Austerity Wars: A New (False) Hope

The intensity of the debate over whether the Baltic economies (Estonia, Latvia, and Lithuania) should serve as models for the rest of the eurozone periphery has been raised a couple notches.  Last week, Paul Krugman noted that the Estonian recovery, while positive, has not been as remarkable as austerity supporters tend to imply.  This prompted a vigorous reaction from Estonia’s head of state (unless there’s someone impersonating Toomas Hendrik Ilves on Twitter).  But let’s bracket for the moment this question of how impressive the Baltic recoveries have been.  They are growing again, and that’s at least something.  Last week, Rainer Kattel and Ringa Raudla put out a policy note that focused on a different aspect of the problem:  whatever you think of the results, to what extent is the Baltic experience replicable?  If the rest of the eurozone periphery can’t reproduce the conditions that led to Baltic growth, then this isn’t a terribly useful model.

The argument is supposed to be that austerity and internal devaluation (that’s basically trying to get your real wages to fall in order to regain competitiveness) should be credited for the recoveries in the Baltics (incomplete though they may be).  As C. J. Polychroniou has been pointing out, the latest attempts at internal devaluation don’t appear to be working terribly well in the rest of the periphery.  But perhaps if Greece and the rest of the GIPSI countries were to suck it up, bite down hard, or whatever is the tough love phrase of the day, they might come out on the other end with a Baltic-type recovery.

The problem with this argument, as Rainer Kattel and Ringa Raudla point out, is that there was very little actual “adjustment” in Estonia, Latvia, and Lithuania.  The Baltic recoveries are largely attributable to economic factors that have little to do with austerity policies.  The recoveries were largely “outsourced,” as Kattel and Raudla put it.  First, the Baltic states have been relying on advanced use of EU structural support funding (as Kattel and Raudla note, a stunning 20 percent of Estonia’s budget is made up of EU funds), and second, Baltic exporters are deeply integrated with the Scandinavian and Polish economies, both of which weathered the crisis quite well. Finally, all of the Baltic economies have very flexible labor markets, accompanied by an usual amount of emigration—which is in part why (very high) unemployment rates have started to tick down.  This is simply not a model that could be replicated periphery-wide.

Moreover, Kattel and Raudla provide reasons to believe that the “outsourced” Baltic recoveries are unsustainable.  The whole thing is worth reading.  A One-Pager version is available here.