country size and economic welfare is imprinted, rightly or not, in the perceptions of policy-makers and lay people. In spite of this, little attention has been devoted until recently to studying the specific issues that affect small countries. There are at least three good reasons to study small countries. First, about one in four countries has a population of less than 2 million people, even if the share of the world population living in these countries is less than 1 per cent. Second, the number of small countries has increased substantially in the 1990s and is likely to continue to increase. As international trade and capital flows expand and democracy becomes the norm, the relative cost of being small decreases. Third, small countries are not just smaller versions of large countries.

We distinguish political viability (the ability of a state to survive in the international community) from economic viability (its capacity to ensure a reasonable level of prosperity for its citizens). Our focus is on economic viability, more specifically, economic growth. We study the relationship between country size and economic growth in light of the economics literature, deriving implications for the case of East Timor.

SIZE AND ECONOMIC PERFORMANCE

Economies of Scale

Neoclassical growth theory identified the sources of per capita income growth as capital accumulation (the increase in the amount of physical or human capital available to each worker) and exogenous technological progress (the increase in output over time, using the same amount of capital and labour). Scale factors played little or no role in the original neoclassical framework. Endogenous growth theory shifted the focus to the root causes of technological progress. The scale of the economy became a pre-eminent candidate to explain technological progress, as endogenous growth theory associated market scale with the emergence and application of innovations. The scale of the market has been measured variously as the total amount of physical capital (Romer 1986), human capital (Romer 1990) or population (Jones 1997).