 Smaller countries lack scale economies in the private sector, leading to a more concentrated production structure and exports (see for example, Lederman and Maloney (2012), Lederman, Pienknagura and Rojas (2015), and Pinies, Wacker and Varma (2015)).<sup>8</sup> Indeed, in our data set, exports of small economies (based on 1.5 million population threshold) are concentrated in services, with the share of the latter in total exports equal to 46% as opposed to just 23% in large countries. Moreover, a substantial fraction of service exports in small economies is derived from tourism. This lowers risk-sharing opportunities across sectors and regions through factor reallocation, thus increasing the exposure of small economies to domestic and external shocks, and amplifying their business cycle fluctuations. Lack of scale economies in the private sector also likely affects private investment by making it lumpy and more volatile, as well as reducing its cyclicality with GDP.

 Smaller economies are more open to trade. This influences both volatility and cyclical dynamics of macro variables in these countries. For instance, Di Giovanni and Levchenko (2012) show how country size impacts on aggregate volatility through the trade channel in the data and in a model of heterogeneous firms. They argue that when the distribution of firm sizes is fat-tailed, idiosyncratic shocks to large firms can generate aggregate fluctuations (see also Delli Gatti et al. 2005; Gabaix 2011). Since smaller countries have fewer firms they will also experience higher aggregate volatility. Trade openness also affects the cyclical properties of macro aggregates. With exports being a larger component of GDP in small economies, its cyclicality with GDP is likely to be higher in these countries. In addition, small states tend to rely more on trade taxes, both due to greater trade openness, as well as prevalence of income tax holidays, “tax havens” for multinational activity, and other incentives in some regions. This narrows their tax base and leads to more procyclical tax base and public revenues in small economies.

 Larger countries are better able to hedge imperfectly correlated shocks across their different regions and jurisdictions. In the environment of imperfect international financial markets, where countries cannot fully self-insure, this implies that smaller countries will have more pronounced business cycles. Indeed, using intranational data for the US and Canada, Imbs (2004) show that bilateral risk sharing tends to be associated with low output correlations.

 Larger countries have greater capacity to build redistributive schemes across regions/jurisdictions, which allows them to better insure against shocks and thus reduce the impact of these shocks on the economies. Such transfers may take place through changes in regional tax payments or explicit transfers in response to temporary or permanent shocks to relative regional GDP. There is a large literature in public finance measuring the extent of fiscal transfers across regions/jurisdictions within countries in response to regional income differentials (see, for instance, Boadway and Shah (2009)). Hagen (2007) and Poghosyan, Senhadji, and Cottarelli

> 8 The literature has discussed various channels through which country size may limit specialization and lead to a greater market size. For instance, Romer (1986), Lucas (1988), and others have argued that greater scale allows countries to benefit from positive externalities in the transmission of knowledge and human capital accumulation. Aghion and Howitt (1998) and Aghion et al. (2002) emphasized the idea that greater scale creates incentives for product competition and thus higher growth.

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