Ramnarain Ruia Autonomous College, Matunga, Mumbai 400019

Class TYBA Sem V Economics Assignment

Div : C
Subject : Economic Thought ( RUAECO603 ) 2020-21
Roll No : 3812
Name : Mrunmayee Mirlekar
Topic : Development Experience of The Baltic States

Introduction, History and Initial Conditions

The Baltic countries have achieved remarkable progress over a dozen years of transition. All
three countries have implemented most of reforms relative to transition from central planning
to a market economy and are considered as first wave EU candidates. The paper deals with
determinants of economic growth and contributes to the discussion of the “Baltic puzzle”.
However the paper does not aim to review the transformation process in the Baltics. Instead,
it focuses on the present countries’ performance and strives to assess key factors that are
associated with hindrance to further growth of the Baltic states.
The paper is organized in the following way: Section 1 provides a brief overview of the
history and initial conditions in the Baltics. Section 2 analyses the macroeconomic transition
and policies. Section 3 is devoted to the financial market development issue. Section 4
provides a discussion of resources, agriculture and rural development. Section 5 examines
human factor and labour market developments. Section 6 comprises the experience of firms
in the Baltic transition; next section discusses the quality of public administration and rule of
law matters. The evaluation of microeconomic policy follows in Section 9. Finally, section 10
summarizes the main paper findings and brings together practical policy recommendations.
The Baltic states – Lithuania, Latvia and Estonia – lie in the very heart of Europe. The Baltics
seem to belong to one homogeneous entity. All three states are small open economies, highly
dependent on oil products and natural gas, with a similar geographical position and natural
resources. Moreover, years of Soviet rule have left the same pattern on the way of life,
mentality, and culture. But although having so much in common, they have achieved
different results during the transition and have different growth prospects over the long run.
The reasons lie much deeper than is usually supposed. Looking closer the three states differ
in religion and culture, history and political preferences, structure of industry and trade, and
many other aspects that influence the behaviour and development of independent units. Table
1.1 displays the basic description of three Baltic and Nordic countries, that often are
considered as a benchmark for the Baltic states. As follows from the table Lithuania is the
biggest and most populous country among the Baltics with highest population density. Then,
according to the total area, and population comes Latvia, followed by Estonia.
One of the widespread myths is uniformity of language and culture. The Latvian and
Lithuanian languages indeed belong to one group and are among the most archaic of the
living Indo-European ethnic group. However, despite this fact Lithuanians and Latvians
could hardly understand each other without an intermediary. Estonian belongs to the Finno-
Ugric tongue. The existence of borrowings from Russian shows the impact of the joint
history with Poland and Russia. Among Baltic languages, Latvian is more linked to Finno-
Ugric than Lithuanian, which in turn was more influenced by Polish. Another difference
relies on different economic orientation, that has been fortified by historical facts and modern
negotiations: the northern part of Estonia is ‘adopted’ by Finland, Lithuania has struck up a
relationship with Denmark, and Latvia is more under the patronage of Sweden. With regard
to religion, in two of the Baltic republics (Estonia and Latvia) Protestantism is dominant. In
Lithuania the Roman Catholic Church is predominant. Starting from the 1830s in the Baltics,
for political reasons, Russians strongly promoted the Orthodox religion. After WWII the
Soviet anti-religious propaganda induced the Roman Church in the Baltics to become the
symbol of national resistance and an opposition force. Another role of the church was
through singing to express the liberation movement. Choral music in the life of the Baltics
could be considered as an ideological matter. It is suggested that religion plays an important
role in overall country performance. Hence, the heritage of Martin Luther has influenced the
mentality of Baltic residents, replacing indifference and passivity with responsibility and
activity. Unfortunately, the long lasting banishment of the church destroyed one more of its
roles - providing chronicles. As a consequence, the church could not present official
statistics, as for instance in the Czech and Slovak republics, where religious statistics were
used as complementary to the census (Gustavsson 1995).
Turning back to the history of the Baltic group, we will broadly mention the state formation
issue. Among three countries, Lithuania is the only old state, founded in the 12th century. As
a sovereign state by the end of 14th century Lithuania became one of the most powerful
empires in Eastern Europe, and governed a large territory in Eastern Europe stretching to the
Black Sea. The state was developing rapidly and became especially successful after creating a
joint Polish–Lithuanian monarchy in the second part of the 16 th century. Estonia and Latvia,
in contrast, emerged in the early 20century. All three states lost their independence in 1939,
when the signing of the Molotov-Ribbentrop pact assigned the Baltics to the Soviet sphere of
influence and virtually formed the pretext for the USSR invasion into the Baltics. (Kim
1998). After the Second World War the Baltics were firmly under Soviet rule. What is similar
for all three states, and makes them different from the other republics of the former Soviet
Union, is that the Baltics over the whole period of occupation, and despite a tight bind to the
Soviet union, kept the desire for natural independence most strong (Hain 1995). And on the
rd
23 of August in 1989 several million people formed a human chain stretching across the
three states, from Vilnius to Tallinn, to protest against the Soviet yoke.
The transition period was very sharp for all three states and was implemented under the
slogan “no pain, no gain”. After the proclamation of the restoration of independence Soviet
military troops occupied strategic buildings and several people were killed during the
demonstrations. Furthermore, economic sanctions were applied in order to compel
repudiation of independence, but with no effect. The rebellion of the Baltic states showed an
example for the rest of the Soviet Republics, while taking the burden and helping others to
avoid the recurrence of what had happened.
Fraught historical relationships with Russia, together with tragic deaths in the early 1990s
have imposed additional pressure on ethnic minorities in the Baltic states, especially during
the first 2-3 years after reestablishment of independence (dismissal from leading positions,
troubles on the streets etc). However in Lithuania the overall situation, concerning ethnic co-
existence, compared to its neighbours was quite auspicious. Since Lithuania has adopted the
so-called "zero-option" system of granting citizenship policy reversals were not a major
problem.
Of course, the ethnic structure of society (see table 1.2) had an impact on relationship
complexities. As a result of the drastic changes in ethnic composition, due to mass
deportation and large-scale migration of workers from Belarus, Ukraine and Russia, Latvia
and Estonia have suffered a sharp drop in their original ethnic population’s share of residents.
By contrast, the share of Lithuanians was always fluctuating around 2/3 in Lithuania.

