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I cannot truly speak as a representative voice of my micro country but I'd like to start off with mentioning some of the negative aspects of merging countries into a new one.
First, countries with a low amount of managers will certainly not be pleased about giving up their comforts in D1 leagues. Merging countries will result into the distribution of managers across several divisions and not a single one like in previous cases. They'd have to give up certain privileges as arena income and overall financial disparities.
There is also the issue of national identity. Of course people take pride into the fact that their barely populated countries(ingame) are represented within the game and the competition. Merging countries could have the said negative effect that the NT's become weakened as users might protest of the slow disappearance of their fellow countrymen in the NT.

I'd advocate for the second option, which already has tweaks of the first option, but lets take it a step further.
As the BB's have said, the NT's/ U-21's will not be merged and every country gets to keep their flags. The only overlapping variable would be that teams from different countries will be put into a 'melting pot', new leagues containing different countries.

Idk if anyone has proposed the following but Ill do it nonetheless:
If we merge smaller countries together, how about we create 2 different versions of NT's ? 1 version would be the traditional way: Every country gets to keep their NT.
However, the second version would be that we create a totally new NT as an 'Unified Basketball Association of A,B,C (etc) while also keeping the countries individual NT's ? This would imply that merged countries will have 2 versions of representative NT's :
One is representing their country, the other will contain the best of the best and will compete united against other countries.

I know this idea could have some implications and requires further discussions and tweaking but I hope you understand the general idea of my proposition.
Having 2 ''versions' of an NT could sove the nationality issue; at the same time we could observe the effects of unifying NT's for several seasons and observe potential power shifts and dynamics of the teams in ranking. We do dont have to implement them immediately. We could test them out at the same time and then make a decision in the seasons to come.

Until now I have a lot of question marks how you will handle the merge.....
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2) will they have to sell their best players if they are going down from DI to DIII...
3) will you make a complete restart????

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2) Yes, but you have to keep in mind that the managers who would end up in a third division are also the worst micro-nation teams currently. Even in merged leagues almost all of the competition will exist in divisions I and II. For the most part division III would be filled with inactive teams or terrible managers.
3) Nope.

2) Do you mean that as a practical matter they will not be able to afford them, or do you mean some sort of forced sale by rule? Either way doesn't sound so good, and forcing it seems harsh and unnecessary.
3) If that is set in concrete, I don't see how you can do anything of sufficient magnitude to make any difference at all.

I haven't made my mind up about this mergers yet, but there is one thing that you really have to take into consideration. The hostility between some of the countries will make potentially difficulties on the forums. Imagine this was 1805 and we proposed USA to be merged with England, as you speak the same language. Israel and Palestine, US and ISIS as you are already fighting a war of terror, you can join together. Aserbaijan and Armenia has been close to war over some territories.

I know this is a non political game, but on some levels you can't avoid to take this into consideration.

If a merger equals ending up in DIV III, the most common strategy would be to sell the expensice/quality players, tank the last one or two seasons and prepare the roster for the lower league. No biggie imo.

Managers of the game we wanted to create Utopia for money, now the prices of players have become absurd.

The micro-nations are not to blame.

To change things simply to interdict the transfer market teams Utopian only the draft and training.

And it is not the players to adapt, it is the game to adapt to the players.

Soon more players to fit you are alone.