havekost masters dissertation

The Baltic Tiger – How labor market liberalization

led Estonia to become the model post-Cold War

transition country of the Baltic region by the 2004

round of EU enlargement

Alexander Havekost

London School of Economics - September 2014

MSc International Political Economy – Alexander Havekost – September 2014

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Contents

Introduction ................................................................................................................................................... 2

Theoretical Presentation ................................................................................................................................ 5

Pre-independence environment ..................................................................................................................... 9

Poland ................................................................................................................................................... 9

Estonia................................................................................................................................................. 10

Latvia .................................................................................................................................................. 11

Lithuania ............................................................................................................................................. 12

Commonalities .................................................................................................................................... 13

Resultant Politics and Society ..................................................................................................................... 14

Political stability ................................................................................................................................. 14

Democratic Disenchantment ............................................................................................................... 15

With Regards to Labor Market Liberalization ............................................................................................ 17

Legislative Capacity, Trade Unions, and Civil Society ...................................................................... 17

Wages .................................................................................................................................................. 20

Contracts and Mobility........................................................................................................................ 23

Welfare ................................................................................................................................................ 25

The “Run-Up” to EU Accession ................................................................................................................. 29

Domestic ............................................................................................................................................. 29

International Interaction ...................................................................................................................... 33

Hard work pays off ............................................................................................................................. 36

Conclusion .................................................................................................................................................. 39

Bibliography ............................................................................................................................................... 41


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Introduction As the Soviet Union (USSR) teetered toward collapse during the late-1980s and eventually fell in

19911, the Baltic region, composed of Poland, Estonia, Latvia, and Lithuania, were able to regain

total independence for the first time since the start of World War Two (WWII)2. Demonstrating a

renewed vitality, this region exceeded, to varying degrees, the successes of most other post-Soviet

regions. Thrust into capitalism, these four republics enjoyed starting points similar to every new

democracy: a plethora of new politicians, national output concerns, social protection issues, and

an uncertain future as individual nations.

Often overlooked, the new democracies of the Baltic region were themselves diverse, with

linguistic, cultural, and historical differences. Political stability, implemented legislation, and

societal concerns in the post-Soviet era varied greatly within the region and led each republic down

its own divergent path of reform. How was it possible for the country of Estonia, comparatively

small in population and industrial capacity, to surpass its two southern neighbors and significantly

larger Poland in reaching Western economic modernity? Of all the reforms made during the

transition, this paper will serve to identify and assert that Estonia’s labor market liberalization

(LML), from its 1991 post-communist independence to 2004 European Union (EU) accession, was

the key policy that elevated its status to the model post-Soviet state. LML acted as a locus – a

convergence of national policies so essential that once effectuated, was instrumental in

determining the pace and path of transition leading to EU accession.

For the purposes of this investigation, “model transition country” assumes a Western, neoliberal

sense of the phrase, due to its status as the dominant global consensus. Neoliberal is a somewhat

1 Miyamoto, Katsuhiro. "The Carrot and the Stick of The Socialist Economy." Bulletin of University of Osaka

Prefecture. 39.(1995).p.1 2 Hiden, Johan and Patrick Salmon. The Baltic Nations and Europe (Revised ed.). Harlow, England:

Longman.(1994).p.189


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vague term that has been defined by many; for the purposes of this paper, two parts from Thorsen

and Lie will be used, one of which paraphrases Friedman’s take in 1960. Thorson and Lie posit

that neoliberalism is “a loosely demarcated set of political beliefs…[that] include the conviction

that the only legitimate purpose of the state is to safeguard individual, especially commercial,

liberty, as well as strong private property rights.”3 Secondly Friedman notes that neoliberalism

“includes the belief that freely adopted market mechanisms is the optimal way of organizing all

exchanges of goods and services.”4

Distinguishing each country is essential for the purposes of this paper. To accomplish this, an

investigation of historical institutionalism and path dependency theory will first be presented to

provide an explanatory framework for LML. Following this, a brief pre-independence context for

each country will first be stated in order to identify the drivers that led to independence. Next,

domestic societal and political situations at the outset of independence will be investigated,

denoting the institutional formation of the new states. From this point of institutionalization and

using five specific determinants of LML, Estonia’s policies and their implications will then be

evaluated in comparison to the rest of the region. Such policy determinants include legislative

capability, trade union presence, and civil society; wages; contracts and mobility; and welfare.

Finally, this paper will discuss the subsequently unique paths and successes determined by the

LML implemented in each republic; comparative levels of LML acted in a dichotomous fashion,

either as a catalyst for positive reform or as indicator of domestic struggles with transition. By

2004 Estonia had succeeded in making the swift adoption of free-market ideals, more so than any

other in the Baltic region. Although the population and Gross Domestic Product (GDP) of Estonia

3 Thorsen, Dag, and Amund Lie. "What is Neoliberalism?."(2006).p.14 4 Ibid


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were comparatively small, the 1.34 million5 people residing in Estonia had overseen significant

reductions in the welfare state, employment protection, union relevance, and barriers to investment

and trade, whilst improving fiscal responsibility, wage and contract flexibility, rule of law, and

overall employment. The support for, and lack of opposition toward, an all-compassing adoption

of free-market capitalism permitted Estonia to avoid the discordance experienced by others in the

Baltic region who struggled with reforms often designed to remove social protections, and

moreover avoid a general disenchantment with the shift to capitalism.

As a point of clarification, this paper will utilize the phrase “Baltic region” or “the region” to

include all four republics in order to facilitate the discussion of the region as a whole. Although

Poland is not considered a Baltic State, it has a major border on the Baltic Sea. For further

explanation, when discussing Estonia, Latvia, and Lithuania as a singular unit this paper will refer

to them simply as the “Baltic States.”

5 United States America. CIA. CIA Factbook 2004.(2005)


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Theoretical Presentation The scope of this paper covers a significant timeframe of the Baltic region’s politics, economy,

and society, requiring theoretical approaches that cover a rich level of detail: historical

institutionalism (HINT) will be the dominant framework to understand the formation and evolution

of Baltic institutions, and path dependency (PDP) will complement this framework as the

discussion of the region moves toward EU accession and Estonia’s successes. It would be wholly

incorrect to assume some sort of institutional void following the collapse of communism. Rather,

inherent informal institutions persisted, complementing what Stark and Bruszt note as the

systematic “reconfigurations of institutional elements rather than their immediate replacement.”6

These institutional approaches hold great explanative power over the fundamental changes in the

Baltic region, and particularly those of LML in Estonia.

Utilizing Ikenberry’s explanation, HINT describes how the “limits and possibilities of policy and

political change within a polity is shaped by the structural setting in which individuals and groups

find themselves.”7 Steinmo similarly notes how HINT’s attention is on “the ways in which

institutions structure and shape political behavior and outcomes.”8 Moreover, historical

institutionalists believe that the institutional organization of the economy and society clash to

advantage some and handicap others in the decision-making process. Asymmetrical power

relations was an invaluable tool in Estonian policy-making; minimal civil society and union

presence permitted new politicians to quickly implement sweeping neoliberal reforms. Institutions

go far beyond those of bureaucracy, too; they include informal institutions such as social norms,

6 Stark, David and Laszlo Bruszt. Postsocialist pathways: transforming politics and property in East Central

Europe. Cambridge. Cambridge University Press.(1998).p.83 7 Ikenberry, G. John. "History’s Heavy Hand - Institutions and the Politics of the State." New Perspectives on

Institutions. University of Maryland.(1994).p.29 8 Steinmo, Sven. "What is Historical Institutionalism?.".(2008).p.150


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procedures, and culture. Estonia was able to capitalize on the informal norms, notably the

widespread democratic disenchantment of its population, to further its own economic policies.

More generally, HINT excellently accounts for the transformational nature of institutions in the

independent Baltic region: actors intermingled within persistent post-USSR norms, longstanding

cultures, and the burgeoning formal institutions to determine levels of LML.