The period between the two wars is of high interest and importance for the Baltic countries,
because it is believed that the roots of present success or collapse could be partially explained
by past performance. It is claimed, that the pre-war development level of Estonia and Latvia,
based on the wage level at purchasing power parity, consumption and the export structure,
was quite similar to Finland’s (Lainela 1994). Agriculture orientated Lithuania experienced
more difficulties and dropped behind. Latvia was the all-round leader according to
production, measured by industry value. However, the most impressive growth rate of
industry 1935-1939 was carried by Lithuania.
The Baltics inherited many problems that are common for the post-communist world. The
initial conditions of the pre-independence period were less then benevolent:
􀀹 Absence of a market price system;
􀀹 Non-existence of private property;
􀀹 Highly administrated prices and misbalanced allocation of resources;
􀀹 Inexistence of pre-requisites of an independent country;
􀀹 Entropy of the whole system, non-operating self-correcting mechanism.

The industrialization decades have formed quite a strong production background. However,
as plants were held under direct control, and created for inner needs (export was Soviet Union
orientated), after reestablishment of independence, the Baltics faced problems with a huge net
of Soviet industrial plants. Furthermore, with their low profitability and overemployment,
those industries were of nearly zero (if not negative, because majority of them ran heavily
into debt) economic value. In the early stage of transition one more concern appeared -
collapse of the production and trade regime. The production decline was a characteristic
feature of the first years of transition and was among the deepest of the Republics of the
Former Soviet Union (FSU). The fall in production in the short run was heavily influenced by
collapse of trade between the FSU. With trade recovery, started in the end of 1993 (Estonia)-
beginning of 1994 (Latvia and Lithuania), production ceased to decline sharply. On the other
hand, the Baltics inherited rather an auspicious economic potential. The productivity level of
Baltic countries, compared to other Soviet republics, was much above average (Lainela
1994).

