The Baltic Republics and the Crisis of 2008–2011

Abstract

This essay explores how the Baltic republics responded to the crisis of 2008–2011. We argue that while there are significant differences in how the Baltic economies responded to the crisis, these responses not only remain within the neo-liberal policy paradigm characteristic of the region from the early 1990s, but that the crisis radicalised Baltic economies and particularly their fiscal stance. We show that there are a number of unique features in all three Baltic republics' political economies that made such a radicalisation possible. However, these unique features make it almost impossible for the Baltic experience to be replicable anywhere else in Europe.

Notes

Research for the essay is partially funded by the Estonian Science Foundation (grant no: 8418), Mobilitas Grant of the European Social Fund (no: MJD43) and the EU FP7 project COCOPS. We would like to thank Aleksandrs Cepilovs for his help with researching this essay, and Jan Kregel and Ken Shadlen for their comments on earlier versions of this essay.

¹ The debate between Krugman and President Ilves took place in blog posts and twitter tweets, mostly in June 2012. A brief summary is available at: http://www.washingtonpost.com/blogs/reliable-source/post/estonian-president-hammers-paul-krugman-on-twitter/2012/06/07/gJQApU0zLV_blog.html, accessed 6 August 2012. See also Grennes (2012).

² Dani Rodrik offers a measured discussion of the conference in his blog entry, available at: http://rodrik.typepad.com/dani_rodriks_weblog/2012/06/what-i-learned-in-latvia.html, accessed 6 August 2012.

³ See also Åslund (2009, 2012).

⁴ Between 2003 and 2007 Latvia witnessed more than a tripling and Estonia and Lithuania more than a doubling of real-estate prices (EC 2010, p. 26).

⁵ The European Commission (2010, p. 46) noted that the growth rates of mortgage loans were especially high in the Baltic republics, with growth rates ‘among the highest recorded in emerging economies in recent times’. See Herzberg (2010) for a more detailed discussion on the private sector debt overhang.

⁶ With respect to financial markets, the Baltic governments did adopt some steps to cool the bubble, such as increasing reserve requirements and tightening the formula for calculating capital adequacy ratios, but these measures came either too late or were insufficient, given the largely foreign-owned banking sector which would have called for swifter and tighter cross-border cooperation between the authorities (Deroose et al. 2010, p. 5).

⁷ By fiscal consolidation we mean the improvement of government's budget-deficit-to-GDP ratio via discretionary changes in fiscal policy (i.e. by expenditure cuts and/or revenue increases).

⁸ Convergence programmes were required for new EU member states and contained commitments to policies and set timetables aimed at achieving compliance with the EU's Growth and Stability Pact which set the conditions for membership of the eurozone. All countries' convergence programmes are available at: http://ec.europa.eu/economy_finance/economic_governance/sgp/convergence/programmes/2012_en.htm, accessed 1 September 2012.

⁹ See also Raudla and Kattel (2011a, 2011b).

¹⁰ As of 2008, 88% of Latvia's private debt was in euros, followed by Estonia (with 85%) and Lithuania (with 64%).

¹¹ See also Purfield and Rosenberg (2010) and Raudla and Kattel (2011a).

¹² As Hansen (2010) put it, ‘In all Baltic Republics devaluation, rightly or wrongly, is seen as Pandora's Box size XXXL and rapid euro introduction is seen, again rightly or wrongly, as an entry ticket to monetary Nirvana’.

¹³ The IMF, in contrast, initially advocated external devaluation.

¹⁴ See, for example, Raudla and Kattel (2011a, 2011b) for a detailed analysis of the austerity discourse in Estonia.

¹⁵ Detailed discussion of the austerity measures undertaken in all three Baltic republics is provided in Raudla and Kattel (2012).

¹⁶ These numbers reflect annual wage changes in the entire public administration, including the local governments (Masso & Krillo 2010).

¹⁷ In 2009 the pay of politicians, judges and civil servants was reduced by an average of 10%; the pay of employees in institutions and organisations supported by the state budget institutions was reduced by 8% on average and the pay of teachers and employees in the social sector and culture was cut by 5%. Although pay reductions were meant to be temporary in 2009, they were extended in 2010.