To lend more weight to the relevance of HINT in the post-communist Baltic region, a counter-

approach will be presented and refuted. Transitology, an approach founded in the 1970s9, is a

relatively amorphous, actor-centric theory that was developed to account for democratic transition

in Latin America and Southern Europe. The primary causal variable in Transitology’s analysis of

transition is elite bargaining, only after which political parties and civil society later gain

importance.10 This differs from the Baltic region, whose independence was largely ignited by the

popular protest and policy change at the USSR-level. With the benefit of hindsight, it is evident

that the democratization that the Baltic Region runs counter to arguments posited in Transitology,

which state that “revolutionary transitions and high levels of mass mobilization endanger, rather

than abet, the process of democratization.”11 Academia has tended to agree with the inapplicability

of Transitology for post-USSR cases, with Tokes claiming, “The negative side...diminishes

analytical benefits that Transitology might offer for a deeper understanding of what took place…in

the communist world in 1989-1990.”12 It can be concluded that HINT better illuminates the

region’s transition because it explains levels of policy continuity over time during periods of great

transformation. In other words, instead of institutions coordinating and “holding together a pattern

9 Gans-Morse, Jordan. "Contemporary Theories of Post-Communist Transitions and the Myth of a Dominant

Paradigm." Post-Soviet Affairs. 20.4.(2004).p.325 10 Ibid. p.326 11 Ibid. 12 Tőkés, Rudolf. "Transitology: Global Dreams and Postcommunist Realities."(1999).p.17


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of politics,”13 institutionalists claim that political and social contexts give rise to and sustain

institutions. This is particularly the case during initial years of Baltic independence, in which

reform-minded actors and civil society gave rise to restructured institutions and paths of transition.

Supplementary to the core HINT idea that “founding moments of institutional formation…send

countries along broadly different developmental paths,”14 the concept of PDP is also incredibly

relevant by suggesting that institutions “continue to evolve in response to changing environmental

conditions and ongoing political maneuvering but in ways that are constrained by past

trajectories.”15 Levi also presents this concept, understanding PDP as how the “entrenchments of

certain institutional arrangements obstruct an easy reversal of the initial choice.”16 To restate, paths

of progress are dependent on specific political, economic, or societal junctures, irrespective of size

or importance. Pierson also develops explanation of PDP, likening it to the economic concept of

“increasing returns-to-scale.”17 Ikenberry describes these critical moments as established logic,

after which any changes “tend to be variations or extensions on that logic.”18 This concept of PDP

conforms to HINT, particularly in that institutions are relatively persistent features and push

“historical development along a set of paths.”19 A counter to the concept of PDP would be that

forces in society engender similar outcomes, no matter the context or country. This alternative idea

may have traditionally held greater theoretical stature, however its largely one-dimensional

understanding of effects being uniform precludes any substantial explanative power when looking

13 Thelen, Kathleen. "Historical Institutionalism in Comparative Politics." Annual Review of Political Science.

2.(1999).p.384 14 Ibid. p.387 15 Ibid. p.387 16 Levi, Margaret. Consent, dissent, and patriotism. Cambridge: Cambridge University Press.(1997).p.28 17 Pierson, Paul. "Increasing Returns, Path Dependence, and the Study of Politics." American Political Science

Review. 94.2 (2000).p.251 18 Op.Cit.Ikenberry. p.16 19 Hall, Peter, and Rosemary Taylor. "Political Science and the Three New Institutionalisms." Political Studies.

(1996).p.941


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at post-communist changes in the Baltic region. Each republic was similar in developing a new

fledgling democracy and similar in evolving from state planning to capitalism, yet entirely unique

by 2004, fundamentally supporting PDP as the correct approach. Seemingly broad-based, PDP

includes a defining characteristic that precisely matches what LML was for Estonia: a locus, or

“critical juncture.” Hall and Taylor’s paraphrased description of the term will be used for the

purposes of this paper, understood as the instances when institutional changes occur, which thus

create a “branching point”20 from which transition moves in a new direction. Although not static

enough to be pinned down to a specific time or piece of legislation, the choice of high LML in

Estonia was critical in determining its path to EU accession and a vivid indicator of Estonia’s

comparative success

When applied in the Baltic region context the intermingling of these sets of concepts adopts the

precise outlook that this paper also uses to address the relative importance of Estonia’s LML. To

provide greater clarity for the impact of LML, Neoclassical Endogenous Growth Theory best

explains the economic causality. A dominant strategy employed by World Bank conditionalities

in the early 2000s, it was necessary to clear the labor market of rigidities in order to encourage

foreign direct investment (FDI), entrepreneurship, and financial risk-taking; internal policy

reforms included areas such as labor code amendments and pension reform, and it was generally

noted that collective labor interests limited the ability to obtain liberated labor markets.21 Such

developments fit well within the HINT and PDP framework, with Estonia exhibiting success in

adhering to the Neoclassical Endogenous Growth Theory.

20 Op.Cit. Hall and Rosemary.p.942 21 Upchurch, Martin. "The IFIs and Labour Reform in Post-Communist Countries." Globalizations. 6.2 (2009).p.298


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Pre-independence environment Like a dark shadow, the Soviet-influenced past of the Baltic region was deeply engrained in the

politics of transitional reforms. Essential to understanding the progress of each country, one must

acknowledge the key political and socioeconomic drivers during the Soviet era. Below is a brief

country-by-country description of the relationship with the USSR, arguably one of the most

significant influences on post-independence behavior. Following this will be a more general

discussion of common features shared by the Baltic region.

Poland

After the Yalta Conference in 1945, the Soviet Union extended its sphere of influence to include

Poland22, which by 1947 had undergone rigged elections to place Communists into power.23 The

following 1952 elections permitted no other party to challenge communist rule24, finalizing the

status of Poland as a Soviet Union satellite state. For nearly a half-century, Poland was controlled

by a USSR-led puppet government, but was able to have limited interaction with the West,

garnering attention from governments and investors due to its large population and economic

potential.25 Shifting further in time, the Polish were the first satellite state to revolt against and

attain independence from the USSR in 1989. Making this possible was the widespread use of civil

resistance and popular engagement, which were focal characteristics that persisted throughout

Poland’s development as an independent nation as well. Societal engagement will prove to be a

central point in this paper, be it in the form of trade unions, non-governmental organizations

(NGOs), or general social power.

22 Brown, Thomas. "The Soviet Union as a Great Power: The Need for Reform." The American Economist. 36.1

(1992).p.78 23 Staar, Richard. "Elections in Communist Poland." Midwest Journal of Political Science. 2.2.(1958).p.210 24 Ibid. p.212 25 Clemens, Walter. The Baltic transformed: complexity theory and European security. Lanham: Rowman &

Littlefield Publishers.(2001).p.1


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The Polish government declared martial law in 1981 to quell disorder from organized labor,

however several years later organization was permitted once more. By 1989 the trade union

Solidarność (Solidarity) had led the charge in rebellion and the country elected the first non-

communist prime minister in over 40 years, Tadeusz Mazowiecki.26 Applebaum notes that what

mattered for post-1989 success was the relevance of pre-independence active opposition: Poland

had an inefficient dictator, General Jaruzelski, who “produced more active citizens than those who

still used terror to suppress their critics.”27 In line with this societal concept, Cook identifies Polish

representative institutions as one of the strongest in the region, having produced labor movements

and “autonomous organizations”28 even before Poland attained independence.