Macroeconomic Transition in the Baltics

This section discusses the macroeconomic aspects of transition in the Baltics in the period
from 1990 until 2001. In particular, in the first part of the section we draw on the Baltics’
growth performance identifying the major factors of trends in growth rates and variations
around them. We then proceed with analyzing the monetary and fiscal policies in the Baltics.
The role of integration into international markets in the performance of the Baltic economies
over the last decade is covered in the final part of the section.

Growth performance over the last decade

Table 2.1 displays the basic macroeconomic statistics for Estonia, Latvia and Lithuania over
the period from 1990 to 2001. As follows from the table the transition period began with
output collapse in all three Baltic economies. In 1995–1996 the economic recovery started
and continued into 1997 when the Baltics recorded the highest growth rates over the whole
decade. The Russian crisis in 1998 substantially hit the domestic economies undercutting
economic growth in 1998–1999, especially in Lithuania. In 2000–2001 the economic growth
in the Baltics was back on track making the Baltics the fastest growing region among EU
accession countries of Central and Eastern Europe. To facilitate the discussion in the
following we analyze two sub-periods in greater details: output collapse in 1990–1994 and
economic recovery in 1995–2001.

In the context of the rest of the transition economies the timing and magnitude of the
economic decline in the Baltics was rather uniform. However, within the Baltic group some
differences can still be identified. The output decline began in Estonia and Lithuania in 1990
while Latvia still enjoyed a positive growth until 1991. In 1991–1992 the stagnation
accelerated in all three countries reaching the highest GDP drop in 1992. In the following
year GDP continued declining, however, at a lower rate and in 1994 it bottomed up in the
case of Estonia and Lithuania. The Latvian GDP, although it was at a slight increase in 1994,
continued to fall in 1995. From figure 2.1 the accumulated output collapse in Baltic countries
can be evaluated by comparing the lowest level of GDP reached over the past decade to the
level of the GDP in the pre-transition year 1989. Such an exercise reveals that Estonia’s
output collapse was the smallest among the Baltics: about 38 percent with the bottom reached
in 1994. Lithuania follows Estonia with around 46 percent of GDP accumulated decline in
1994. Latvia’s performance is the worst: approximately 49 percent fall reached by 1995.

