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Professor Sutela opened his remarks by pointing out that next year will mark
the 10th anniversary of the Estonian Currency Board. Although Latvia and Lithuania
did not fix their exchange rates quite so early, all three Baltic states have
successfully maintained a fixed value for their currencies for nearly a decade.
This is an exception to international experience, and according to Professor
Sutela it is but one very important facet of the exceptional economic reform
initiatives that the Baltic states have undertaken
.
Not only have the Baltics maintained fixed exchange rates for many years, they have
also maintained large current account deficits. Concurrently, all three states
have pursued financial liberalization with equal vigor. Taken together, these
three features of the Baltic economies (fixed exchange rates, large current
account deficits and financial liberalization) represent an anomaly among transition
economies and, moreover, is a combination that many development experts believed
to be a recipe for disaster. In this sense, the Baltic economies present the
example of a surprisingly successful and unique system of macroeconomic reform.
Apart from the economic success of the Baltic states, there have been a number
of other positive developments in the region. Estonia has closed its privatization
board, marking the end of its privatization process. Likewise, the OSCE has
closed its office in Estonia and will close its office in Latvia shortly, in
recognition of the progress these states have made in dealing with their
Russian-speaking minorities. Looking into the future, it seems ever more likely
that all three states will be invited to join NATO this year and that membership
in the EU will follow after that.
It has become almost commonplace to attribute this success to what Dr. Sutela
calls the 'standard explanation', namely that the economic success of the Baltics
is due to the good fundamentals of these states, their relatively small budget deficits
and, most importantly, to their well-educated labor force. All this may be true,
but Dr. Sutela considers this an inadequate explanation of the true secret to
the success of the Baltics.
In a word, the key to the success of the Baltics can be found in the small size
of their financial markets. All three Baltic republics have almost no market
for government debt instruments, only a small inter-bank market, hardly any
market for equity and not much of a market for bank debt. As a result, Estonia,
Latvia and Lithuania have all been spared the destabilizing effects of the large
but fickle capital flows that have ripped through the markets of other transitioning
and developing economies. In effect, the three Baltic states have managed to
avoid the sort of speculation that has been at the root of so many the financial
crises of the past decade simply because there is very little on which one might
speculate in these countries.
The question remains, however, why these states have such small financial markets.
In part, Dr. Sutela explained, the size of the financial markets in the Baltic
states was by design. As prudent government policies kept budget
deficits to a minimum, there was little need for government bonds. But small
markets were also simply a result of small economies. This predisposition
was re-enforced by unforeseen circumstances like the banking crisis that all
three states experienced. In the wake of this crisis, the ownership of most Baltic banks was
taken over by foreign entities (namely Nordic banks) who had little incentive
to cultivate local markets since they had access to larger financial markets
both at home and in the larger economies of Europe.
In the end, the small size of the financial markets in these three countries has not been
a problem. This is due, in large part, to the regional approach to development
that these states have pursued. Instead of focusing on their economies from
a national perspective, all three Baltic states chose fast and deep integration
into the North European region and its economies as the key to development as
a whole. In turn, this alleviated the burden of having to develop a capital
base within each nation by providing access to far larger sources abroad.
The motivation to pursue this regional approach to development stems from the
deep-seated desire of each Baltic state to move away from the legacy of the
Soviet Union and Russia's influence as quickly as possible. All three states
felt that they had been given an historic opportunity to break from their past
and that the quickest and best way to do this was through integration into Northern
Europe. This specific motivation precludes the possibility of duplication elsewhere
but, as Dr. Sutela pointed out, a great number of similarities can be drawn
between the Baltic states and Hungary. Much like its northern cousins, Hungary
pursued a regional approach to its development that stressed openness and receptivity
to foreign capital and it has prospered. In contrast, the Czech Republic emphasized
the development of a complete national economy with restrictions on foreign
ownership (for good reason) and it has suffered as a result.
As good as the economic performance of Estonia, Latvia and Lithuania has been
to date, it is not without risks. In Dr. Sutela's view, the greatest risk these
states now face is the possibility of developing two-tiered economies. While
the small size of the financial markets in the Baltic states has helped to insulate
these nations from external shocks, it has also served to limit the amount of
credit available for small, local business. The foreign-owned banks have primarily
catered to the high-end, big-name clientele in each country and given little
credit to small business and local entrepreneurs. Thus, while the big businessmen
in the three capitals of the region have little difficulty securing financing,
small business and start-ups outside the big cities have few if any alternatives.
Over the long term this could lead to a division of society between those with
access to foreign capital and those without.
Among the questions that followed, several concerned the attributes of the North European
region into which the three Baltic states were being integrated. According to
Dr. Sutela, one of the most interesting things about this region was the level
of competition exhibited by the Scandinavian countries in getting close to the
Baltic states. Instead of opting for a unified cooperative approach to the development
of the region, Sweden, Finland and Denmark each competed individually in granting
aid to Latvia, Lithuania and Estonia. As a result, the cause of regional development
was approached with a great deal more vigor and energy than has been the case
elsewhere and this contributed mightily to the success of the initiatives that
were undertaken. In pointing out the critical contributions made by the states
of Scandinavia to the development of the Baltic states, Dr. Sutela stressed
that enough could not be made of the American support for these initiatives.
In the end, it would not have been possible for countries like Sweden and Finland
to act with such certainty and directness towards their neighbors had they not
been sure of the American commitment to the region.
Summary by Karlis Kirsis, Junior Fellow, Russian & Eurasian Program.