Estonia

Guaranteed as part of the Molotov-Ribbentrop Pact29, Estonia found itself forced to accept Soviet

occupation by mid-194030, becoming the Estonian Soviet Socialist Republic (ESSR). Unlike

Poland, Estonia was unable to retain its own government and was instead annexed directly into the

Soviet Union. 50 years of direct rule developed industry so that over 90% of trade was not only

conducted with the Soviet Union, but also directly and involuntarily managed by Moscow.31

Despite the lack of an exiled government, by 1987 Estonian scholars and economists had begun to

formulate plans for an independent economy.32 Civil engagement also proliferated toward the late

1980s and three specific parties emerged: the Rahvarinne (Popular Front), who wanted gradual

26 Tagliabue, John. "Opening New Era, Poles Pick Leader." New York Times.(1989) 27 Applebaum, Anne. "Does Eastern Europe Still Exist?". LSE IDEAS.(2013) 28 Cook, Linda. Postcommunist Welfare States: reform politics in Russia and Eastern Europe. Ithaca: Cornell

University Press.(2007).p.16 29 Estonian Government. Soviet deportations from Estonia in 1940s. <www.estonia.eu> 30 Op.Cit. Hiden and Salmon.p.114 31 Pautola, Niina. "Fiscal Transition in the Baltics." Review of Economics in Transition.(1997).p.5 32 Lainela, Seija. "Private Sector Development and Liberalization in the Baltics." Review of Economics in

Transition.(1994).p.28


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change from Soviet institutions followed by a declaration of independence; the Eesti Kodanike

Komiteed (Estonian Citizens’ Committees or Restorationists), who demanded an immediate and

complete break with Soviet past to restore the pre-WWII republic; and the Interdvizheniye

(Intermovement), the pro-USSR party (ultimately banned in 1991) that was meant to counter the

nationalistic sense growing in the ESSR.33 Despite the Intermovement, pro-independence forces

were overwhelmingly successful in the 1991 independence vote with the Popular Front securing

victory and the nonelected Restorationists evolving into the first parliament, the Eesti Kongress

(Congress of Estonia), in 1990.34

Latvia

Another element of the Molotov-Ribbentrop Pact, Latvia was annexed by the USSR to become

the Latvian Soviet Socialist Republic (LASSR). Latvia shares many commonalities with Estonia,

having boasted similarly focused pre-independence political movements during the late 1980s.

The Latvijas Tautas fronte (Popular Front of Lativa) and the Pilsoņu komitejas (Citizens

Committees) had similar goals to their Estonian counterparts: the Front desired a more gradual

break from the USSR, integrating some of its institutions, and the Committees wanted an

immediate break from the Soviets.35 The USSR-loyal party, Interfront (International Front), was

also significant during Latvia’s burgeoning political scene; by the 1980s ethnic Latvians were “on

the verge of becoming a minority in their own republic.”36 In fact, it has been reported that of all

the non-Russian republics, only Kazakhstan underwent greater russification than Latvia.37 Despite

this, the International Front represented an insufficient counter-force to the dynamic shifts of

33 Budrytė, Dovilė. "From Ethnic Fear to Pragmatic Inclusiveness? Political Community Building in the Baltic

States (1988-2004)." Ethnic Studies.(2011).p.15 34 Ibid. 35 Ibid .p.17 36 Op.Cit. Hiden and Salmon.p.126 37 Ibid p.127


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societal views. Latvia’s Popular Front succeeded in 1991, with the Citizens Committees waning

in importance by this point; the Popular Front was able to gain control in parliament, the Supreme

Council, and in the executive branch of Latvia. The Soviet-loyal Latvian International Front,

similar to its Estonian Intermovement counterpart, was banned by 199238 in an attempt to further

distance the country from its communist past.

Lithuania

The most southern Baltic State, Lithuania was occupied by the USSR in 1940 after the agreement

of the Molotov-Ribbentrop Pact, becoming the Lithuanian Soviet Socialist Republic (LISSR). The

LISSR industrialized relatively quickly, and heavily, compared to the other Baltic States, but

“remained less advanced and did not experience so massive an influx of immigrants from outside

its borders.”39 Unencumbered by the heavy russification experienced in the ESSR and LASSR, the

LISSR was able to develop its domestic support base to form a unilateral challenge to Soviet

authority.40 The dominant party, Lietuvos Persitvarkymo Sąjūdis (Lithuanian Reform Movement),

was the major reform-minded party in the LISSR, countered by Yedinstvo (Unity) who were

created in 198841 to counter electoral pressures of nationalist party divisions. Attempts to lessen

the influence and intensity of the Reform Movement were in vain and thus Lithuania became the

first Soviet Republic to declare independence in 1990.42

38 Op.Cit. Budryte.p.17 39 Op.Cit. Hiden and Salmon.p.126 40 Ibid. p.127 41 Ibid. 42 "Lithuania: History."Global EDGE. Michigan State University.<http://globaledge.msu.edu/countries/lithuania>


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Commonalities

The economy of the USSR combined high employment protection with significant wage

compression, which translated into inefficiently allocated labor within rigid markets.43 Contrary to

capitalism, trade unions would often act as “transmission mechanisms” to “justify and implement

wage and social policy,” without a significant presence in wage determination.44 Lack of autonomy

was a common theme throughout the Baltic region; the European Community was required to

interact with the Soviet Council for Mutual Economic Assistance in order to organize any level of

trade relations in the Baltic States.45 The region was only able to regain some national footing,

however, when Gorbachev initiated his policy of glasnost and perestroika, meaning government

openness and economic and political reform, respectively.46

On an entirely different track than societal movements, strategic concerns were of great

significance, particularly when discussing the three Baltic States. As formerly independent

republics and as buffers between the USSR and the West, they were among the most militarized

regions in the entire Soviet Union. Moreover, the Baltic States served as a tactical “jump-off” point

for a theoretical westward incursion.47 Combine the military dynamic with the detail that the Baltic

republics were the only members of the League of Nations not to be restored to full sovereignty

after WWII48, and evidence further builds to explain the post-independence desire to ensure

sovereignty by decisively shifting towards the EU.

43 Eamets, Raul, and Jaan Masso. "Labour Market Flexibility and Employment Protection Regulation in the Baltic

States.". Institute for the Study of Labor (IZA) Bonn.(2004).p.2 44 Huber, Peter, Herbert Brücker, et al. European Union. Regional and Labour Market Development in Candidate

Countries.(2002).p.21 45 Dinan, Desmond. Europe Recast. Hampshire: Palgrave Macmillan.(2004).p.272 46 Op.Cit. Hiden and Salmon.p.1 47 Op.Cit. Clemens.p.7 48 Op.Cit. Hiden and Salmon.p.125


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Resultant Politics and Society The Baltic region quickly found itself wholly independent for the first time since WWII. With

politically energized and hopeful populations, turnout at the first elections was impressively high

across all four republics.49 This section will describe the levels of political stability and subsequent

levels of democratic disenchantment, which determined the pace and capability of LML. In order

to assess the explanative power of selected transition and labor market theories in the subsequent

section, exploring these characteristics for each state in the Baltic region is vital.

