The paradox of Baltic development: marketization or state-building?

This post focuses on political and economic development of the Baltic States. These countries have experienced one of the most radical transitions from the Soviet state-based economy. Their taken reform path could be classified as the most neoliberal one in Central and Eastern Europe. A closer investigation, however, may help us to better grasp the on-going complexities of the post-socialist order.

The Baltic countries have earned the ‘neoliberal’ label for several reasons. Firstly, the public financing of welfare policies is one of the lowest among the EU countries. Moreover, they have strictly followed the currency board regime from the outset of transformation. They significantly narrowed the scope of government actions in order to win the trust of markets. This was a rather maverick move at that time. They also introduced flat tax rates in early crisis period and were fast to liberalise trade. And finally they strived to implement both small- and big-scale privatisation as soon as possible.

This transformation path is often called the ‘shock therapy’. It stands in contrast to a more ‘gradualist’ approach applied by the four Visegrad countries (Czech Republic, Hungary, Poland and Slovakia) as well as Slovenia. This regional divergence of reform paths is largely explained by different structural circumstances. The Baltic countries being a part of the decaying Soviet Union faced additional challenges. Their economy was much more structurally distorted and they had much less time to adapt to the changing environment. Moreover, they had to make a greater effort to re-build the state. The process was more complex in Estonia and Latvia due to residing large ethnic Russian minorities. Against this background, rebuilding the nation-state and full de-sovietisation has thus been a key idea legitimating new Baltic democratic regimes and their transition agenda. It overshadowed a concurring alternative of enhancing societal solidarity via redistribution or other welfare policies. On the other hand, it does not necessarily mean that the latter ones were totally forgotten or ignored.

Entry to the EU reinforced these trends. It has encouraged the expansion of regulatory capacities of these states rather than their welfare policies. Besides, it further reduced the scope of governmental actions in the monetary policy area (with the ultimate adoption of the EURO). Moreover, it opened borders for emigration and thus diminished the importance of fighting unemployment by local means. And finally it created circumstances for stimulating the economy via relatively cheap and abundant real-estate loans from banks (mostly from the Nordic countries). The latter factor was responsible for a steep rise of prices in the real-estate sector, which later contributed to the severity of the financial crisis in 2008-2010. However, the way in which the Baltic countries chose to cope with the crisis (i.e. internal devaluation and keeping price stability) has also confirmed the already established national patterns of market-oriented economic governance.

Despite these observations, the whole picture cannot only be seen in black and white. Foremost, one should not ignore the overall robust economic growth in these countries since their access to the EU. When in 2004 Estonia’s, Latvia’s and Lithuania’s GDP per capita in Purchasing Power Standards was respectively equal to 57%, 47% and 52% of the EU average, in 2013 it rose to 72%, 67% and 74% of the EU average (Eurostat). Against this background, the rather lean welfare states have also received considerable financial inflows. In absolute numbers, the financing of main welfare areas (education, health and social security) doubled in all three countries during 2004-2012. Moreover, the welfare areas’ share of the GDP also increased. While in 2004 in Estonia and Lithuania it was respectively equal to 20.5% and 20.9%, in 2012 it raised to 24.1% and 23.6% GDP, which almost reached the average of the Eastern and Central European (ECE) EU member states (24.3% in 2012, while in 2004 it was 22.9%). Only in Latvia the public financing of welfare policies remained virtually unchanged (20.1% in 2004 and 20.9% in 2012), and the gap with other ECE EU member states even widened (Eurostat). This differentiation among the Baltic countries has occurred in 2007-2009, and could be related to different responses to the financial crisis, when Latvia had to ask for IMF assistance under strict conditions.

Such differentiation may also suggest that there are other important trends of well-being that may vary among the Baltic countries. Truly, if one looks at welfare-related indicators adopted by the EU2020 strategy, one could see a certain variation, see the Table No. 1.

Table No. 1. Welfare-related indicators, EU 2020 strategy

Estonia Latvia Lithuania EU-28 average
2005 2012 2005 2012 2005 2012 2005 2012
People at risk of poverty or social exclusion(% population) 25.9 23.4 46.3 36.2 41 32.5 25.7 24.8
Employment rate (20-64 age, %) 72 72.2 70.3 68.1 70.7 68.5 67.9 68.4
Early leavers from education and training 14 9.5 14.4 10.6 8.8 6.5 15.7 12.7
Tertiary educational attainment(30-34 age, %) 31.7 39.5 18.5 37.2 37.7 48.6 28.1 35.8

Source: Eurostat

One can draw several observations from this table. Firstly, Latvia’s indicators are the most challenging, although in some cases they surpass the EU average. Secondly, Lithuania scores especially well regarding the last two (education-related) criteria. More precisely, Lithuania’s record is one of the best in the EU regarding tertiary educational attainment. Nevertheless, one should be cautious placing too much importance on this achievement, as it could rather be a reflection of the runaway expansion of the tertiary level educational system at the expense of other sectors. For instance, school graduates who cannot succeed in finding a job may elude unemployment by signing in for a university degree. Thirdly, Estonia exceeds other Baltic countries in employment rate and more particularly – in fighting social exclusion. To some extent this is striking, as Estonia has earned a reputation of implementing neoliberal reforms with great ardour. However, as it was aforementioned, the foremost task for the Baltic decision-makers at the outset of post-communist transformation was the (re-)building of the state. And while the shock therapy was implemented, the main motive behind it was not the ‘hard’ neoliberal thinking, but rather the striving for a speedy de-sovietisation in order to diminish potential geopolitical and institutional influences of the Kremlin as far as this was possible in such a limited time frame.

As various key factors (such as trust of political institutions, stability of the party system and the perception of corruption) show, Estonians have managed to build a more effective and more transparent state than the other Baltic countries during these two decades. Exactly this factor suits best for explaining why Estonians have been both the most coherent in implementing market reforms and on the same time the most effective at achieving a relative social well-being among the other Baltic countries and other post-socialist states in general.

In the next post I will try to sketch how and why the Estonians have achieved better results in specific welfare areas such as healthcare and education with a similar amount of finances compared to the  other Baltic countries. In turn, that will also help to formulate what exact lessons from the Baltics could be applied for politics in Central and Eastern Europe and beyond.

Fotocredit: Iwamp. via Flickr

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