¹⁸ Following a constitutional court ruling in Latvia, the government had to cancel the pension cut and compensate for the unpaid parts of the pensions. Nevertheless, the indexation of pensions was frozen from the end of 2013. In Lithuania, progressive cuts to pensions were implemented in 2010, with larger pensions facing larger cuts.

¹⁹ In Estonia, the state-financed contributions to the second pillar were stopped from 1 July 2009 until 31 December 2010. In both Latvia and Lithuania, the part of the social insurance contributions transferred to the funded pillar was reduced (from 5.5% to 2% in Lithuania and from 6% to 2% in Latvia). The savings from this measure were considerable, ranging between 0.5% and 1% of GDP per year.

²⁰ In Latvia, the standard VAT rate was increased from 18% to 21% in 2009 and then to 22% in 2011. The VAT increases were from 18% to 21% in Lithuania and from 18% to 20% in Estonia. In addition, the lists of goods with favourable VAT rates were shortened and the favourable rates were increased.

²¹ The revenue generated by additional dividends amounted to 0.78% of GDP in 2009 and 0.31% of GDP in 2010.

²² For example, Lithuania explicitly waited in the early 1990s to see how the Currency Board would work in Estonia (Hanke 2009).

²³ Proceeding from the assumption that the GDP growth for 2008 would be 3.7% (instead of the projection of 7% growth that had been the basis for adopting the initial budget for 2008), the supplementary budget reduced projected revenues by €390 million (with the lower than originally projected GDP growth leading to lower tax revenues) and expenditures by €205 million (implying an expenditure cut of 3% compared to the originally planned budget and amounting to about 1% of GDP). Of those cutbacks, €44 million came from investments, €145 million from transfers and €11 million from operating costs.

²⁴ Parex held at the time about 20% of the domestic banking market (Purfield & Rosenberg 2010).

²⁵ In fact, Estonia was able to participate in this support action with €100 million. This lent considerable political support both domestically and internationally to the Estonian government. Furthermore, government reserves gave the Estonian government significantly more room in terms of building the case for fiscal retrenchment as international financial support with respective conditionalities was depicted as a loss of sovereignty: the politicians could argue that Estonia still needed to hold on to the accumulated reserves, in order to avoid a situation similar to Latvia's, which in turn necessitated fiscal retrenchment, rather than spending the entire rainy-day fund.

²⁶ Elections to the European Parliament were held in all three countries in 2009.

²⁷ The new Employment Contracts Law in Estonia, enacted in July 2009, relaxed provisions pertaining to regular labour contracts, notice periods for redundancies were shortened, severance payments were curtailed and constraints on using fixed-term contracts were lifted. In Lithuania, the regulations concerning flexible work arrangements, such as temporary and part-time employment, were relaxed, but additional security for workers under fixed-term contracts was stipulated at the same time (Masso & Krillo 2011).

²⁸ Comparing 2008 and 2009, the expenditures on labour market policies increased from 0.2% to 1% of GDP in Estonia and from 0.4% to 0.9% of GDP in Lithuania (Masso & Krillo 2011, p. 43).

²⁹ For example, for start-up subsidies, the available sum was doubled, eligibility conditions relaxed and the self-financing rate decreased. The ceiling for subsidised loans available for start-ups was doubled (Masso & Krillo 2011).

³⁰ For a more detailed overview of the labour market measures adopted in the Baltic republics, see Masso and Krillo (2011, Appendix 1).

³¹ See http://ec.europa.eu/economy_finance/economic_governance/sgp/convergence/programmes/2012_en.htm, accessed 2 September 2012.

³² See http://ec.europa.eu/economy_finance/economic_governance/sgp/convergence/programmes/2012_en.htm, accessed 2 September 2012.

³³ For a discussion on the evolution of budgetary institutions in Estonia, see Raudla (2010a, 2010b).

³⁴ See Suurna and Kattel (2010) for a case study.

³⁵ See also Ikstens (2010, p. 1056) for discussions on the role Commissioner Alumina played in the introduction of tax increases and the progressive real-estate tax in Latvia in 2009.

