A Microstate with Scale Economies: The Case of Iceland

This paper looks at the importance of scale economies – defined in terms of the benefits from innovation – from both a theoretical and an empirical perspective. We argue that one can only gauge the degree of scale economies at the industry level by taking account of the degree of specialization – hence the reliance on international trade – as well as the size of an economy. We show that in Iceland specialization in fishing results in a sector which ranks 13 in the world, hence belying the small size of the population and the overall economy. Not surprisingly, the bulk of R&D in Iceland is focused on providing this industry with an ever-expanding range of inputs, resulting in a high rate of growth of GDP – as well as a high standard of living in the country as a whole – in comparison with other OECD economies. JEL Classification System: Q2, Q3, O1