Economic recovery
The economic recovery in the Baltics began in 1995–1996. The growth figures for the region
over these two years fluctuated in the range from 3 to 5 percent. The latter were rather
moderate rates given the initial output fall. However, already in 1997 growth accelerated to
impressive levels, especially in Estonia where the real GDP grew at a level over ten percent.
One of the important sources of the Baltics’ economic recovery in 1995–1997 was expansion
in exports, in particular to the EU. In Estonia, for example, the real export rose by over 30
percent in 1997. In Latvia the highest growth in real exports was recorded in 1996: around 20
per cent. Lithuanian real exports grew approximately 19 percent in 1996 and 1997.
Among other expenditure items of GDP investments also showed significant increase in all
three countries. For instance, real gross fixed capital formation in 1997 grew by 17.5 percent
in Estonia, 20.7 percent in Latvia, and over 22 percent in Lithuania. The latter would be hard
to achieve without foreign direct investment inflows, which intensified in 1996–1997 (for
more details on foreign direct investment in the Baltics see section 6).
The macroeconomic environment improved significantly. Already in 1995 the annual
inflation rate fell below the 40 percent level in all three countries. In 1996–1997 inflation was
further declining and in 1998 it reached single digits. The exchange rates of the national
currencies were stabilized either through a currency board arrangement (Estonia and
Lithuania) or strict monetary policy (Latvia). At the same time unemployment figures
worsened over the period in question. The latter, however, can be viewed (with some
reservations) as a favorable and necessary development accompanying the restructuring
process. In turn, the main concern of the domestic policymakers and international observers
became the deterioration of current accounts in all three economies. The impressive growth in
exports was exceeded by even higher growth in the Baltics’ imports. Rapid real appreciation
of the domestic currencies and the significant role of re-exports in the Baltics’ foreign trade
largely explain high growth in the Baltics’ imports. In terms of macroeconomic balance
current account deficits emerged as a result of growing investments parallel to falling
national savings
When analyzing the Baltic inflation stabilization performance it is instructive to evaluate the
policy credibility aspects as well. The policy credibility is a key element of successful
inflation stabilization: it makes the process of disinflation faster and less painful in terms of
output. Due to the lack of recent history of Baltic central banking, stabilization in the Baltics
began with a low level of credibility of the national monetary authorities. An important step
towards building up credibility of the monetary authorities was done by giving the Baltic
central banks greater political, legal and economic independence.
Äimä (1998) analyses the credibility of the Baltic central banks based on independence
established in the Baltic central bank laws and actual independence. The author finds that the
laws on central banking in the Baltics are roughly in line with norms of legal central bank
independence. At the same time Äimä concludes that the Latvian and Estonian law on the
central bank establishes a relatively bigger room for central bank independence than in the
case of Lithuania, where the Government has some possibility to influence monetary
policymaking. However, as the author pointed out, deficiencies of the central bank law in
Lithuania was largely compensated by the CBA constraints that had come into force eight
months before the Law on the Bank of Lithuania was passed.
When analyzing the actual independence of the Baltic central banks Äimä finds that in the
period from 1992 till 1998 there were 6 (of which 2 temporary) central bank governors in
Lithuania, 2 in Estonia, and only 1 in Latvia. Besides, providing some interesting details
concerning the removals of the BoLi governors the author shows that the BoLi experienced a
considerable political pressure over the period in question.
Financial markets in the Baltics
Effective financial intermediation is akin to economic growth. By transferring resources from
surplus sectors to deficit sectors of the economy financial markets contribute to balanced and
continuous economic development. Given well-developed financial markets investors can
effectively allocate risks while loan seekers can get access to larger and cheaper (due to
economies of scale) credit. Thus, not surprisingly development of sound financial systems in
the Baltics was on the agenda right from the start of economic transition. Despite some initial
failures, substantial progress has been made in the process of formation of the domestic
financial sectors. An important factor of financial sector development was financial
liberalization, which, among other impacts, led to greater integration of the Baltic financial
markets into the international financial system.
In the following we briefly review some of the key developments of financial markets in the
Baltics and evaluate them in terms of efficiency and significance for the domestic economies.
We restrict our discussion to only two types of financial intermediation, namely, the banking
sector and securities markets. Although other sectors of domestic financial systems
(insurance companies, pension funds, etc.) are present, their economic role in the Baltics
remains insignificant.
At the end of this section we investigate the development of the housing sector in the Baltic
States, with particular attention to the mortgage loans market. The latter is a special issue,
which is closely related both to financial market development and the real sector of the
economy. The importance of the housing sector in the discussion of growth determinants of
the region comes from the fact that an underdeveloped housing market and shortages of
living space inhibit labor mobility, which in turn prevents the efficient allocation of factors of
production. Another issue is that public subsidies into the housing sector often strain public
budgets and the financial system, as well as create unfavorable conditions for private
development in the housing loan market.

