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Phoenix from the Ashes: The Recovery of the Baltics from the 2008/2009 Crisis

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Abstract

This paper argues that the deep bust and strong recovery of the Baltics were to large extent the result of the sharp adjustment the private sector was forced to go through between 2007 and 2009. When private capital flows suddenly stopped, firms were forced to quickly reduce their net lending gap. They slashed investment and cut costs, including by shedding labor. This led to a deep recession, but also to a sharp improvement in profitability and competitiveness, which set the stage for a subsequent export boom.

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Notes

  1. See Aslund (2007), p. 204.

  2. Estonia first introduced a currency board in 1992 (vis-à-vis the US dollar), followed by Lithuania in 1994 (vis-à-vis the Deutsche Mark). Latvia pegged its exchange rate against the SDR in 1994. By end 2005, all three Baltics had anchored their currencies on the euro (Purfield and Rosenberg, 2010). Latvia’s exchange rate regime in practice resembled the formal boards adopted in Estonia and Lithuania (Wolf, 2016).

  3. Estonia and Lithuania in 1994; Latvia in 1995.

  4. In 2007, general government expenditure amounted to 34% of GDP in Estonia, 33% in Latvia, and 34% in Lithuania, while government debt in the three countries amounted to 4, 7, and 17% of GDP. Source: IMF, WEO, Vintage Spring 2017 (http://bit.ly/2qv2wnS).

  5. Emigration from Latvia and Lithuania was mostly to the UK and Ireland. In 2015, the share of Latvian and Lithuanian population residing in Great Britain was, respectively, 4.9 and 5.8%. Source: Office for National Statistics, Eurostat. Estonians chose Finland as the main country of destination (Lulle, 2013).

  6. In Estonia, the decline was 16%, in Lithuania 22. Source: Haver/Eurostat, code: A939POP@EUDATA, A941POP@EUDATA, A946POP@EUDATA.

  7. GDP per capita in Latvia increased from 24% of that in Germany in 1995 to 54% in 2007. In Estonia, it increased from 33 to 69%; in Lithuania from 27 to 55. Source: The Total Economy Database, GDP per capita in 2016 USD (converted to 2016 price level with updated 2011 PPPs) (http://bit.ly/1PhgcWP).

  8. N. Roubini, June 10, 2009, Latvia’s currency crisis is a rerun of Argentina’s (http://on.ft.com/2uPtSqx); E. Yeyati, June 22, 2009, Is Latvia the new Argentina? (http://bit.ly/2vRSv2A); S. Kuper, June 5, 2009, What went wrong with Latvia? (http://on.ft.com/2tCOpyy).

  9. We excluded Ireland in this comparison. In July 2016, Irelands Central Statistics Office (CSO) revised substantially the national accounts for 2015, mainly due to corporate restructuring operations of a small number of multinational companies, including the relocation to Ireland of companies entire balance sheets and the shift of assets to Irish subsidiaries. As a result, the GDP growth rate was upgraded from 7.8 to 26.3%. Although computed strictly in line with international best practices and statistical standards, Irelands headline GDP and GNP figures no longer provide an effective measure of economic activity that physically takes place in the national territory, as a very significant amount of activity carried out in other countries is now recorded in Irelands national account (IMF, 2017).

  10. The Slovak Republic entered the European exchange rate mechanism (ERM II) in November 2005 and opted for a standard ±15% fluctuation band around the central parity. The parity was revised upward twice (by 8.5% in March 2007 and by 17.7% in May 2008), and by mid-2008 the appreciation of Slovak koruna was similar in magnitude to that of the Czech koruna or Polish zloty. When the Slovak Republic adopted the euro in 2009, the conversion rate was 29.6% stronger than the initial central parity in ERM II.

  11. See Bakker and Gulde (2010).

  12. Foreign bank flows are defined here as the exchange rate adjusted change in BIS reporting banks’ external claims on all sectors. Source: BIS Locational Banking Statistics.

  13. In 2009, total disbursements from the EU, the IMF, the World Bank, and the EBRD were 2.7 billion euro (11% of GDP). See Aslund and Dombrovkskis (2011, p. 46).

