Academic journal article Public Finance and Management

Public Finance Systems for Coping with the Crises: Lessons from the Three Baltic States

Academic journal article Public Finance and Management

Public Finance Systems for Coping with the Crises: Lessons from the Three Baltic States

Article excerpt

ABSTRACT

Of all EU member states the three Baltic countries were hit the hardest by the economic crises in 2008-2010 but they recovered relatively quickly, with all three countries even being able to qualify for EMU membership (Estonia joined the Eurozone in 2011, Latvia in 2014 and Lithuania in 2015). The speed and determination with which the Baltic countries carried out austerity measures is often put forward as an example for other E(M)U member states. This paper critically assesses the validity of various models of austerity (expansionary fiscal contractions, internal devaluation and fiscal devaluation) when applied to the case of the Baltic States. It is argued that in the case of the Baltic countries more complex economic mechanisms were at play then these models suggest. In the paper specific attention is paid to the way fiscal consolidation was shaped in the three countries, and to the role of EU structural funding. The paper concludes with a discussion of the lessons that can be learned for other EU countries.

1. INTRODUCTION

Mid 2007 the world entered into a financial crisis which led to the most severe economic downturn since the end of WWII. The crisis began in the United States as a result of the sub-prime mortgage-backed securities crisis and spread out to a more general financial crisis which then hit the real economy and ended with (global) recession. Additionally, in the Eurozone a sovereign debt crisis emerged.

Even though in 2010 financial market conditions improved and economic growth resumed in most countries - these improvements having resulted largely from the massive support measures taken by governments and central banks in Europe and North America, with a significant impact on fiscal deficits and public debt levels - the economies of most EU member states declined again as from 2012. Early 2014 economic recovery regained ground (European Commission, 2014a) but slowed down again and came to a halt at the end of 2014 (European Commission, 2014d). Economic recovery in Europe seems to be a matter of fits and starts.

This article focuses on how the three Baltic States (Estonia, Latvia and Lithuania) handled the crises. The case selection of these three countries is based mainly on similarities in general background variables as size, GDP per capita and time of EU membership (2004). Comparing the three countries is interesting because even though the starting point before the crisis was more or less the same for all three Baltic countries, the situation during the crises and the measures taken were different. Still, what the three countries have in common is that - in comparison to other EU countries - they had very high growth rates before the crisis, were hit very hard in 2008-2010, but then recovered relatively quickly. Throughout the crisis Estonia was able to keep its public debt level one of the lowest in the EU and qualified easily for euro membership (which started in January 2011). The two southern Baltic States were in a more difficult situation and saw their deficits and debts rise significantly from 2008 onwards. The Latvian government responded to EU and IMF pressure by taking on debt; early 2009 it accepted a 7.5 billion euro EU-IMF loan package. Just as Latvia, but without support, Lithuania has been able to reduce deficits and to keep the public debt level acceptable. Latvia has adopted the euro in January 2014; Lithuania is scheduled to join the Eurozone on January 1, 2015. Currently, the three Baltic States are among the few EU Member States for which no in-depth-review (IDR) is considered to be needed within the framework of the Macroeconomic Imbalance Procedure (MIP) (European Commission, 2013).

The Baltic experience with the crisis has drawn considerable academic attention. Various authors have tried to make sense of what happened in the runup to the crisis and of how recovery took place in the Baltic countries (Brixiova, Vartia & Wörgötter, 2010; Deroose et al. …

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