Political stability

The four republics had a shorter history of central planning than most others who fell under USSR

control in the 1920s, allowing them to draw on pre-war knowledge and legislation where possible

for the creation of new laws.50 Nevertheless, a commonality in some of the region emerged:

“nationalists were better at gaining independence than managing a modern state.”51 Poland’s new

government struggled with balancing its “shock-therapy,” or high-intensity pace of economic

reform, whilst retaining support of the public. Moreover, Poland did not employ a politicized or

heavy-handed lustration toward the communist “old-guard,” most likely due to its more

“easygoing”52 experience with communism; continued influence by the old-guard caused

persistent conflict within the political ranks. Latvia was the last of the region to hold free

parliamentary elections. It reinstalled its 1922 constitution53 but was forced to reorganize many

governmental structures post-election, which progressed at a sluggish pace due to the ruling

49 Ervasti, Heikki. Nordic social attitudes in a European perspective. Cheltenham: Edward Elgar.(2008).p.114 50 World Bank. From Plan to Market. New York: Oxford University Press.(1996).p.99 51 Op.Cit. Clemens.p.61 52 Calhoun, Noel. Dilemmas of Justice in Eastern Europe’s Democratic Transitions. Basingstoke: Palgrave

Macmillan.(2004).p.95 53 Bozóki, András. "Democratization in Central Europe." Taiwan Journal of Democracy. 4.2 (2008).p.17


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coalition’s minority in Parliament.54 Plagued by corruption and political scandals, this added

another level of difficulty for Latvian governance during transition. Lithuania differed from Latvia

and Poland, retaining greater ties to the communist style of governance. The 1992 parliamentary

elections led to former communists and some of the Lithuanian Democratic Party as the ruling

political force. A comparatively lesser break from the past left the public and the West with an

unclear sense of reform commitment for the future.55 Estonia was comparatively stable, with the

majority of seats in Estonian Parliament held by reform-committed right-wing parties who had

united with social democrats to form the governing coalition.56 Although the Soviet Communist

Party had been banned from Estonian politics, the Estonian Communist Party was permitted to

participate in post-independence governance and reform.57

Democratic Disenchantment

High turnouts for first elections quickly shifted to ennui and disappointment among voters. This

shift in allure was mostly due to the decline in living standards except for the nouveau riche.58

Secondary to this reason, one must account for the effort it took to attain independence. Once

achieved, the masses may have experienced activist fatigue, which only worsened with the poor

performance of the economy. Citizens quickly found themselves in a newfangled economic system

with an entirely new, private ownership-oriented, and profit-encouraging mindset. The promise of

independence quickly turned into a problematic reality, spurred by dysfunctional monetary and

payment arrangements.59 Russia was no longer the sole focus, causing trade to decline by 10-15%

54 Op.Cit. Lainela.p.28 55 Ibid. 56 Ibid. 57 Krupnick, Charles. "Expecting More from Democracy in Central and Eastern Europe." Whitehead Journal of

Diplomacy and International Relations.(2005).p.154 58 Op.Cit. Clemens.p.61 59 Op.Cit. Pautola.p.9


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of GDP, inflation to spike, and shortages of raw materials to arise.60 Essential economic relations

with former Soviet states had to first disintegrate and be “rebuilt under market principles.”61

Looking inward, tax bases established under centrally-planned principles suddenly disappeared,

which required major cuts in public spending and reconstruction of underdeveloped fiscal

institutions.62 What once were centrally-determined principles, those of social welfare and

employment protection, devolved into a void, a void that inexperienced governments were ill-

prepared to fill.

Disillusioned with post-communist hardships, the region experienced a substantial weakening of

its civil society, indicative of citizen alienation.63 This was a marked change from the pre-

independence efforts, which had marshalled a significant portion of society to become politically

active. Attempts by each republic to revive the economy and public spirit would soon follow; the

Baltic States would initiate their exclusive Baltic Free Trade Agreement (BFTA) to improve output

and levels of inter-state cooperation64, which, with assistance from Nordic countries65, would

reignite the common public interest in becoming fully legitimate EU members. Poland, fortunately

at the peak of the EU “accession queue,”66 would soon join the Central European Free Trade

Agreement (CEFTA) to spur economic recovery and further its path toward EU membership.

60 Op.Cit. Pautola.p.9 61 Sorsa, Piritta. IMF. Regional Integration and Baltic Trade and Investment Performance.(1997).p.4 62 Op.Cit. World Bank.p.145 63 Op.Cit. Krupnick.p.152 64 Adam, Antonis, Theodora Kosma, and Jimmy McHugh. IMF. Trade-Liberalization Strategies: What Could

Southeastern Europe Learn from the CEFTA and BFTA?.(2003).p.3 65 Hilson, Mary. The Nordic Model: Scandinavia since 1945. London: Reaktion.(2008).p.143 66 Op.Cit. Dinan.p.276


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With Regards to Labor Market Liberalization This paper will not adopt a chronological approach due to the coverage and magnitude of the

investigation. Instead, utilizing the framework of HINT and PDP, the analysis will aggregate the

aspects LML into four sections: Legislative Capacity, Trade Unions, and Civil Society; Wages;

Contracts and Mobility; and Welfare. These groupings highlight the successes of Estonia’s LML

relative to the accomplishments and shortcomings of Latvia, Lithuania, and Poland.

Legislative Capacity, Trade Unions, and Civil Society

Within the fledgling capitalist republics, democratic disenchantment was a common feature that

developed among the masses. Pautola notes that “one of the most fundamental issues connected

with fiscal transition…[was the] common distrust of government and politicians.”67 This was a

huge turnaround that drastically altered how the public would negotiate and influence public

policy; according to Clemens, “unlike the Popular Fronts of the 1980s, few NGOs cut across

societal divisions to represent the public at large.”68 To put this in perspective of labor, the

coverage of collective bargaining apparatuses in Estonia was low for the Baltic region, and more

so when compared to EU Member States69, signaling potential for labor market flexibility.

Nevertheless, apathy was not all-inclusive in the Baltic region. Although a vital critical juncture

for Estonian progression, LML in the other three states were either restrained by the desires of

legislators or constrained somehow by societal groups. This therefore restricted Latvia, Lithuania,

and Poland from achieving a comparable level of transition to Estonia.

67 Op,Cit. Pautola.p.7 68 Op.Cit. Clemens.p.83 69 Op.Cit. Eamets and Masso.p.17


18

From 1991-2001, no strikes or lockout-induced losses of working days occurred in Estonia.70 It is

a marvel to claim such a feat by any standards, but this was not necessarily due to ideal working

conditions. Simply put, this period in Estonian history had few active, domestically-focused

collective bodies. As a consequence to activist fatigue and dissatisfaction with capitalism, labor

retreated from the forefront of politics, leaving few who joined trade unions. Noncitizens also

found difficulty in organizing politically71, forcing them to act as less-effective outsiders through

street marches and popular gatherings. By 1995, few of the 750 Estonian NGOs included labor

concerns in their mandates, instead directing their focus internationally and on macro-level

national activities.72 Minimal social resistance permitted the newly appointed Prime Minister Mart

Laar to enact sweeping reforms of trade policy beginning in 1992, drastically reducing trade

barriers to the Estonian economy.73 Reform-minded legislators adopted and implemented the

liberal policies endorsed by Laar, signaling the importance of liberal economic ideas within

Estonia’s institutional framework. The quick transition to democracy left minimal time for civil

society to gain a foothold within the political framework, which left the door wide open to free-

market reform.

The rest of the region demonstrated similarly demoralizing statistics of voter apathy. For example,

confidence in Latvian political parties rose only from 5% to 10% between 1992-1997, and by 1996,

32% of Lithuanians believed voting unimportant.74 Nevertheless, the institutional framework in

the remaining states of the region were still not as conducive to overhauls in labor market reform.

Poland in particular had crafted its democratic system in which the executive was somewhat weak

70 Funk, Lothar, and Hagen Lesch."Industrial Relations in Central and Eastern Europe."Intereconomics.(2004).p.270 71 Op.Cit. Clemens.p.84 72 Ibid. 73 Ibid 74 Ibid.p.70


19

and more inhibited for unilateral action, which gave greater political leverage to interests whose

focus was on social welfare. As Cook notes, Poland had comparatively higher societal defenses

for entitlements and welfare75, the effects of which will be discussed in a subsequent section. With

regards to Polish labor markets during the early 1990s, the World Bank reported about the

historical persistence of institutional arrangements, discussing the heavily unionized labor markets

that had previously been part of the Polish government. These forces impeded the government’s

desires to privatize at a rapid pace.76 Such institutional legacies spurred new pacts to be put in

place during transition, like the 1990 legislation that required workers to be paid even during a

strike.77 Of the four Baltic republics, Poland endured the highest rate of strikes in 1991-1996,

peaking in 1992 with a 223-day strike.78 Most evident from the Polish case is the applicability of

HINT; institutional structures molded the dynamics of interaction to favor labor, more so than in

any other republic in the region.