Banking sector
The model of “universal banking” adopted in the Baltics led to commercial bank dominance
practically in all niches of financial intermediation. Although different by timing and
magnitude, in the past decade the Baltic banking sectors went through three main stages: the
so-called “mushrooming” period, bank crisis, and period of consolidation.
The first period lasted about 2-3 years and was characterized by rapid increase in the number
of commercial banks: both newly established and those transformed from the former parts of
the Soviet mono-bank system. The first commercial banks in the Baltics were set up in
23
1989 By the end of 1992 there were registered 51 Latvian, 42 Estonian, and 20 Lithuanian
commercial banks. The fast rise in the number of commercial banks was to a large extent
conditioned by low start-up capital requirements .
and weak legal regulation. In this period financing of long-term investment projects was
largely sacrificed and greater emphasis was put on short term lending to the trade sector. In
addition, in the period prior to introduction of the national currencies the exchange rate
market offered large returns on arbitrage activities, which made foreign exchange operations
an important source of profits for commercial banks.
Currency reforms in 1992–1993 effectively eliminated the scope for foreign exchange
arbitrage. At the same time the output collapse in the beginning of the nineties gave rise to
non-performing loans in the bank portfolio leading to a severe liquidity problem. Rising
competition and higher capital requirements forced many commercial banks out of business
or to merge with other banks.
The bank crisis first erupted in Estonia. As a result, in 1992–1993 the total number of
registered commercial banks almost halved. In dealing with the crisis the BoE took a tough
position. All problem banks were liquidated leaving deposit holders and bank owners to carry
the entire burden of the crisis. Estonia also went through a second bank crisis in 1994. It was
smaller than the first one. The response of the Estonian authorities was also different. In this
case deposits were compensated while the government covered the restructuring costs.
In Latvia and Lithuania bank crisis came later partly due to slower development of the
banking systems. In 1995 15 Latvian commercial banks were closed including Bank Baltija,
which alone accounted for almost 30 per cent of the domestic banking sector. While small
commercial banks were allowed to go bankrupt the Latvian government agreed to provide
financial aid and re-capitalize Bank Baltija. By the end of 1995 it became clear that 6
Lithuanian commercial banks had serious liquidity problems. In the course of 1996
operations of 15 banks were suspended. To cope with the crisis the Lithuanian government
issued bonds and re-capitalized the two largest banks, which faced liquidity difficulties.
Bank crises in the Baltics encouraged bank consolidation and forced those that survived to
change their behavior leaving behind risky speculative operations and concentrating on more
traditional bank activities. In addition more effective bank supervision was established
leading to better risk management and transparency of bank activities.
As follows from table the number of banks decreased in the aftermath of bank crises
implying increasing market concentration. Opening up the domestic financial market to
foreign competition was also a particular feature of this period. Foreign banks were allowed
to open their subsidiaries as well as purchase local commercial banks. At the same time
Baltic commercial banks were encouraged to borrow from and lend abroad which also leaned
towards greater integration of the domestic banking sector into the world financial system.
The latter was expected to boost bank competition domestically as well as to shield domestic
financial systems against possible liquidity problems.

The interest rate spread between the bank deposit and bank loan interest rates has declined over
the nineties in all three Baltic countries indicating efficiency gains. The latter should be largely
attributed to successful privatization and consequent restructuring of the Baltics’ banking sector.
The process of privatization was in particular characterized by sell-off of the public banks to
western foreign investors. As a result by 2001 the interest rate spreads in the Baltics were
comparable to the corresponding indicators in the western market economies, which on average
made up some 3-5 percentage points.
Next, in Lithuania, as compared to Estonia and Latvia, a relatively larger part of bank
resources are channelled to the domestic market: about 60 per cent of total assets. However, a
closer look at the Lithuanian data reveals that almost one-third of these resources is directed
to the public sector in the form of loans to the public sector and investment into government
securities. Dissimilarly, in Estonia and Latvia claims on the public sector are rather small. As
regards the share of claims on the private sector only, it follows that both the Estonian and the
Lithuanian banking sector devote similar shares of their resources to the private sector.

