Monday, 16 April 2012

A 'closer look at Estonia'

Michael Burke: ‘Those who declare with infinite certainty that spending cuts and tax increases cannot work, or that there is no example of an economy cutting its way out of recession should take a closer look at the Baltics.’ So says Dan O’Brien, the Economics Editor of the Irish Times.

When it has been previously pointed out that other European countries, such as Germany and Sweden adopted measures to stimulate the economy, we were told that Ireland is unique. When we pointed that small open economies like Belgium had imposed windfall taxes on banks and energy companies to fund government investment, we were told Ireland is not Belgium. Since tautology cannot be disproved, this seemed to settle matters, at least to our critics’ satisfaction.

But now we are told, Ireland is Estonia, or at least should emulate its ‘success’, which is all that was being asserted in the case of countries which boosted investment to spur recovery. Tom McDonnell’s piece on the Baltic States is very welcome in puncturing this nonsense.

There is just one point worth adding, I think. That is, there is no ‘success’ of the Estonian model via what is euphemistically called internal devaluation, aka severe wage cuts to boost the rate of profit.

Below is a table compiled from the IMF country report that Tom helpfully linked to. It shows 3 things. First is the level of GDP growth. Here the Estonian Finance Ministry has issued an updated forecast for 2012, which is that growth will slow dramatically to 1.7% in 2012. Second is the net contribution from the EU as a proportion of GDP. Third is simply the sum arising from deducting two from one, ie what growth would have been without the EU net contributions. The latter does not include any multiplier effect from the spending of the EU, just its arithmetical total.

Estonia GDP and EU Subventions

Source: calculated from IMF, Estonian Finance Ministry data

Before taking into account EU funds, Estonian GDP is now officially expected to end 2012 still 7.6% below its peak in 2007. The entire EU subvention over the period will be equivalent to 20.6% of GDP. The entire growth over the period, from the low-point is just 11.6%. Without the EU funds the Estonia economy will have contracted over the period by 25.3% (again, taking no account of any multiplier effects arsing from that investment).

As is well-known, the EU is a public body. Insofar as there has been any recovery in Estonia it is entirely a function of state, or supra-state bodies. Equally it is well understood that these subventions come in the form of subsidies to particular sectors, especially agriculture, and in the form of structural and cohesion funds. These investment funds are the larger part of the EU funds provided, equivalent to 16% of GDP over the period. They concentrate on infrastructure, transport and other areas.

The ‘internal devaluation’ model has been a disaster for Estonia. Those who want to rescue profits by reducing wages are searching far and wide to find examples of where this had led to growth. But they are failing. The sole success for Estonia over the period has been investment from state bodies. This is the lesson from the Baltics, and one which does apply to Ireland.


paul sweeney said...

This is an informative and helpful piece.
It is worth pointing out that there has been no internal devaluation in Ireland with falling average wages. Overall Irish earnings on an hourly basis have been surprisingly stable, since the Crash of 2008. The aggregate wage bill has fallen as over 300,000 jobs were lost and public sector employees took a big bit too, as did some in the private sector.
But for those still in work, most have not been hit, though only a minority have had wages rises. They are largely in the exporting sectors which we have been repeatedly told will be our saviours, lifting the whole economy into growth.
Those economists who see competitiveness only in terms of short-run movements in aggregate worker's wages are puzzled by the "inflexibility of the Irish labour market", Yet many studies show how flexible the Irish labour market is (in terms of non wage factors).

govs from Latvia said...

The positive role of EU funds has been greatly exaggerated in the West. First, these are allocations, not real money. National pre-financing at 100% is needed to finish the projects, and in reality can severely spoil the government’s balance sheet. Structural funds are absolutely not something like Framework program where the cash flow starts immediately after signing the contract. Therefore large amounts of Structural funds are not used because there is just not money for pre-financing. Banks view Structural fund projects as very risky, and often the project realisateurs need to pay more than 100% for the lettre accreditive which they need to supply together with a Structural fund project. Not a surprise that JC Juncker has called all this European Structural fund system a European perversion.

The only similarity between Estonia and Ireland is in the high export dependence. Other similarities – as the enormous bank bailout costs – are completely missing. Bank system stabilisation costs for Estonia were 0,00. It is rather surprising how a country with no crisis costs fared so badly – the GDP loss has been -20%. The other bad example is just over the Finnish bay – Finland also fared badly during crisis with GDP loss in 2008 of -7%. Despite all the exaggerated Finnish research excellence, numbers of scientific articles and other decorations.

Increase in essential competitiveness has not happened in any of the Baltic states. Producer prices have fallen for minuscule 2-3%, because austerity measures have led to rapid dying of firms and unprecedented monopolisation and oligopolisation. There have been scientists at least in Latvia which have analysed competitiveness issue in detail. One of them also emphasizes that there were no institutional improvements in bank supervision, which was then greatly confirmed by the bankruptcy of Latvian Krajbanka (Sparkasse!) just a few months ago. The problem is that Latvian authors are rarely accepted by contemporary scientific journals, and therefore the economic literature is missing the field research. Analysis of Baltic case in the scientific literature is dominated by mathematic and econometric equilibristic by well-renowned economic dreadnaughts, not verified in the practice even for the smallest details.

It is somewhere surprising why the Irish economy has been analysed by so banal comparisons. IE economy is extremely competitive, confined with very few bilateral investment treaties. The Irish problem has been the banking sector, however, what the help for that if the competitiveness increases 10 times??