Do the Baltic Countries Show that Austerity Brings Growth? Nope.

20 Apr

Or at least that’s what two pesky Balts say on triple Crisis:

“European crisis resolution seems to rest on one hope: austerity can bring growth. History and most of economic theory seems to suggest that this is not possible. The Baltics peg to differ. Or so it seems. During the 2008-2010 crisis the Baltic economies of Estonia, Latvia and Lithuania experienced peak-to-trough reductions in GDP as high as 20%, 25% and 17% respectively. Governments decided to stick to currency pegs and opt for austerity and internal devaluation by cutting government expenditure in 2009 around 8-9% and additional 3-4% (of GDP) in 2010. By 2011, all Baltic economies were growing again, real GDP growth, driven by rapid recovery in exports, topping European charts with 7.6% (Estonia), 5.5% (Latvia) and 5.9% (Lithuania).”

” In fact, a closer look shows that the current Baltic recovery has not resulted from the internal devaluation but rather from other factors not under the control of the Baltic governments. While many analysts hasten to call the internal devaluation successful, the downward adjustment of prices and wages in the Baltics was relatively modest – especially in the light of how overheated the economies had become by the end of the boom. None of the three countries actually experienced any significant deflation; in fact, in 2010 and 2011, inflation in all three countries resumed an upward trajectory. The reduction of real wages was from peak to trough about 15% in all countries. By the end of 2009, the real effective exchange rates had fallen by 3-5 percentage points from their boom-time peaks.

If not internal devaluations, then what is behind the Baltic recovery in 2011? There are two key factors: flexible labor markets and integration of export sectors into key European production networks. Flexible labor markets have had two consequences: first, persistently high unemployment, which did not lead to significantly higher social expenditure (automatic stabilizers are relatively unimportant as benefits are low and brief, and active labor market measures are financed largely by EU structural funds); second, while particularly in Lithuania emigration was high already before the crisis, the latter seems to have fastened emigration in all Baltic states (Lithuania’s and Latvia’s census in 2011 showed dramatic drop in population numbers; Estonia’s census data will come in later in 2012). As Baltic states are strongly ‘simple polities’, reflected, inter alia, in low levels of popular unrest and restrained civic dialogue, voice does not seem to be an option for many and thus exit becomes the preferred choice for a increasing number of people.

However, both high unemployment and exit are forms of future costs in terms of future social issues and lack of workforce. Thus, while during the crisis the costs of external devaluation were argued to be higher than internal devaluation (or adjustment, as it is mostly referred to in Baltic debates), it remains to be seen whether this is really so given persistently high levels of unemployment and emigration.”

So “the Baltic cases are unique and unreplicable in the EU context: first, most EU countries, especially in the troubled periphery, are already in the eurozone, so they cannot justify short-term austerity measures with eurozone entrance as an exit strategy from the crisis; second, very few EU countries have as weak civil societies as the Baltic countries and thus austerity breathes very visible unrest and instability; and third, few if any EU countries have such narrow and detached policy elites who have become accustomed to satisfy their European policy peers rather than domestic partners.

Furthermore, there are a number of economic and structural factors that make the Baltics relatively unique. First, high levels of internationalization of the economy (both in exporting and financial sector); second, high dependence on larger neighboring economies (Scandinavia, Poland) in terms of trade and, in the case of Scandinavia, also of technology transfer. All these economies recovered quickly (Scandinavia) or did not experience almost any crisis at all (Poland). Thus, as Wolfgang Münchau argues, while the EU is more and more behaving as it was a small open economy where budget discipline is important for convincing the investors and markets, the experience of small open economies dealing best with such fiscal policies cannot be of almost any use to other troubled EU members.”


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