Securities market
The development of the securities markets is an important contributor to economic growth.
Developed securities markets offer financial intermediation at lower than the banking sector
cost, diminish informational asymmetry in the economy, and allow allocating risks
efficiently. In terms of fiscal policy it allows the government to run a balanced budget
without altering the taxes and/or expenditures each period. 27
The first stock exchange established in the Baltics was the National Stock Exchange of
th
Lithuania (NSEL). It was founded already in September 1992 and began its activities on 14
th
September 1993. The Riga Stock Exchange (RSE) was open on 25 July 1995. Initially, both
the NSEL and RSE chose the continental stock exchange model where all securities were
dematerialized and recorded in a central securities depository and all transfers took place on a
28
book-entry basis. The Tallinn Stock Exchange (TSE) started trading only in May 31 1996.
In contrast to the NSEL and RSE, trading system on the TSE was centralized, paperless, and
based on a dealer system from the start. The latter approach proved to be more flexible and
appropriate for a small stock exchange. Furthermore, the trade in securities on the TSE was
conducted on a daily basis from the start while both the RSE and NSEL were open only once
or twice a week. The continuous trading on the RSE and NSEL began only in 1997–1998.
Finally, in the first years of its operation the TSE was the most electronically equipped stock
exchange in the Baltics, which facilitated efficient handling of large trade turnovers (Luštšik,
1997).
Development of some key characteristics of the Baltic stock exchanges over the last several
years is presented in table 3.5. In terms of total market capitalization the NSEL has been a
clear leader in the Baltics throughout all the period considered. It has been twice as
capitalized as the TSE and several times as capitalized as the RSE. The latter can be partially
explained by larger size of the Lithuanian economy and lower capital requirements needed to
enlist a company on the exchange. When the size of the economy is taken into account the
capitalization of the TSE and the NSEL become similar. The RSE, in terms of capitalization
and its share in GDP, remains far behind the corresponding indicators both of the NSEL and
TSE.
Decomposition of the total turnover reveals that trade in equities dominates other securities
traded on the TSE throughout all the period in question. A similar picture was observed on
the RSE with exceptions in 1995 and 2000–2001, when the debt market turnover exceeded
the equity market turnover. The latter could be largely attributed to expansion in trade of debt
securities issued by the Latvian Government. In Lithuania the share of equity market turnover
in total turnover has been much lower than in Estonia. It is one of the underlying differences
between the two stock exchanges. Contrary to the TSE, the NSEL has a well-developed
market for the Government’s debt securities. The latter is a result of loose fiscal policy
conducted by the Lithuania Government over the period considered. At the same time
prudent fiscal policy in Estonia led to only small public borrowings and, therefore, rather
negligible role of the domestic public debt securities on the TSE.

Microeconomic Policy
Taxation
Taxation has been a very difficult area for all transition countries, as it is for all developing
countries. A number of areas remain to be reformed. Estonia and European Commission
(2000) points to increases in excise taxes and a reduction of exemptions from VAT needed to
harmonise with the EU. Estonia (2001) highlights the role of the Tax Board in issuing and
checking tobacco excise revenue stamps and notes the implementation of a system of bonded
warehouses to increase alcohol excise duty collection. There is fairly heavy criticism of
Estonia’s tax system in European Commission (2000b). Excise taxes are too low, there is a
lack of tax warehouses, tax enforcement capacity is low and there is a lack of cooperation
between the relevant authorities in this area. Tax policy appears to be one of the biggest
hindrances to Estonia’s economic progress. In contrast with this, however, is the very
favourable situation with regard to taxation of imports – tariffs. Heritage Foundation (2001a),
in its report on Estonia to accompany the 2001 Index of Economic Freedom labels Estonia
“essentially a duty-free country”.
European Integration Bureau (2000) suggests that reduction of exemptions for VAT is a
priority for Latvia also. In order to improve tax administration the government introduced
into the State Revenue Service a new three tier structure, Business Change Management Plan,
Tax Collection Manual, and Internal Audit division. 480 personnel were retrained to work in
the new three tier structure. Surprisingly, the Pre-Accession