  14. See Blustein (2016, pp. 66–71).

  15. A January 2009 blog by Christoph Rosenberg, IMF mission chief to Latvia, Why the IMF Supports the Latvian Currency Peg (http://bit.ly/2vyfNdv) discusses the various considerations of the IMF in supporting the peg.

  16. Source: Bakker and Klingen (2012, p. 123).

  17. 1 lat was worth 1.42 euro. After a 30% devaluation 1 lat would be worth 1.00 euro. This would mean that the local currency cost of 1 euro would increase from 0.70 to 1.00; a 43% increase.

  18. The fall of overall wages was sharpest in Latvia, because public sector wages there declined by 25% between 2008Q3 and 2009Q4. Source: Haver/Eurostat, code: S941LWOS@EUDATA.

  19. Blanchard et al. (2013) argued that most of the cost cutting in Latvia was largely the result of a drop in employment, rather than wages. For Lithuania, wage adjustment also played an important role.

  20. Source: The EU Commission AMECO database, gross saving as percentage of gross disposable income, code: ASGH.

  21. Housing prices in Estonia declined by 49% 2007Q2 and 2009Q4. Source: Bank of International Settlements (http://bit.ly/2eHCDMS).

  22. In Lithuania exports grew by 53%, while imports of its trading partners grew by 33%. For Latvia, export growth was 40%; import growth in its trading partners was 35%.

  23. In Estonia CDS spreads declined from a peak of 725 in February 2009 to 191 at end 2009; in Lithuania they declined from a peak of 848 in February 2009 to 317 at end 2009.

  24. Source: The EU Commission AMECO database. Population aged 15–64 years, code: NPAN.

  25. We use the term “euro area crisis countries” to refer to the countries that were hit in 2010–2011 by the European Sovereign Debt Crisis, viz., Greece, Ireland, Spain, and Portugal.

  26. Total demand is the sum of domestic demand plus exports.

  27. Source: IMF, WEO, Vintage Spring 2017 (http://bit.ly/2qv2wnS).

  28. Private sector wages in Greece started to decline after the euro area crisis broke in Spring 2010 and in 2016 were 25% below the 2010 level. However, many other developments meant that at the same time productivity fell sharply too, inhibiting a recovery of employment.

  29. We excluded Ireland from this comparison, for reasons explained in footnote 8.

  30. Source: IMF, WEO, Vintage Spring 2017 (http://bit.ly/2qv2wnS).

  31. Source: Eurostat. Unemployment rate as percentage of active population aged <25 years.

  32. Source: Haver/Eurostat, code: S939R@EUDATA, S941R@EUDATA, S946R@EUDATA.

  33. Ebeke and Everaert (2014) attribute the high NAIRU to skill mismatches, high tax wedges, and unemployment and activity traps.

  34. Source: The EU Commission AMECO database.

  35. Source: Eurostat. Labor cost index: wages and salaries in business economy.

  36. This ULC-based real exchange rate is the real exchange rate relative to the 37 defined industrial countries, deflated by nominal unit labor costs in the economy as a whole, from the European Commission Price and Cost Competitiveness Database (http://bit.ly/2svbcsp).

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Acknowledgements

The views expressed herein are those of the authors and should not be attributed to the IMF, its executive board, or its management. This paper has benefited from comments by Jörg Decressin, Ben Kelmanson, Christoph Klingen, and two anonymous reviewers. All remaining errors are the sole responsibility of the authors.

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  1. IMF Regional Office for Central and Eastern Europe, Zielna 37C, 00-108, Warsaw, Poland

    Bas B. Bakker & Marta Korczak

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  1. Bas B. Bakker
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  2. Marta Korczak
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Correspondence to Bas B. Bakker.

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Bakker, B.B., Korczak, M. Phoenix from the Ashes: The Recovery of the Baltics from the 2008/2009 Crisis. Comp Econ Stud 59, 520–544 (2017). https://doi.org/10.1057/s41294-017-0034-4

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