³⁶ In fact, Andrius Kubilius, Lithuanian Prime Minister from 2008, was also in office during the aftermath of the Russian crisis in Lithuania in 1999–2000, a fact that supported his credibility in the post-2008 crisis (see also Brozaitis 2005).

³⁷ In Estonia, the Union of Pro Patria and Res Publica (Isamaa ja Res Publica Liit), a conservative political party, campaigned for a balanced budget rule in the run-up to 2011 parliamentary elections. In Latvia, a set of fiscal rules on budget balance, debt level and countercyclical fiscal policy were being planned.

³⁸ As Kuokstis and Vilpisauskas (2010) point out, in Estonia public trust in the government actually increased at the height of the crisis in 2009: while in spring 2009, 38% of the population trusted the national government, the figure increased to 47% by the autumn of 2009, after three austerity packages had been adopted.

³⁹ In Estonia mass protests as a means of expressing discontent had been stigmatised in spring 2007, when Russian-speaking youths reacted with riots and looting to the relocating of the Bronze Soldier statue commemorating the Soviet victory over Nazi Germany from the city centre of Tallinn. Thus, as argued by Kattel (2010), the Estonian public feared that mass protests against the government's austerity measures would be likened to the rioters and looters during the Bronze Soldier events.

⁴⁰ See Ikstens (2010, p. 1055) on Latvia and Woolfson (2010, p. 496) on Lithuania.

⁴¹ As Woolfson (2010, p. 502) notes, trade unions in Lithuania were reluctant to organise another major protest action as they did not want to be made responsible for provoking social unrest and violence.

⁴² For example, in summer 2009 the Lithuanian trade union confederation protested against the government plan to cut basic monthly salaries in the public sector, which would have primarily affected the lowest paid employees, by organising a hunger strike in front of parliament. As a result of the protest, the government amended the plan and introduced more progressive pay cuts (Masso & Krillo 2011, Appendix 3).

⁴³ As Woolfson (2010, pp. 504–5) notes, the pact still entailed cuts to wages, pensions and parental benefits.

⁴⁴ For more detailed discussions, see Raudla and Kattel (2011a, 2011b).

⁴⁵ See also Raudla and Kattel (2011a, 2011b).

⁴⁶ See also Kuokstis and Vilpisauskas (2010). In 2009, net migration from Estonia remained unchanged, but increased to 2% of the population from Latvia and to almost 5% from Lithuania (Eurostat, available at: http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database, accessed 6 August 2012).

⁴⁷ In 2009, trade union density was 7.6% in Estonia and 10% in Latvia and Lithuania (Gonser 2011).

⁴⁸ As Gonser (2011, p. 412) points out, although on a number of occasions collective agreements were changed and pay cuts or freezes implemented without consultation with unions, employees accepted the changes without protests.

⁴⁹ See van Apeldoorn (2009); for a discussion of this concept in the context of the crisis, see Bideleux (2011).

⁵⁰ See also Thorhallsson and Kattel (2012).

⁵¹ Estonia's prime minister in 2012 had been in office since 2007; the leading coalition party, the Reform Party (Reformierakond), had been in the government since 1999.

⁵² On Estonian minority politics, see Aidarov and Drechsler (2011).

⁵³ See also Woolfson (2010).

⁵⁴ See Peters and Pierre (2004) on forms of politicisation.

⁵⁵ See also Åslund (2010, pp. 7, 32).

⁵⁶ See also Lütz and Kranke (2010) for interviews with the IMF staff.

⁵⁷ While in 2009 tax revenues fell by about 30% in Latvia and Lithuania, they declined by less than 5%, year on year, in Estonia (see also Staehr 2010).

⁵⁸ See Table 1; see also Krugman (2011) and Knibbe (2011). In 2009, the private sector outpaced the public sector in Lithuania in nominal pay adjustments. The pattern was similar in Estonia, while in Latvia the public sector led by a wide margin (see, for example, Table 4 in Purfield and Rosenberg (2010)).

⁵⁹ See also Grennes (2012).

⁶⁰ See also European Commission (2010, p. 64).