Summary, Conclusions and Policy Recommendations

Being small open economies with scarce natural resources the Baltic states are highly
dependent on world performance, and it is not surprising that the Baltics converge towards
Europe. Over the last decade it became clear that the Baltics have most in common with
Europe’s Nordic countries. Despite the resemblance in geographical position, start of the
transition period, and initial conditions, each of the Baltic states has developed quite an
independent path for economic achievement. The success of the transition may be distributed
through social, political and economic factors. However, the Baltics still needs to strengthen
its positioning facing high competition from the EU.
Prudential macroeconomic policy in the Baltics over the last decade established an
environment of macroeconomic stability favoring sustainable economic growth. Inflation has
been brought to a level comparable to the EU. The main policy challenge now is to lock in a
low level of domestic inflation. Given the limited role for active central bank policy this tack
will be largely dependent on the stance of fiscal policy. The scope for policy co-ordination
between the central banks and governments in the Baltics is large indeed.
The volatility of the effective exchange rate of the Baltic domestic currencies has also largely
declined. Much of the latter was due to rapid orientation of the foreign trade away from the
unstable CIS markets in combination with the Baltic strict pegs versus western hard
currencies. Provided there is large and growing trade with the EU, pegging to the euro will
effectively reduce the nominal exchange rate volatility. Thus, the re-peg the litas to the euro
in February 2002 seemed to be a move in the right direction. Given the Latvian foreign trade
structure by countries we would recommend a switch to the euro peg before entering the EU.
Facing an economic slowdown in the EU economy maintenance of large trade with the more
dynamic CIS economies might be a good policy in order to sustain growth in external
demand in the medium term. However, two considerations must be accounted for. First,
despite the recently rapid growth of the CIS, the purchasing power of this region remains
low. Second, in the long run dependence on less stable eastern economies might be hazardous
to economic growth as the 1998 crisis aftermath revealed. Thus, a strategy aimed at greater
involvement of the Baltic countries with the EU both in terms of trade and financial flows
will be associated with sustainable economic growth of the region in the long run. In this
respect Lithuania has to catch up with its Baltic neighbors. The re-peg of the Lithuanian litas
to the euro, hopefully, will lead to increase in the share of the EU in Lithuanian foreign trade.
The large current account deficits that persisted in the Baltics in the second half of the
nineties by now have declined to acceptable levels. In order to prevent the current account
deficits from raising the Baltics need to implement reforms that would increase domestic
savings. In particular, the Baltic governments could contribute to sustainable the current
accounts by running balanced budgets. Better tax administration and elimination of numerous
tax exemptions could help to achieve the latter. On the expenditure side, timely pension
system reform will relieve much of the public social security burden. At the same time
speeding up pension reform would increase private savings.
Further progress in pension reforms is also desirable in terms of enriching the financial
markets in the Baltics. Despite notable progress in the banking sector development of other
financial sectors remains rudimentary. In particular, there is a great need in development
mortgage institutions. Further international integration of the Baltic securities markets is
highly recommended as well.
There are five main things, in the area of labor market policy, that should be done in order to
improve the performance of the Baltics: first, creating a favorable and market orientated
educational system; second, increasing labor mobility; third, re organization of the
agricultural sector; forth, accelerating rural development, and fifth – reducing poverty and
ensuring a minimum level of income. All these recommendations are strongly interrelated.
The initially high educational level of the population in the Baltics declined during the first
years of transition, however over the last 5 years the demand for education has been
increasing notably, especially that of higher education. Although the significant progress in
upgrading the curriculum and harmonizing of grading and teacher certification standards was
made, some steps to improve the linkage between the education system and the labor market
should be taken. Firstly, an effective forward looking analysis of market needs should be
carried out, followed by an adequate educational strategy and, to some extend package of
active labor market policies, directed mainly on long-term unemployed. The main attention,
however, should be paid to creating vocational schools, as at least the short and medium-term
prospects in the Baltics are connected with manufacturing and highly skilled workers, a.k.a.
blue-collar employment.
Possibly the most depressed area in the Baltics is agriculture. In this report we argue that one
of the main reasons for this is the lack of functioning land markets through which agriculture
could be reorganised into a more economically viable structure. One of the most urgent
reforms then, given the need to improve the very low living standard of the large numbers of
people still associated with the agriculture sector, is to establish a properly working land
register. This issue is intimately connected with tax administration and should be enacted in
cooperation with the effort to measure the tax base more accurately. The existence of a clear
definition of the ownership of all land plots will enable firms to use land as a normal input to
production, hence providing more opportunities to increase the productivity of this resource
and to make Pareto improvements in its distribution.
There are many signs of hope in the Baltic economies, and ways in which they are more
dynamic than Western countries. That is why we feel confident that the Baltics will
experience a relatively fast catch up with the West and their GDP can be expected to grow at
average rates of 6-8%, as they did in 1997-98 and have now started to again, for at least the
next 10 years. There is, nevertheless, plenty of scope for policy reforms of areas that
presently hinder growth, factors which thus far have prevented the Baltics from experiencing
the 10% growth rates that Taiwan, for example, was able to achieve for so long. The most
important priorities are the absence of a labour market orientation in education, ineffective
taxation land markets. Improvements in these three areas are key, we argue, as they will
free up resources for reforms in many other areas such as fiscal policy, development of
financial markets, labour mobility, judicial reform, improvement of public administration,
regulation of natural monopolies and border control.

