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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
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Into the Crisis
Out of the Crisis
What’s Next?
Lessons for Others
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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
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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
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What Drove the Pre-Crisis Growth Spurt?
• Expansionary fiscal and monetary policy?
• Export-driven growth?
• Capital inflows?
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Government DebtBaltic Sea Region Countries
Government debt as% of GDP
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Trade IntensityBaltic Sea Region Countries, 2007
ExportImport
% of GDP
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Trade in the Baltic Sea Region
Source: UNCTAD (2012) State of the Region-Report 2012
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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
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Current Account BalanceBaltic Countries and Poland, 2000 – 2006
Current Account Balance,in % of GDP
Baltic Sea Region
Lithuania
Latvia
Estonia
Poland
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Unit Labor CostsBaltic Countries and Poland, 2000 – 2007
2000 = 100%
Baltic Sea Region
Estonia
Latvia
LithuaniaPoland
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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?
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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
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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
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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
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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
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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
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Is e-stonia Different?
Outcomes below potential:
• Employment
• Exports
• Foreign Direct Investment
E-government
ICT infrastructure
EducationalPrograms?
Cluster mobilization?
Investment attraction?
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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
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Current Account BalanceBaltic Countries and Poland, 2000 – 2010
Current Account Balance,in % of GDP
Baltic Sea Region
Lithuania
Latvia
Estonia
Poland
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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
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Unit Labor CostsBaltic Countries and Poland, 2000 – 2010
2000 = 100%
Baltic Sea Region
Estonia
Latvia
LithuaniaPoland
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Labor Market ImpactBaltic Countries and Poland, 2000 – 2011
Recorded unemployment rate, %
Baltic Sea Region
Estonia
Latvia
Lithuania
Poland
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Latvia’s Exports State of the Region Report 2013
Markets
Products
Markets per product
Source: State of the Region Report 2013
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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
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Rate of annual change/Share of GDP%
Source: EIU (2013)
Key Macroeconomic Indicators: Latvia
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Productivity LevelsSelected Countries
Labor Productivity per hour worked, 2011, Germany = 100%
Source: The Conference Board, 2012
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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
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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