Coming from a slightly different standpoint, Lithuania had neither the intensely reform-minded

politicians seen in Estonia nor a strongly unionized labor force. The least industrialized in the

region, Lithuania bucked the Baltic trend and instead employed the most gradual path of liberal

reform. There was a steady trade union revival throughout the 1990s, whose coverage peaked at

10-15% of the working population.79 This transition approach nevertheless still encountered

repeated large-scale privatization delays due to corruption and dishonesty. This issue was so

prevalent, it would plague Lithuanian politics throughout the 1990s up to the 2000 election.80

Latvia had corruption concerns disrupting its legislative capabilities as well, but its shock-therapy

75 Op.Cit. Cook.p.194 76 Op.Cit. World Bank.p.61 77 Ibid. p.89 78 Op.Cit. Funk and Lesch.p.269 79 Op.Cit. Clemens.p.85 80 Ibid. p.70


20

reform proved less turbulent. Industrial action was restricted in Latvia, with a requirement to notify

employers at least 14 days in advance.81 Risk of job loss in the transition was too significant a

concern for workers – few dared to try and organize against employers. Moreover, according to

Funk and Lesch, “most workers also recognize[d] the necessity of structural change in order to

strengthen the international competitiveness of domestic firms.”82 Until 2002, the Latvian labor

code stated that unions had to consent to employee dismissal before the action could take place.83

This practice would dissuade employers from expansion and would discourage foreign firms from

choosing Latvia for investment. In terms of NGO presence, Lithuania underwent a decline in

registrations during the mid-1990s. Latvia, on the other hand, reached over 4000 NGOs by 1998,

but awareness and prestige of their activities was largely absent.84

Wages

Wage liberalization is an essential component of LML, potentially including a lowering of taxes,

or perhaps permitting market forces and employers to determine wage and employment levels.

According to the model presented by Aghion and Blanchard, expected wage levels, among other

factors, will be positively correlated to job reallocation and negatively associated to the

unemployment rate.85 As part of the shock-therapy liberalization undergone in Estonia, previous

wage regulations were removed to allow for market-determined wages. The stark redirection in

state policy had positive ramifications, one of which being by 2000, Estonian wage differentials

between men and women were declining.86 Moreover, Estonia was the first to restructure their tax

81 Kohl, Heribert. "Where Do Trade Unions Stand in Eastern Europe Today? Stock-taking after EU Enlargement."

Internationale Politik und Gesellschaft.(2008).p.122 82 Op.Cit. Funk & Lesch.p.270 83 Op.Cit. Eamets and Masso.p.17 84 Op.Cit. Clemens.p.84 85 Aghion, Philippe, and Oliver Blanchard. "On the Speed of Transition in Central Europe." NBER. 9.(1994).p.8 86 Rõõm, Tairi , and Epp Kallaste. "Men and Women in the Estonian Labour Market: An Assessment of the Gender

Wage Gap.". Praxis Center for Policy Studies.(2004).p.1


21

system by switching to a flat personal income tax in 1994 to 26%87, setting a high future standard

for the Baltic States.88,89 This restructuring created a more attractive business climate and

incentivized FDI to funnel into Estonia, the results of which will be detailed shortly. Both Latvia

and Lithuania followed suit, adopting flat income tax rates of 25% in 1994 and 33% in 1995,

respectively.90 Wage determination in these two states was mixed; subject to governmental

guidelines, market forces determined wages as privatization increased throughout the 1990s, but

were not nearly as liberalized as Estonia. For example, Lithuania underwent a turbulent economic

transition and was forced to deal with briskly rising real wages during 1992, which required a

downward adjustment by almost 55% in 1993.91 The mid-1990s was a period of fiscal restraint

due to huge losses in government revenue through shrinking tax bases and industry privatization.

Poland, in contrast to the Baltic States, struggled with wage rigidities during reform attempts. Such

rigidities included pre-determined public sector pay scales, bloated union-negotiated wages, and

other occurrences that prevented labor supply from meeting demand at market levels. Particularly

as a consequence of the problematic initial Polish shock-therapy liberalization, wage determination

became strictly moderated by the 1993 government, under The Democratic Alliance. The Alliance

implemented higher levels of public sector pay, heightened public spending, and more moderated

social policy.92 This policy redirection was in stark contrast with the initialized reforms already

underway, but better conformed to the desires rippling through popular discourse. Most apparent

in Polish regulation was the apparatus in place for minimum wages. Whereas the levels in the

87 Saavedra, Pablo. "Flat Income Tax Reforms." Fiscal Policy and Economic Growth. World Bank.(2007).p.256 88 Lehmann, Martmut, and Alexander Muravyev. "How Important Are Labor Market Institutions for Labor Market

Performance in Transition Countries?.". Institute for the Study of Labor (IZA) Bonn.(2004).p.8 89 "The case for flat taxes." Economist.(2005) 90 Op.Cit. Saavedra.p.256 91 Op.Cit. Pautola.p.18 92 Op.Cit. Cook.p.199


22

Baltic States wavered and decreased throughout the 1990s, Polish minimum wages proved “sticky”

and did not decrease (relative to inflation) during the entire decade.93 Adjustments were made

during these years by the labor ministry, in consultation with unions, on a quarterly basis to ensure

fair levels were reaffirmed.94 Strict adherence to minimum wage policies were followed due to the

recurring levels of high Polish inflation. In 1990 Poland had an annual inflation rate of 555.7%,

which in the following years remained comparatively high but continued to decline, justifying

trade union expectations to recalculate minimum wages quarterly. The post-1990 rates exhibited

in Graph 1 illustrate the downward trend of average annual inflation in Poland, but its substantial

level over many years would serve to formalize labor-employer wage relations during a time of

institutional infancy.

Graph 195

Wage ceilings existed during the early 1990s, but were found to be rarely binding during the time

of price liberalization96; firm-level works councils and larger industry unions had significant wage

negotiating ability, preventing LML from becoming the kind of critical juncture in Poland as it

93 Op.Cit. Huber et al.p.22 94 Ibid. 95 Op.Cit. Bozóki.p.26 (data used for graph) 96 Op.Cit. World Bank.p.49

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was in Estonia. Poland had strength in industry, geographical size, size of labor force, and

proximity to the EU, however its struggle with LML prevented a utilization of these advantages.

Contracts and Mobility

Improving the physical and industry mobility of labor, as well as deregulating labor contracts, are

two key facets of LML. Mobility was improved through privatization, which was essential in

providing new and accessible labor opportunities. The pace at which these programs progressed

was vastly different throughout the Baltic region due to institutional norms and legislation. A 1996

World Bank report on transitions to market economies praised Estonia for its reforms thus far. In

line with the neoliberal ideology, Estonia was providing far greater opportunities for its labor force

by crafting and implementing “top-down privatization programs.”97 This contrasts the Polish

experience, where they were unable to reform in such a manner due to their comparative

decentralization of power and more effective employee unionization. Estonia was decisive in

industry transitions; previous constituencies often had absolute or relative specializations, and four

out of five constituencies were then diversified in their focus through 1990-1999, greatly

improving GDP per capita levels.98 Such improvements attracted entrepreneurship and production

by large domestic and international businesses, which would translate ultimately into greater

national facilities, such as infrastructure and telecommunications. Contractually-related, by 2000

the Organization for Economic Cooperation and Development (OECD) had rated Estonia with a

low 2.4 on their index of employment protection legislation, based on a 0-6 scale.99 Estonia’s

expenditure of less than 0.1% of GDP on “active labor market policies” was factored into this

97 Op.Cit. World Bank.p.65 98 Op.Cit Huber et al.p.56 99 Op.Cit. Ervasti.p.141


24

rating, which continued to reaffirm Estonian commitment to LML.100 Once again, institutional

circumstances, and particularly the legislators acting within these institutions, were vital in

attaining such levels of liberalization.