References
Äimä, K. ”Central Bank Independence in the Baltic Policy,” Review of Economies in Transition
4, Bank of Finland (1998): 5-35.

Åslund, Anders (2001). “The Myth of Output Collapse after Communism,” Carnegie Endowment
for International peace, Working Papers, March, No 18.

Bank of Latvia. (2002). “Tabulas” [“Tables”], Latvijas Maksajumu Bilance: Ceturksna Biletens
[Latvia’s Balance of Payments: Quarterly Bulletin], 4.
<http://www.bank.lv/izdevumi/latvian/maksbil/2001_4/tabulas-2001-04.pdf > (10 July
2002)

Bank of Lithuania. 1998. 1997 Annual Report. Vilnius.

______________. 1999. 1998 Annual Report. Vilnius.
______________. 2000a. 1999 Annual Report. Vilnius.
, 12 (2000b): 38.
______________. “Guidelines for the application of the Bank of Lithuania monetary policy
instruments” <http://www.lbank.lt./Eng/about/Kryptis.htm (12 September 2001).

Bank of Estonia, “Survey of the Estonian economy, March-April 1995”, Eesti Pank Bulletin 5
(1995) <http://www.ee/epbe/bulletin95/5/survey/index.html> (12 September 2001).
_____________, “Estonian banking in 1996”, Eesti Pank Bulletin.2, 29 (1997)
<http://www.ee/epbe/bulletin97/2/banking/index.html> (12 September 2001).
_____________, “International Investment Position and Foreign Debt”.
<http://www.ee/epbe/en/rip.html> (20 October 2001).
tivity” <http://www.ee/epbe/fdi/4d.html.en> (10 July 2002).
<http://www.ee/epbe/fdi/4b.html.en> (10 July 2002).
Beck, T., Levine, R., and N. Loayza. 2000. “Finance and the Sources of Growth”, Working
Paper.

Calmfors, L., A.Forslung and M.Hemström, (2002) Does Labor Market Policy Policy Evalutaion.
Center for International Private Enterprise (2001). “Red Tape Ranking”. Retrieved November 3,
2001 from the World Wide Web: http://www.cipe.org/efn/informalsector/redtaperanking/.
Central Statistical Bureau of Latvia, The Baltic and the Nordic Countries. Riga, 2000.
Central Statistical Bureau of Latvia (2001a). Investment in Latvia (Riga). #1(21), July.

Central Statistical Bureau of Latvia (2001b). Statistical Yearbook of Latvia 2001 (Riga).

Central Statistical Bureau of Latvia (2001c). “Public Finance of Latvia”, Statistical Bulletin
(Riga).

Centre of Forest Economics (2000a). Statistical Yearbook of Forestry 2000.

<http://miskai.gamta.lt/mec/2/lenteles.htm> (20 October 2001).
______________________ (2000b). Statistical Yearbook of Forestry 2000.
<http://miskai.gamta.lt/mec/2/paveikslai.htm#2.2> (20 October 2001).

Competition Council. Annual Report 2000.

<http://www.konkuren.lt/english/annual/2000_23.htm> (11 November 2001). ______________,
“Loans to individuals by purpose”, Monthly Bulletin _____________ (2002a). “Direct
investment stock by fields of ac _____________ (2002b). “Direct investment stock by countries”
Work?Lessons from the Swedish Experience. IFAU- Institute for Labor Market Central
Statistical Bureau of Latvia (2000). Macroeconomic Portrait of Latvia’s Regions (Riga).