Baltic Slow Down in the Aftermath of the Financial Crisis

December 12th, 2009   Uncategorized

The economies of Estonia, Latvia and Lithuania for quite some time resembled an express train, on its way from Soviet communism to modern Europe. For those who have not visited any of the Baltic countries in the last fifteen, ten or even five years, it is impossible to fully understand the changes in the three countries, according to Peeter Luksep. He adds that it will be interesting for foundations such as the Jarl Hjalmarson Foundation “to follow the discussion on the weak link in the political life of Latvia, brought forward by the [financial] crisis”.

Riga, gray from the melting snow, provides obvious inspiration for writing about economic difficulties. But, bearing in mind the Riga of the Soviet era, the city of today is a fairy tale in every aspect, from the newly built sky scrapers and malls, down to the simplest kiosk or even litterbin.
It’s not surprising that the most common answer to questions about the economy is “if this is a crisis, what was it before?” Evidently, just as in the rest of the world, there is a widespread concern. However, these fears are beyond those emphasised in ignorant or even prejudiced comments in the western media. The Baltic countries have not experienced any Lehman crashes or car industry downturns. Here, the Swedish banks continue, as far as anyone can see, to make money and few foreign companies have left the country.

Slow Down After Record Growth
It is difficult to describe the development in terms that we in Sweden can relate to. A 12 percent fall of GDP seems a lot but it only means that the country is back on the level it was on in 2006-2007. On the labour market the boom that made it difficult for many sectors to find enough workers has been replaced with an unemployment of about the same level as Sweden’s in Estonia and Lithuania. In Latvia, unemployment is somewhat higher, but still lower than Spain. In the housing market the prices have dropped rapidly. However, since the fall follows several years of significant increases, most housing loans are still below face value.
The progress differs between the three Baltic countries, just as for the Nordic countries. Evidently, many of the preconditions are similar, for example the lack of natural resources, the forced communist occupation and the recently achieved possibilities as members of the European Union. All three countries have received a significant amount of foreign investments, mainly in the form of direct investment in business, but lately also in more speculative areas such as real estate. However, the economic focus, as well as the political habits, differ between the three countries.
Part of Latvia being more severely hit than Estonia and Lithuania can be explained by the country’s financial sector, which has been more affected by the Russian economic bust. The difficulties are also due to weaknesses in the political structure. Too many politicians have become the tools for special business interests. Although such problems exist in Latvia’s neighbouring countries as well as in many other countries in northern Europe, they seem to be more frequent in Latvia. It is hard to find any other reason for the weak state finances.
The buffer saved by several Estonian governments from different parties during the prosperous years now allows the country to combine savings with investments. Also Lithuania’s economy is more stable due to a smaller foreign dependency.

No Devaluation
In some ways the Baltic countries are very much alike. There is a fundamental commitment to continue on the liberal and market oriented path chosen so far, and there is a concern that the “old Europe” is moving towards a dead end of protectionism and governmental support aimed at wrecking competition.
Even more important is their commitment to reject devaluation. The most important reason for this is that the crisis is not due to higher costs for the export business. It is difficult to know which export would increase as a result of devaluation. However, a devaluation would hit households since many have loans in Euros and most of the energy is imported from abroad.
It should be noted that the present exchange rate fluctuations do not correspond directly to their underlining conditions. The price of the US dollar is increasing despite the economic downturn in America. Simultaneously, the British pound and the Swedish krona shrink despite a relatively strong economy, at least in Sweden. If currencies such as the krona and the British pound could be subjected to pressure based on speculation or anxiety, the dangers are even bigger for currencies such as the Estonian krona, the Latvian laten or the Lithuanian lita.
Furthermore, the crash of the ruble at the end of the Soviet era is an experience that should not be forgotten. Just as for the Germans, the memory of hyperinflation has resulted in a strong support for stable currencies. In addition, all three countries have imposed strict regulations on their currencies in order to stabilise them further.
As a consequence, the economic policy has to have the flexibility needed to compensate for these restrictions. In Estonia, which has been conducting a restrictive financial policy since their independence, while also creating a buffer, the parliament recently voted in favour of cutting the state budget with about a tenth. It has also granted the government the possibility of having a certain percent of budgetary deficit.
For Latvia, the situation is more challenging. The resigning government conducted a few drastic tax increases and budgetary cuts. However, the elected coalition, led by the young prime minister Dombrovskis, claims it remains another expected deficit of close to a billion Euro in the 2009 state budget. Thus, more tax increases and budgetary cuts are imminent.

The Role of the Party Structure
The global crisis will put democratic systems in many countries under pressure. In the Baltic States, the citizens vividly remember how the crisis of 1930 boosted undemocratic movements, against whom the states protected themselves through emergency laws and restrictions on free speech. In Germany, this led to Hitler, the second world war and thereby the Soviet occupation of the Baltic States.
The memory of this painful historic experience prevents extreme political movements in the domestic debates, but there is a substantial concern for what the crisis may lead to in Russia. There is also a fear for extremists among the Russian population that moved in during the Soviet time. Since these activists, searching to end the independence, do not have the same historical perspective, they might be tempted to use the crisis for political purposes.
The most vulnerable country is Latvia. There, Soviet nostalgics are numerous. Furthermore there are more weaknesses in the structure of the political system, a problem frequently commented on, not only by Latvian experts. So far, this has been viewed as a minor flaw. Though, in times of crisis, such a flaw can prove to be expensive.

Experiences for the Future
The responsibility for a well functioning party structure lies with the politicians, parties and voters. In a stage of change and development, the Jarl Hjalmarson Foundation can, along with other organisations from more experienced democracies, offer support through knowledge and experiences. That phase is long gone in an EU country such as Latvia. However, for our ongoing work in other countries, it will be interesting to follow the discussions on the weak link in the Latvian political society as well as how the political systems of Estonia and Lithuania are able to deal with the most substantial challenge since their independence.

Text: Peeter Luksep
Former Member of Parliament (M) and board member for the Jarl Hjalmarson Foundation. Mr Luksep was one of the founders of the Monday movement, which supported the Baltic countries struggle for independence from the Soviet Union.

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