The rest of the region fared differently than Estonia, although Lithuania privatized exceedingly

rapidly. With ethnic Lithuanians forming approximately 80% of the population, there was less

concern that other nationalities would acquire a disproportionate amount of new wealth from

privatization.101 In fact, by 1993 70% of all state companies were privatized; these levels occurred

so quickly that there were major concerns that purchases were made with illegal money through

larger, institutionalized corrupt practices.102 Lithuania reaped some benefits of greater

privatization and perhaps greater mobility of labor, but its slower reform in other aspects of LML

and general lack of industrialization hindered its progress. Latvia exhibited the slowest rate of

privatization of the Baltic States. Moreover, the Latvian institutional framework permitted

communist-era firms and their market-counterparts to often hold monopsony power over labor

throughout the transition.103 Labor mobility was severely restricted: officially workers needed a

stamp in their passports to designate where they would be allowed to live and work. These policies

were profoundly limiting for any kind of geographical or industry shift, with worker opportunities

only worsened by the publicly owned housing market104, which made it extraordinarily difficult to

obtain a change of residence.

100 Op.Cit. Lehmann and Muravyev.p.8 101 Op.Cit. Lainela.p.30 102 Ibid 103 Chase, Robert. "Labor Market Discrimination During Post-Communist Transition: A Monopsony Approach to

the Status of Latvia’s Russian Minority." Johns Hopkins University.(2000).p.7 104 Ibid.


25

Looking towards Poland, industrial asymmetry was a major concern during liberalization. The

USSR had selected the east of Poland for superior resource allocation to supply large areas of its

Soviet Republics, which often led to the formation of substantial industrial bases surrounded by

agriculture production. This type of manufacturing was well-suited to state-owned enterprises that

acted as cogs in the communal national machine, however the transition to a market economy

found these hubs laden with out-of-date infrastructure and inefficient labor practices.

Asymmetrically, western areas of Poland had proven to be better equipped to manage supplies

directed toward the West, even before 1990.105 This meant that inherited capital and labor practices

were better able to adapt to Western capitalism. This division in industry styles imposed a

structural rigidity that made the Polish labor market quite uneven throughout the 1990s. Standard

practices in the East produced the relatively static skills of the Eastern labor market, which made

it difficult to migrate to another industry or geographic location. By 2000, Poland had the highest

unemployment in the Baltic region106; the issue of unemployment would become a core in Polish

national concerns as it neared EU accession.

Welfare

The transition to capitalism rapidly shifted former bases of public sector finances for the entire

region. A part of LML, welfare can include unemployment benefit provision, pension provision,

and subsidies, all of which were determined differently in the region. Three distinct governmental

approaches arose, the most radical of which was demonstrated by Estonia. By 1996, Estonia had

formalized the requirement that unemployed workers, who were able-bodied, must perform at least

105 Duffy, Fiona, and Patrick Walsh. "Individual pay and outside options: evidence from the Polish labour force

survey.". Institute for the Study of Labor (IZA) Bonn.(2001).p.2 106 Op.Cit. Huber et al.p.22


26

80 hours of monthly public service in order to be eligible for unemployment benefits.107

Additionally, the unemployment benefits offered by 2003 were only 7% of the average Estonian

wage. This level was by far the lowest of the region, as can be seen in the Graph 2 on the below.

Graph 2108

As can be seen above, the rest of the Baltic region averaged closer to unemployment benefits at

20% of the average wage. This is one of many indicators that Estonia was region’s model liberal

transition country by 2004.

107 Op.Cit. World Bank.p.93 108 Cazes, Sandrine, and Alena Nesporova. "Combining flexibility and security for employment and decent work in

the western Balkans." South-East Europe Review.(2006).p.17 (data used for graph)

0 5 10 15 20 25

Estonia

Latvia

Lithuania

Poland

2003 Unemployment Benefits

(% of average wage)


27

Contrary to what might be expected, Estonia did not reserve the finances kept from frugal

unemployment benefits to promote policies that incentivized working. To give an example of such

policies, Latvia had enacted legislation to pay lower benefits to early retirees, whilst incentivizing

retirement postponement by raising benefits for those who waited and continued to contribute to

an employer or the national pension system.109 As is illustrated in Graph 3, Estonia did not use the

surplus of funds for labor market expenditures.

Graph 3110

As is demonstrated in Graph 3, the Baltic States refrained from the level of labor expenditure that

Poland employed. Prospects for EU membership solidified the historically institutionalized social

welfare dynamic in Poland of high health, labor, education, and social services spending.111 These

aspirations matched with civil society’s concerns of social provision and welfare state change,

which were often considered a form of compensation for the costs of liberalization during the early

1990s.112 Poland was able to ease its fiscal balance through subsidy reductions, although social

109 Op.Cit. World Bank.p.90 110 Op.Cit. Cazes and Nesporova.p.17 (data used for graph) 111 Op.Cit. World Bank.p.35 112 Op.Cit. Cook.p.200

0.00% 0.20% 0.40% 0.60% 0.80% 1.00% 1.20% 1.40%

Estonia

Latvia

Lithuania

Poland

2003 Labor Market Policy Expenditure

(% GDP)


28

transfers remained persistently high. This practice was similar to Estonia, who had abolished all

industry subsidies by 1997, including the often heavily-protected agricultural sector, except for

few subsidies in the energy sector.113 Nevertheless, the institutionalized, democratic representation

of concerned parties in Poland was pivotal in upholding expenditures. Bargaining capability,

whose importance is reaffirmed by HINT, is engrained in Polish history and persisted due to the

rise of neoliberal forces running counter to social welfare. Such counter-forces would gain

momentum due to the significant strains on the fiscal base of the government that quickly

developed, such as the 28% rise in Polish pensioners between 1989-1993, matched only by a 1.5%

increase in population during the same time period.114

Looking briefly towards Latvia and Lithuania, one of their roles in the USSR had been to

contribute significant transfers to the greater union. Once this obligation was removed with the fall

of the USSR, they were able to improve their fiscal balances; initial surpluses in national accounts

provided the opportunity to implement cash rationing and expenditure controls.115 Both countries

followed the Estonian policy agenda of limiting expenditure in subsidies and social transfers, albeit

to a lesser extent. Lithuania, for example, implemented cuts in pensions, public sector wages, and

unemployment benefits to reign in fiscal expenditures between 1992 and 1993.116 The slightly

greater presence of civil society and pursuance of less absolute reforms meant that the two

countries fell in the middle of the Baltic reform spectrum.

113 Op.Cit. Pautola.p.11 114 Sachs, Jeffrey, and Andrew Warner. "Achieving Rapid Growth in the Transition Economies of Central Europe.".

Harvard Institute for International Development.(1996).p.45 115 Op.Cit. Pautola.p.5 116 Ibid p.19


29

The “Run-Up” to EU Accession For the Baltic region, there was a magnetic attraction to EU accession. Membership was one of

the final hurdles to ensure no future retrogression into the former-Soviet sphere. Moreover, EU

membership held promise of profound growth potential through access to the economic and

political union. Evidence presented thus far in this paper of LML in the region undoubtedly

demonstrates not only the institutional legacies of the four countries, but also the relevance of

LML as the critical juncture for Estonia within the PDP framework. PDP’s analytic strength in

this capacity is that of explaining outcomes in situations when key actors attempt to alter, or

successfully achieve an alternation in the status quo. Several resultant outcomes of LML in the

Baltic region will be presented below in a grouping of domestic results, subsequent external

influences, and specifically notable outcomes that confirm the critical juncture claim on the eve

of EU accession.

