Conclusion

This paper has argued that size matters for economic performance and that country size is endogenous and depends on economic factors such as free trade, public goods pro­vision and preference heterogeneity.

Much remains to be done. On the theoretical side, we have shown how scale effects could be derived in a simple neoclassical growth model, without appealing to increasing returns technologies, endogenous R&D or human capital spillovers, but simply by ap­pealing to the existence of a border effect driven by trading frictions. However, whether the scale effects that we observe in the data come from the border effect, technology or spillovers remains to be investigated.

The models that we discussed are based on the assumption that heterogeneity within a country has negative effects on average utility. However, heterogeneity may also bring about some benefits. In fact, the gains from trade in our model do stem from a kind of heterogeneity - the production of different intermediate goods by different regions - and this is why a larger country, for given barriers to trade, brings net economic gains through the trade channel. By “heterogeneity” costs here we mean the specific costs associated with disagreements over the basic characteristics of a government (including policies about official languages, religion, etc.). A richer discussion of the pros and cons of heterogeneity is certainly called for.

On the empirical side, debates are still raging. Even the literature on the effect of trade on economic performance is now subject to debates on the nature and extent of this effect. The literature on the effect of country size is even more contentious.

Finally, in a broad historical sweep, we have suggested that the types of trade-offs identified by our framework have been at play at various stages in modern history. In a way, current developments provide an ideal setting for observers of country cre­ation. Since the Second World War, increasing globalization has threatened nation-states “from above”, while rising regionalism and decentralizing forces have threatened them “from below”. The construction of the European Union epitomizes this tension, as a fundamental redrawing of the distribution of political prerogatives is being orchestrated. Powers are being transferred down through decentralization, and up through the Euro­pean construction. It is likely that if globalization proceeds apace, so will regionalism. If the backlash against globalization succeeds, however, large centralized nation-states could initiate a comeback.

Acknowledgements

We are grateful to the NSF for financial support with a grant through the NBER. We also thank Jessica Seddon Wallack for excellent research assistance. We thank Philippe Aghion, Francisco Alcala, Michele Boldrin, Antonio Ciccone, Yannis Ioannides and seminar and conference participants at the University of Modena, Harvard University, the European University Institute, the University of Rochester, and New York University for useful comments. All remaining errors are ours.

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