Liechtenstein: It is worth taking a closer look
About the challenges of a small state – or: Can we learn something from Liechtenstein?
With almost 40,000 inhabitants, Liechtenstein is not only one of the smallest countries in Europe, but also one of the wealthiest in the world. When looking for the reasons for the high level of prosperity, you will certainly be surprised – and you will have to bury one or the other prejudice about the small neighboring country.
Liechtenstein is primarily known abroad for its financial centre. Surprisingly, however, the main reason for the high level of prosperity is not in the financial sector. At 46 percent, Liechtenstein’s industrial sector contributes almost half to the gross domestic product (GDP) – more than twice as much as the financial sector. The strong industrial base, which distinguishes Liechtenstein from other financial centers, consists of many SMEs, but also some large and globally successful niche players. The high level of innovation in Liechtenstein is striking. Expenditure on research and development is over six percent of GDP, higher than in any OECD country and almost twice as high as in Austria. This expenditure pays off: Liechtenstein had almost 500 patent applications in 2021 and more than forty times as many per capita as Austria. Productivity is correspondingly high, and so is the average wage. But why is Liechtenstein so successful?
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Short distances
Liechtenstein is located in prosperous Central Europe and the economically dynamic Lake Constance region. Within these framework conditions, it is possible to use the advantages of small size in connection with statehood for oneself. Liechtenstein already laid important economic policy foundations for this in the interwar period, for example through the creation of a liberal economic and legal system. In addition, the task-economic cost disadvantages of the small size could be cushioned by concentrating only on really necessary state concentrations and by reducing certain expenditure burdens through international partnerships. The small-state “short paths” in politics, administration and business and the associated flexibility and speed of action were also helpful.
Another success factor is the special institutional environment. On the one hand, Liechtenstein has had a customs union agreement with Switzerland since 1923, on the other hand, the small state is a member of EFTA, the WTO and the European Economic Area (EEA). Through the EEA, the principality is part of the European single market and thus also takes over EU regulation. Liechtenstein is the only country that has market access both in the EU/EEA area and in free Switzerland – a major competitive advantage. In addition, Liechtenstein is in a currency union with Switzerland and thus benefits from the stability of the Swiss franc, albeit without a say in monetary policy.
No debt
Other important factors are political stability and healthy public finances. Liechtenstein has no debt, but a high public net worth, which clearly emphasizes the GDP. Even in the Corona crisis year 2020 – despite the package – a clear budget surplus was recorded. The goal of a healthy public budget is undisputed in politics, among other things in order to preserve the independence of international bond markets as a small country.
In addition to the direct-democratic elements, the key lies in political transparency. When it comes to public spending, every franc can be tracked down to the last detail, which ensures public control and implicit savings. As a result, the state and fiscal ratios are at a consistently low level in an international comparison and are less than half as high as in Austria. The focus of fiscal policy – also against the background of the low multiplier – is not on anti-cyclical measures, but on creating good economic framework conditions, for example through little bureaucracy or good infrastructure if possible.
Similar to other (very) small open economies, Liechtenstein is characterized by high GDP volatility and sensitivity to global economic shocks. The volatility is more than twice as high as in the larger neighboring countries, in the financial crisis of 2009 and in the Corona crisis of 2020 the GDP collapsed in the double-digit percentage range. But Liechtenstein has learned to deal with these economic fluctuations: Unemployment rose to just two percent during the Corona crisis, and it was not much more during the financial crisis.
Resilient labor market
The Liechtenstein labor market is therefore very stable when it comes to economic downturns and the empirical connection between GDP growth and the unemployment rate, also known as Okun’s law, is practically non-existent. The tax system also plays a role here: the deduction of interest on equity creates an incentive for companies to keep a lot of equity in the company in order to reduce the tax burden on profits. As a result, the Liechtenstein economy has a very low level of debt. This means that companies can afford to keep employees in a recession. However, the shortage of skilled workers is also likely to play a relevant role: recruiting new skilled workers would probably be more expensive for the company than continuing to create the existing ones during phases of economic weakness.
Of course, Liechtenstein is not an island of the blessed and also faces practical economic policy problems that are similar to those of other countries. For example, the debt ratio of private households is high due to the high real estate prices and is associated with corresponding risks. However, it is crucial that the problems are tackled proactively and transparently by authorities and politicians.
Today there are more employees in Liechtenstein than inhabitants and the gross national income per capita is the highest in the world. The fact that about a third of the Liechtenstein population has a passport, that more than half of the employees commute from abroad and that key positions – including in public administration and the judiciary – are held by people without Liechtenstein citizenship is seen as completely normal. In any case, the mixture of an optimal legal and institutional environment, political stability, transparent and healthy public finances, economic openness and high reserves in the private sector seems to be a recipe for success that makes it worthwhile for other countries to take a closer look.
Martin Gaechter is Head of Financial Stability at the Financial Market Authority (FMA) Liechtenstein and previously worked for the OeNB and the ECB, among others. He received his doctorate and habilitation from the University of Innsbruck.
Andrew Brunhart is Head of Economics Research at the Liechtenstein Institute. He received his doctorate from the University of Vienna.