Domestic

Proponents of neoliberal reform shared a common concern: uncertainty. Politicians new to

democracy lacked the foresight to see long-term policy implications, particularly in the Baltic

States, which hadn’t enjoyed institutionalized independence for over 50 years. Economists from

across the world were discordant in opinion over how quickly market-oriented reforms should

occur.117 Estonia implemented the rapid pace of shock-therapy reform and largely succeeded,

whereas Poland was rife with disenchantment following its shock-therapy attempt. As has been

noted previously, Lithuania adopted the most gradual reform of the Baltic States from the outset,

matching what Stiglitz claimed to be the ideal method of reform in 1999. Stiglitz was

unquestionably in favor of privatization and encompassing reform, and also remained consistent

117 Op.Cit. Clemens.p.107


30

with HINT, but suggested there were “institutional preconditions that include[d] a build-up of

social and political capital to enable necessary reforms.”118 The post-communist transition of the

Baltic region was unprecedented in complexity and scope.

Estonia was not without fault through the transition, with its politics affected by various scandals

and corruption. Several governments came to power throughout the 1990s, with Prime Minister

Laar returning to power in 2000 as part of a relatively weak coalition, reaffirming Estonia’s reform

commitment.119 Specifically looking at Laar’s 1994 Estonian flat tax reform, the fiscal

consequences were fortunately inconsequential: before the reform in 1993, government tax

revenues approximated 39% of GDP. By 2002, these revenues approximated 40% of GDP.120 The

tax reforms did not prove a detriment to Estonian fiscal balances, and as a by-product Estonia

obtained a significantly more attractive business climate. Shifting focus to the other two Baltic

States, Latvia and Lithuania also endured malpractice and criminality during their transition to

market economies.121 Attempts to form a financial sector and effective supervisory mechanisms

that could support new businesses required structural changes, which have different difficulties to

legislating social reform.

Poland was similarly plagued with political disorder throughout the 1990s. The lack of a lustration

law until 1999122 left a non-legalized break with pre-independence politics, creating several

political scandals. Throughout the decade, social expenditures waxed and waned according to

growth levels and political fortitude. Growth during 1994 and 1995 permitted higher social

118 Stiglitz, Joseph. "Whither Reform? Ten Years of the Transition." Annual Bank Conference on Development

Economics. World Bank. Washington DC.(1999).p.4 119 Op.Cit. Clemens.p.63 120Op.Cit. The Economist 121 Op.Cit. Leinela.p.40 122 Op.Cit.Calhoun.p.128


31

expenditures, however the years of 1996-1998 brought on re-clarifications on welfare eligibility.

Finally, the government spearheaded reforms on pensions, healthcare, and education in 1999 to

improve overall levels of national efficiency.123 Despite various reform measures in social

provision, which ran counter to the neoliberal ideals of government restraint, Poland still had low

levels of phone and computer access, lower rates of higher education, and lower life expectancy

than the three Baltic States.124

Poverty was a key concern in Poland through the solidification of regional disparities and industrial

asymmetries. These structural issues were a severe determinant to the economy, often precluding

a significant portion of the relatively high labor supply from obtaining employment from the 1990s

into the 2000s.125 Graphs 4 and 5, on the following page, illustrate this trend.

123 Piêtka, Katarzyna. "Labor Supply Effects of Social Security Transfers." in: Poverty Dynamics in Poland Selected

quantitative analyses. Warsaw: Center for Social and Economic Research, Warsaw.(2002).p.39 124 Op.Cit. Clemens.p.168 125 Golinowska, Stanislawa. "Poverty in Poland: Causes, Measures and Studies." in: Poverty Dynamics in Poland

Selected quantitative analyses. Warsaw: Center for Social and Economic Research, Warsaw.(2002).p.35


32

Graph 4126 Graph 5127

Evident from both graphs was the prevalence of unemployment in Poland, which by 2000 rose to

levels markedly higher than the rest of the Baltic region. As has been explored throughout this

paper, institutional configurations and industrial asymmetries were significant determinants of the

unemployment. A study in 2006 found a negative correlation between trade union density and

youth unemployment; the protection of core workers through these unions may prevent younger,

less experienced workers from joining the workforce.128 Poland followed a historical path of trade

union presence throughout its transition, which could explain the approximately 40% youth

unemployment by the time of EU accession.

Graphs 4 and 5 also illustrate the Estonian trend of comparatively low unemployment, although

youth unemployment reached similar levels seen also in Latvia and Lithuania. Following the PDP

126 "Unemployment Rates in Estonia, Latvia, Lithuania, and Poland." Indexmundi - Data from World Bank ‘World

Development Indicators’. www.indexmundi.com 127 Ibid. “Youth Unemployment Rates in Estonia, Latvia, Lithuania, and Poland; Ages 15-24”. 128 Op.Cit. Cazes and Nesporova.p.20

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concept directed by Estonian LML, the country offered external interests more than deregulated

wages, but also a highly educated and well-trained workforce of skilled professionals. Aspirations

of EU accession, fear of job loss, and exceedingly limited unemployment benefits incentivized

workers to perform with diligence. Latvia was able to follow a similar path: by 1998, 66% of

workers were in the private sector and strikes were rare.129 The most government intervention was

exhibited by Lithuania, whose expansionist fiscal policies tended to push wages upwards at rates

higher than GDP growth.130 These consequences, understood in the PDP context, were due to the

gradual reform employed by Lithuania. Nevertheless, by 1998 Lithuania had revised its general

outlook by providing firms with incentives to improve human capital.131 Nearing the 2004 EU

accession, the Baltic States were able to offer foreign investors cheap and skilled labor, with

potential for relocation throughout Europe and Russia.132

International Interaction

While the Baltic region was under USSR control, external actors had already begun to realize their

economic and political potential. As the region developed further, EU accession aspirations drove

greater international interaction. Poland had immediate attention from the EU due to its proximity

to Europe and sizeable population. Across the region the EU would also form individual trade

agreements (Europe Agreements), whose purpose was to provide closer political and economic

ties; schedules for tariff reform; and technical, legal, and financial assistance.133 The Europe

Agreements served in an advisory role, as well as presenting the tantalizingly close carrot of EU

membership. National governments would then provide the stick to drive reform and meet

129 Op.Cit. Clemens.p.172 130 Ibid 131 Ibid 132 Ibid. p.170 133 Op.Cit. Adam, Kosma, and McHugh.p.5


34

accession conditions. Unique to the Baltic States, the BFTA was formed as a truly free-trade

agreement without so-called “loophole clauses” that would have given rise to disputes. Liberal

reforms and the ability to openly engage competitive pressures, as would be experienced in the EU

Common Market, sent positive indications to the EU and other foreign investors.134 Below is

Graph 6, depicting comparative FDI inflows to the Baltic Region.

Graph 6135

Graph 6 is highly illustrative of the business climates that developed as a result of the region’s

transition to liberal market economies. Initial focus is on 1998, when Estonia rapidly received a

surge in FDI flows. Following Russian oil crisis that damaged the Baltic economies, flows from

Scandinavia rapidly increased to take leading roles in Baltic investment.136 With Poland as the

134 Kazlauskiene, N., and W.H. Meyers. "The Baltic Free Trade Agreement in Agriculture: Early Results of the

Experiment."MOCT-MOST. 9.(1999).p.292 135 Op.Cit. Indexmundi. “Net FDI Inflows in Estonia, Latvia, Lithuania, and Poland.” 136 "Foreign Investments in Latvia." Baltic Export. Lithuania. <ww.balticexport.com>.

0

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Ne

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35

primary focus of the EU for a significant period during the 1990s, the Nordic countries shifted

substantial human and physical resources into Baltic State projects. As the northernmost of the

Baltic States, Estonia shared close “lingual, historical, and geographic ties with high-tech and high-

wage Finland.”137 The ties with the region served to accelerate the positive reforms within Estonia,

funding high-technology improvements and promoting job creation. Although slightly beyond the

scope of this paper, one can clearly see in Graph 6 the rapid investment post-accession; Estonia

had been primed to take advantage of full market access. The Nordic countries felt far fewer ties

with Poland despite significant emigrant communities, primarily due to the restricted privatization

programs and conflicting politics138, making the business climate less attractive than Estonia’s.

