Friday, 13 April 2012

The Baltic Experience

Tom McDonnell: Dan O'Brien recently argued that the Baltic countries provide good examples of the case for front loading austerity. He notes that: "Estonia’s GDP grew by a blistering 7.6 per cent last year, Latvia’s by 5.5 per cent and Lithuania’s by 5.9 per cent. The three were – by a considerable distance – the fastest growing economies in the developed world." He suggests that front loaded austerity and greater competitiveness i.e. internal devaluation, are required to resuscitate the economy.

I would argue that this feel good story needs to be put in context. Unfortunately the recent experience of the Baltic countries has not been a happy one and these countries grew so fast in 2011 in part because they had previously fallen so very far. Table 1 of this paper by Terazi and Sanel shows the scale of the decline in real GDP in 2009 alone. The Baltic countries suffered the largest declines in economic output in the EU despite already being amongst the poorest EU states in terms of GDP per capita.

The Latvian experience has been particularly traumatic. This paper from Weisbrot and Ray of the CEPR provides an overview of the Latvian experience. Latvia's loss of output was 24.1 per cent - even larger than Ireland's (see figure 1 for a comparison with historical downturns).The IMF estimates that Latvia's real GDP will only return to 2007 levels in 2016 (see figure 2). Effectively a lost decade and surely no blue print for 'best practice' in managing downturns. Weisbrot and Ray argue that the data contradicts the notion that Latvia's experience provides an example of successful internal devaluation and they caution that weaker euro zone economies should be wary of becoming locked into pro-cyclical policies.

Unemployment in the three Baltic states also remains above the EU average of 10.2%. Estonia fares best at 11.8% while Latvian unemployment is 14.6% and Lithuanian unemployment is 14.3%. The employment rate in all three countries is also below the EU average. Even these figures don't tell the full story as it is estimated that Latvia's net loss of population in 2009-2011 amounts to as much as 10 per cent of the labour force.

Overall the picture is mixed. Estonia has certainly fared better than Latvia and Lithuania. The IMF country report for Estonia is here. Figure 3 on page 23 of the pdf shows the impact on employment since Q3 2007 with net employment still below 2007 levels. GDP still remains below 2007 levels five years on, although Estonian GDP is forecast by the IMF to pass that threshold in 2012 (see table 1 on page 29 of the pdf).

I guess success is relative.


govs from Latvia said...

It is senseless to base any conclusions on Baltic example. They are very small economies, and the 100-200 thousand emigrants really was a relief to social systems. This number however is completely „Tropfen auf heissem Stein” for Ireland, Portugal, Greece or Spain.

Another point – the crisis onset was very rapid and severe, because of PAREX bank affair and the EU pressure to overtake this bank (which had several branch offices in Germany and Sweden). The following immediate sovereign bankruptcy treat followed as the bank has bankrupted the state immediately. Therefore emigration occurred in the first half of 2009, when western economies were still in pretty good fashion, and then resumed only in the 2nd half of 2010, when there was definite growth in some EU countries. This was a happy occurrence for Latvia.

Paul Hunt said...

@Govs from Latvia,

Thank you. You speak with some knowledge and conviction. Your comment is very welcome as it serves to counter the predilction here to seek out specious comparators anywhere and everywhere to justify inappropriate policy actions in Ireland - or, more frequently, to criticise ones required so as to avoid consideration of ones even more badly required.

Anonymous said...

Aren't the Baltic states in recepit of structural funds - which would heavily offset any effect of austerity measures?

Proinnsias Breathnach said...

The graph which provided the basis for Dan O’Brien’s article is based on Eurostat data on volume changes in exports which do not take relative price shifts into consideration, and therefore are a poor indicator of the economic impact of growth or decline in export value. Thus, for example, the Eurostat data show a 2.7% fall in the volume of Norway’s merchandise exports in 2011. However, two thirds of Norway’s merchandise exports consist of oil and gas, whose price appreciated significantly in 2011. As a result, the value of Norway’s merchandise exports in common dollar terms (as reported in the database of the International Trade Centre (ITC), a joint venture of the UN and WTO) increased by 20.9% in the same period.

The Norwegian case is also highly relevant to the case of the Baltic states, as petroleum and iron & steel (another commodity whose price rose strongly in 2011) figure prominently in these countries’ exports. The combined shares of these two products in the merchandise exports of the countries in question in 2011 were as follows: Lithuania 28%, Estonia 21%, Latvia 16%. Thus, to a significant extent, their rapid export growth last year is attributable to price hikes in two basic commodity sectors in which they happen to specialise.

In a letter to the Editor of The Irish Times regarding O’Brien’s article (still unpublished at the time of this writing) I added the following:

O’Brien’s suggestion that Ireland should look to the Baltic states as examples of how austerity can promote export growth is rather misplaced. The principal exports of these countries include petroleum (currently enjoying a price boom) and wood and wood products, cable and wire and basic metal products – low-value products associated with low wages.

Ireland’s principal exports are software, pharmaceuticals and business and financial services – high-wage sectors in which low production costs have little bearing on competitiveness. Ireland’s ability to attract high-quality inward investment has not been affected by the current crisis, and indeed this country was named the top destination in the world for foreign direct investment in terms of the value of the projects and investment it attracts, according to the 2011 IBM Global Location Trends report.

As the report observed: “This clearly shows that companies are looking at structural factors such as a favourable business environment, skills availability and cluster/sector strengths when deciding where to invest, rather than cyclical phenomena such as short-term economic growth
prospects or fiscal deficits.”
Working on these strengths is clearly a better option for Ireland than seeking to emulate East European countries which are over thirty years behind us in development terms.