from overheating to euro-zone membership: lessons from the baltics?

From Overheating to Euro-Zone Membership:

Are the Baltics a Role Model for Successful Crisis Management?

Dr. Christian H. M. KetelsInstitute for Strategy and Competitiveness

Harvard Business School

88. Kieler KonjunkturgesprächBerlin, Germany

17 September 2013

Into the Crisis

Out of the Crisis

What’s Next?

Lessons for Others

From Baltic Tigers … Basket Case to Phoenix?Prosperity Trends in Selected Countries

GDP Per Capita, US-Dollar PPP-adjusted

Source: The Conference Board, Sept 2012

From Baltic Tigers to Basket Case to Phoenix?Prosperity Trends in Selected Countries

GDP Per Capita, US-Dollar PPP-adjusted

Source: The Conference Board, Sept 2012

What Drove the Pre-Crisis Growth Spurt?

• Expansionary fiscal and monetary policy?

• Export-driven growth?

• Capital inflows?

Government DebtBaltic Sea Region Countries

Government debt as% of GDP

Trade IntensityBaltic Sea Region Countries, 2007

ExportImport

% of GDP

Trade in the Baltic Sea Region

Source: UNCTAD (2012) State of the Region-Report 2012

FDI Stock over Time Baltic Sea Region Countries

State of the Region-Report 2011Source: UNCTAD (2011), author’s analysis.

IcelandSwedenDenmarkFinlandBSRGermanyNorwayRussiaEstoniaPolandLithuaniaLatvia

Outward Inward

Share of GDP Share of GDP

Current Account BalanceBaltic Countries and Poland, 2000 – 2006

Current Account Balance,in % of GDP

Baltic Sea Region

Lithuania

Latvia

Estonia

Poland

Unit Labor CostsBaltic Countries and Poland, 2000 – 2007

2000 = 100%

Baltic Sea Region

Estonia

Latvia

LithuaniaPoland

What Drove the Pre-Crisis Growth Spurt?

• Expansionary fiscal and monetary policy? NO

• Export-driven growth? SOMWHAT

• Capital inflows? CRITICAL

• What policy choices drove these dynamics?

Past Policy Reforms in the Baltics

Macro

Political Institutions

Rule of Law

Human Development

Related and Supporting Industries

Demand Conditions

Context for Strategyand Rivalry

Factor InputConditions

Micro

Admin

Skills InnovationCapital

Logistics

Social Infra-structure and Pol.

Institutions

Macroeconomic Policy

Business Environment Quality

Company Sophistication

ICT

EU Accession

EU Accession

Structural Funds

Baltic Countries’ Competitiveness RankingMicroeconomic Competitiveness, 2005 - 2012

Latvia

Lithuania

Estonia

Source: World Economic Forum Global Executive Opinion Survey 2012, ISC analysis

1

25

50

75

100

Baltic Countries’ Competitiveness RankingSocial Infrastructure and Political Institutions, 2005 - 2012

Latvia

Lithuania

Estonia

Source: World Economic Forum Global Executive Opinion Survey 2012, ISC analysis

1

25

50

75

100

Baltic Countries’ Competitiveness RankingMacroeconomic Policy, 2005 - 2012

Latvia

LithuaniaEstonia

Source: World Economic Forum Global Executive Opinion Survey 2012, ISC analysis

1

25

50

75

100

The Role of EU Accession

Macroeconomic policy• Euro zone conditions• Stability and Growth Pact

Microeconomic policy• Acquis Communitaire• Common Trade, Competition, and

Agricultural Policy• Structural Funds, Framework

Programs, CIP• Lisbon Agenda

PROVIDED• Minimum standards• Reducing weaknesses• Generic policy targets

PROVIDED• Minimum standards• Reducing weaknesses• Generic policy targets

LACKED• Strategic priorities• Creating strengths• Unique objectives

Is e-stonia Different?

Outcomes below potential:

• Employment

• Exports

• Foreign Direct Investment

E-government

ICT infrastructure

EducationalPrograms?

Cluster mobilization?

Investment attraction?

The Crisis Moment

• Capital Inflows dry up as global risk appetite wanes

• New credit, investment, and then consumption drop

• Unemployment quickly rises

• Slowing global demand adds to the region’s pains

Current Account BalanceBaltic Countries and Poland, 2000 – 2010

Current Account Balance,in % of GDP

Baltic Sea Region

Lithuania

Latvia

Estonia

Poland

Crisis Response: The Latvian Experience

Pre-Crisis Policy Response Impact

• Excessive capital inflows

• Credit growth, real estate bubble, wage growth, …

• Insufficiently active public policy response

• Austerity program to balance government budget

• Internal devaluation through pressure on nominal wage levels

• Fiscal pressure used to drive overdue structural reforms, e.g. health care

• Ring-fencing of social spending to most vulnerable groups in society as far as possible

• Budget deficits meeting international commitments

• Unit labor costs dropped, current account balanced, export growth (quantity, quality)

• Unemployment spiked, slowly receding

• New wage of emigration

Unit Labor CostsBaltic Countries and Poland, 2000 – 2010

2000 = 100%

Baltic Sea Region

Estonia

Latvia

LithuaniaPoland

Labor Market ImpactBaltic Countries and Poland, 2000 – 2011

Recorded unemployment rate, %

Baltic Sea Region

Estonia

Latvia

Lithuania

Poland

Latvia’s Exports State of the Region Report 2013

Markets

Products

Markets per product

Source: State of the Region Report 2013

Latvia’s Exports by Clusters2000 - 2011

0.0%

0.1%

0.2%

0.3%

0.4%

-0.05% -0.03% -0.01% 0.01% 0.03% 0.05% 0.07% 0.09% 0.11%

Compound annual growth rate of Latvian world export market share, 2000 - 2011

Furniture

Latvian World Export Market Share, 2011

Entertainment/Reproduction Products

Transportation & Logistics

Note: Bubble size is proportional to absolute export value Source: UNCTAD Trade Data; International Cluster Competitiveness Project at ISC (HBS)

Building Fixtures

ForestProducts

Agricultural Products

Containers/Packaging

ProcessedFood

Apparel

Tourism

Rate of annual change/Share of GDP%

Source: EIU (2013)

Key Macroeconomic Indicators: Latvia

Productivity LevelsSelected Countries

Labor Productivity per hour worked, 2011, Germany = 100%

Source: The Conference Board, 2012

Outlook

Opportunities

• Euro-zone accession (has) will remove(d) risks

• Exports dynamics indicate new growth opportunities

Challenges

• Recovery growth push will gradually dissipate

• Weak growth outlook in Europe provides difficult external context

• IMF projects lower trend growth rate

Lessons for Others

• Reforms are possible

• The Euro remains an important policy goal; it is not a barrier to a quick resolution of the crisis

• Fiscal consolidation is not sufficient to embark on a solid and sustainable growth path

• Country-specific conditions are highly important (political, economic)

• We need to rethink the role of the EU across different policy areas– Benchmarks work for macro policy and legal framework conditions– Benchmarks are insufficient and potentially dangerous for efforts to

upgrade microeconomic competitiveness