Despite the relatively modest investments from Nordic countries, Poland was able to be the first

of the region to join the World Trade Organization (WTO) in 1995.139 This accomplishment was

hugely beneficial for Poland, who had struggled with LML and more general resistance to liberal

reforms. WTO membership obligations not only formally protected Polish trade, but ensured at an

early stage of transition that liberal regimes would remain. Poland had significant sectoral interests

who held great privilege in policy-formation, which WTO obligations mediated from any form of

trade regime protection or backsliding.140 Latvia and Estonia were able to complete the accession

process to the WTO in 1999, with Lithuania joining by 2001.141 WTO membership for the Baltic

States gave an early form of security before that which was gained by EU accession. Moreover,

entrance to the global regime served to condition the three countries further in Western-led

economic practices. The Baltic region utilized external interactions throughout transition to

137 Baldwin, Richard, and Charles Wyplosz. The Economics of European Integration. 4th ed. Berkshire: McGroaw-

Hill Education.(2012).p.200 138 Op.Cit. World Bank.p.77 139 Ibid. p.147 140 Ibid. p.147 141 Op.Cit. Kazlauskiene and Meyers.p.292


36

expedite the implementation of best practices in their own economy, whilst situating themselves

better on the global stage for further inclusion in the West.

Hard work pays off

The evidence of LML as a critical juncture within the PDP framework illuminates how transition

progressed within the Baltic region. According to a 2003 Economist Intelligence Unit report,

Estonia had the most robust business environment in Central and Eastern Europe.142 The labor

market factors leading Estonia to this success have been discussed throughout this paper, and

whose quantification will be illustrated in terms of GDP per capita in Graph 7 below.

Graph 7143

As is demonstrated in Graph 7, Estonia’s LML prevailed by utilizing its centralized government

to sustain the increasing rates of GDP per capita. Poland may have been the first country in the

142 "Baltic States: Country outlook." EIU ViewsWire.(2003): ProQuest Business Collection. 143 Op.Cit. Indexmundi.“GDP per capita in Estonia, Latvia, Lithuania, and Poland”.

0

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1990 1992 1994 1996 1998 2000 2002 2004

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37

Baltic region to re-obtain 1989 levels of production, which it achieved in 1995144, but its

institutional focus on industrial policy and social inclusiveness came as part of its more

“embedded neoliberalism,” which could not match the consensually-desired and ideal market

economy that Estonia boasted.145 Despite the socially-focused policies implemented in Poland, a

2004 study of 26 European countries found Poland to have the lowest trust in its national

parliament, politicians, political parties, and legal system. Internally conflicting politics and

erratic policies during transition put Poland on a path of low trust, which ultimately fell below

countries such as Ukraine and Hungary, both of which were notorious for political corruption.146

Returning to FDI inflows, Krupnick reaffirmed HINT and PDP’s relevance for Estonia:

neoliberal policies pursued by each Estonian government were hugely beneficial for prosperity

and economic harmonization with the EU.147 Although the Baltic States had reformed at

different paces, full GDP recovery was reached in all by 1998148 and Estonia emerged as the

clear forerunner for reform commitment.149 Clemens likened the success of the Baltic States to

the “Asian Tiger” of Taiwan: working with limited natural resources and every-wary of their

former subjugator.150 GDP per capita rose in Estonia due to their ability to utilize highly-skilled

and low-cost labor.151 These skills were constantly modernizing, with Estonia also ranked as one

144 Upchurch, Martin. "Persistent economic divergence and institutional dysfunction in post-communist economies:

an alternative synthesis."Competition and Change.16.2.(2012) 145 Baboš, Pavol. "Varieties of capitalism in central and eastern Europe: measuring the co-ordination index of a

national economy." Journal for Labour and Social Affairs in Eastern Europe.(2010).p.450 146 Op.Cit. Ervasti.p.141 147 Op.Cit. Krupnick.p.155 148 Op.Cit. Upchurch 2012.p.5 149 Op.Cit. Lainela.p.34 150 Op.Cit. Clemens.p.2 151 Op.Cit. Sorsa.p.6


38

of Europe’s most computerized societies; by 1998 more than 10% of Estonia’s population used

computers, which matched similar levels in France and Germany.152

A final indicator of Estonia’s success was that as the country neared EU accession its economic

policies were found to be too liberal and had to be reduced before entry to the EU. Moreover,

Estonian tariffs were so low that by 2000, in order to be admitted into the EU, Estonia would

have to raise tariffs on over 10,000 items against non-EU countries.153 It was evident that EU

accession undermined the highly liberal Estonian labor and trade policies employed in the 1990s.

Estonia was by far the model transition country of the region, exhibiting comparatively low

growth rates of industrial production, strict fiscal policies, and low levels of social welfare,

which had to be revamped to better fit EU standards of trade and social protection.154

152 Op.Cit. Clemens.p.109 153 Ibid. p.170 154 Op.Cit. Baboš.p.448


39

Conclusion “Actors who seek to move in new directions find that their choices are constrained by the

existing set of institutional resources. Institutions limit the field of action, preclude some

directions, and constrain certain courses.”155 This quote from Stark and Bruszt succinctly

identifies the key explanatory capacity of HINT and PDP in the case of Estonian LML. Pre-

independence frameworks preconditioned the governance capabilities of the Baltic region; these

frameworks went far deeper than formal governmental institutions to include cultural and social

norms. Following the collapse of the USSR and the introduction of market capitalism,

institutional legacies had varying effects on reform attempts. Dependent on governmental reform

commitment, civil society presence in policy formation, and democratic disenchantment, the

critical juncture of LML was either a breakthrough moment for continued reform, or as a marker

signaling internal conflict.

Estonia was willing and able to capitalize on the free-market ideals that permeated through its

political arena, and with the general withdrawal of popular counter-forces, was able to put itself

on a path of reform towards an ideal neoliberal economy. The other three countries of the Baltic

region inherited an expectation of social provision and more generous state coordination from

their socialist past, whilst also striving to obtain the benefits of democracy and independence.

The early 1990s was a period of necessary fiscal constraint for the entire region due to legislative

reform and shifting tax revenue bases, causing many of these expectations not to come to

fruition. Resistance to liberalization, particularly in Poland, hindered the effectiveness and

sustainability of Polish shock-therapy reforms at the outset of its independence. With few laws

restricting strikes and significant inclusion of unions in wage negotiations, the whole society

155 Op.Cit. Stark and Bruszt.p.83


40

came to embody same mindset – that of social entitlement. Struggles with disillusionment went

on to plague Polish attempts to move towards a neoliberal economy, leading to several instances

of social policy “flip-flopping.” Reform was often pushed forward by the desire for and eventual

entrance to the WTO and future prospects for EU accession. For Poland, Latvia, and Lithuania,

guidance in developing Western-approved governmental and political institutions156 provided an

avenue to somewhat steer the path of development, helping to offset the urge to slide into

becoming an economically non-competitive nation.

The critical juncture of LML was absolutely vital for Estonian success. Historical desires for

Westward-looking reform and active policies of liberalization such as wage deregulation and

privatization paved the road to success for this small Baltic State. It transcended shortcomings of

resources, geographic size, and population to become a high-tech country with a highly skilled

labor force. Nordic FDI inflows surged as EU accession neared, unemployment rates were

comparatively low for the region, and there were tight fiscal policies that minimized

expenditures for unemployment benefits, pensions, and other social transfers. The coordinated

efforts of Estonian governments over the 15 years of transition created a reputation for

commitment to market economics and rule of law, which only furthered its success – a virtuous

cycle was established. It was so successful that the EU required Estonia to temper its neoliberal

policies to better match EU trade and social welfare policies before it joined to the union.

156 Lane, David and Martin Myant. Varieties of capitalism in post-communist countries. Basingstoke. Palgrave

Macmillan.(2007).p.35


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