How Do the Baltic Countries Cope?

It is time for an update on the economic developments in the Baltic countries. Official GDP numbers for the third quarter of 2009 have recently been published and a clearer picture emerges. I have been asked by many foreigners how the Baltic countries look these days. The foreigners ask whether unemployed and poor people hang around in the streets and whether people are gearing up to protest against the economic crisis and the actions of their leaders. I live in Estonia and travel regularly in the two other Baltic countries, so it is my hope that I can contribute with some personal experiences from the ground. I do not want to downplay the seriousness of the economic downturn, but I will argue that the situation in the Baltics might be less bleak than the statistics suggest.

Figure 1 shows annual GDP growth as percentage change from the same quarter the year before. The picture for the third quarter 2009 is dismal with GDP having fallen between -15 and -20 percent during the last year. The output drop seems to have stabilised, however, suggesting that the contractions will soon become smaller. The feeling of catastrophic fall has been replaced by a sense that there is light at the end of the tunnel.

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Figure 2 shows the unemployment rate derived from Labour Force Surveys. The picture is bleak in all three countries, but Latvia seems to be hit the hardest. It is noticeable that also the unemployment rates exhibit some form of stabilisation or at least slower growth in recent quarters. More disaggregated data show that in particular those under 25 years disproportionally affected with unemployment rates around 30 percent or more. The unemployment is slightly higher among men than women.

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Such data naturally leads to the question of how people in the Baltic countries are coping with the situation. The answer is: surprisingly well! At the street level, the crisis is hardly noticeable. Some building sites have been left unfinished and the traffic jams during the morning and evening rush hours in the major cities have diminished a bit. I have not observed a notable increase in the number of beggars (which there were not many of in the first instance) and poverty problems do not feature prominently in the press. With the exceptions of minor skirmishes in Riga and Vilnius last year, there have been no signs of strikes or street protests. The question is why there is such a discrepancy between the dismal statistics and the perceived economic problems.

First, the accumulated GDP amounts to around 20 percent or a bit more in each of the three countries. In most western countries such GDP falls would have devastating effects, but this is less the case in the Baltics. The Baltic countries have grown very rapidly since the turn of the century, clocking up 8-9 percent growth per year in the period 2000-07. Thus, a 20 percent fall in GDP have set these countries 2-3 years back, i.e. to the levels in 2004. (The West European countries have seen GDP drops of 5-8 percent, which incidentally implies that also these countries have been set back 2-3 years.)

Indeed, the boom from 2000-07 was extraordinary and allowed many households to accumulate assets such as dwellings, summer houses and cars. There are still lots of expensive cars in the streets. If you go to YouTube and type the search phrase “Baltic countries”, one of the very first videos to emerge is labelled “Expensive Cars in Baltic States (Lithuania, Latvia, Estonia)”. It basically shows a large collection of pictures of absurdly expensive cars with licence plates from the region…

Second, most people in the Baltics still have memories of living standards and economic possibilities in the Soviet Union and during the difficult transition process in the beginning of the 1990s. It is a recurrent theme in the public debate that if people could manage in a situation, where even getting food on the table was a challenge, then it would be disproportionate to complain in the current situation. More generally, the history has been rather unkind to the people in the Baltics, and a recession seems like a trifle compared to the experiences in the 20th century.

Third, the functional distribution has changed markedly. Until the middle of 2009, the bulk of the falling income derived from falling profit income, while wage income exhibited a much smaller decline. (Thus, the share of wage income in total GDP has increased markedly and now exceeds the figures for many West European countries.) Until recently, the crisis has to a large extent been felt in the form of falling corporate and proprietary income, which mainly affects foreign equity owners and well-off individuals in Estonia. Only recently, higher unemployment and lower nominal wages have led the burden of the crisis to become more widespread.

Fourth, the increasing number of unemployed manage on unemployment benefits or social assistance although the payouts are usually relatively small. The Baltic labour markets are flexible and turnover is rapid, so the chances of getting a new job might be relatively good even in a tight labour market. There are also employment possibilities in the relatively large informal economy; anecdotical evidence suggests that the informal sector is expanding these days.

Fifth, the share of households defaulting on their debt has hitherto stayed below what had been widely expected. The reason is partly that the ECB has kept the short interest rate in the Eurozone low and most households have floating rate loans denominated in euro. The low interest rates make it easier for existing debtors to service their debt.

To sum up, the GDP contractions of 20 percent or more in the Baltic countries have set back the economies by 2-3 years. The crisis might have bottomed out and economic growth seems to return in 2010. Meanwhile people are coping with the crisis and there have been no major protests or political upheavals. History has taught people in this part of the world that things change both for the better and for the worse.