28 Nov 2014

Baltic economy expert: Past ten years a rollercoaster ride

 

By Morten Hansen, Head of the Economics Department at Stockholm School of Economics in Riga

The Baltic countries are often lumped together—just consider the name “Baltic countries”—as if they represent identical political and economic values and development. In many ways they do not, but in some ways they certainly do: for instance in terms of the wish for still closer integration with the West.

The past ten years have seen the three countries join NATO, the European Union and the Schengen Area, with entry into the euro zone underway (Estonia in 2011, Latvia in 2014, Lithuania from 2015) and with OECD membership also in the pipeline (Estonia in 2010, Latvia from 2016, and Lithuania not much later).

In many ways, this has served the Baltic countries very well. The countries are highly integrated into the EU in terms of foreign trade, and have in the past ten years obtained partial economic convergence with GDP per capita levels jumping from 57% to 72% of the EU28 average in Estonia, from 47% to 67% in Latvia, and from 52% to 74% in Lithuania. This is quite impressive, although it still leaves the countries behind the “old EU”, including Portugal and Greece.

The past ten years were more of a rollercoaster ride than steady economic development. All three allowed massive credit booms in 2004–2007, and in particular Latvia and Lithuania followed this with reckless procyclical fiscal policies, thereby exacerbating the booms and subsequent busts when drastic austerity measures were needed to rein in the excessive spending of the boom years. Here, the Baltic economies demonstrated that the way they conducted their economic policies was too short-sighted and with inadequate competence. These shortcomings, however, have been partly remedied with much-improved fiscal policies, e.g. the formation of fiscal discipline councils in Estonia and Latvia.

The Baltic economies have grown—and grown up—over the past ten years, but they still face formidable challenges. Poor demographics with very low birth rates from as far back as the Soviet perestroika years have now started to affect the labour markets, with small cohorts of young people joining, a trend that will continue for at least twenty years.

Combined with substantial outward migration due to wages lower than in most of the EU and because of high unemployment during the 2008–2010 recession, this will have a permanent crunch effect on the labour markets. Add the brain drain which is part of the outward migration, and the path to economic convergence is severely hampered; these countries may face what is known as “middle-income trap”.

This even dwarfs the immediate challenges of being quite dependent on Russian Federation for trade and energy imports. Having said that, the Baltic countries have undertaken many reforms since they joined the EU, and most structural indicators put them in a much better position for future growth than, for instance, many countries in southern Europe.

The next ten years look quite positive for the Baltic countries, but it will be uphill most of the way.

Morten Hansen

Morten Hansen

Head of the Economics Department at Stockholm School of Economics in Riga