The Economic Crisis and its Aftermath in the Nordic and Baltic Countries

Do As We Say and Not As We Do

Hilmar Hilmarsson, Hilmar Þór Hilmarsson

• Publisher: Routledge
• Year: 2018
• eBook ISBN: 9781351046817
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Political Economy
• Index: Politics & International Relations

The Nordic-Baltic region has become highly integrated. The Nordic countries have been successful in balancing competitiveness and economic growth with social inclusiveness, while the Baltic States have grown economically but remain vulnerable with weak social systems and highly unequal income distribution. European Union (EU) membership and inter-linkages with the continental Nordic banking systems appear to have affected the 2008/09 crisis response of the Baltic States.

In spite of their strengths, including their social systems, continental Nordic states are faced with a challenging mix of large, cross-border banks and highly indebted households at a time of rather weak global growth. The Baltic States are challenged by slow economic growth post-crisis, security concerns, and large-scale outward migration of the youngest and most highly educated people.

It is now a decade since the Baltic States were hit by the global crisis. It is time to take stock of their progress and assess their relations with other countries in the region and with the EU. This book focuses on the Baltics and their Nordic partners pre- and post-crisis: successes, failures, lessons learned, and future challenges, examining and comparing the crisis response of these various small states that enjoy different income levels, operate different welfare and tax systems, and seek different levels of integration with the EU.

1    Theories employed and methodology applied in this book

The theoretical approach employed in this book is multidisciplinary. It draws on theories in economics, international trade and finance, political science, public administration, and public policy. This broad approach also reflects the author’s academic training and diverse experience in economic development, international trade and finance, and public administration; working as a staff member of a global financial institution—the World Bank Group—in three different continents, as an advisor to a minister for foreign affairs, and in academia as a professor.

Definitions and theories used in the book are introduced and discussed in more detail in each chapter where they are employed. These include different definitions, some still debated, such as what constitutes a small state. This discussion is relevant for the study, because the Nordic countries and the Baltic States—upon which the book focuses—are all classified as small states in European small states literature. But what is small is relative to what one is comparing with. What is a small state in the Asian context may not be small in the European context.

Theories about the behaviour of small states in multilateral institutions are also discussed, along with how they co-operate with, influence or are influenced by larger states, as well as other small states, when participating in multilateral arrangements including regional and global institutions. For example, a small state may seek shelter by co-operating with a large state on a bilateral basis—e.g. Iceland and the USA—but also by becoming a member in international organizations, e.g. the Baltics as European Union (EU) member states. Both cases involve costs, benefits and associated risks, which will be discussed in the book. As will be seen, shelter can be both a blessing and a curse for small states.

The book also mentions theories of economic integration in the context of the Nordic countries and the Baltic States. These countries have sought different levels of economic and political integration in Europe and thus have different arrangements with the EU as member or non-member states. The different pathways chosen in the Nordic-Baltic region may complicate future co-operation. Security is also central for the survival of small states, which may want to address security concerns in co-operation with other countries. The transatlantic link with North America has been central to the security of the Nordic-Baltic region, so the book refers to academic literature in this field. The North Atlantic Treaty Organization (NATO) is discussed in the book, since six out of eight countries in the Nordic-Baltic group are members, while the two non-members (Finland and Sweden) co-operate closely with NATO.

Different approaches and theories of exchange-rate policy and optimal currency areas are discussed in the context of the euro area, which some countries in the Nordic-Baltic region have entered, while others have chosen to keep their own currency and different exchange rate regimes, floating or pegged. The economics of monetary union are discussed, focusing on the euro area, including challenges related to fiscal union, banking union and common deposit insurance, as well as other issues. The book also analyses cross-border banking interconnectedness and the benefits, costs and risks associated with financial integration in the Nordic-Baltic region and participation or non-participation in a common EU banking union.

The extreme cases of Iceland and Latvia are compared and contrasted. Both countries were exceptionally hard hit by the 2008/09 crisis but chose very different pathways in their quest for recovery. In Iceland the local currency depreciated sharply and fiscal deficits were large and long-lasting, while Latvia kept the exchange rate fixed and implemented austerity. Iceland and its interactions with international organizations are also discussed to highlight the vulnerability of small states when they are isolated from international assistance, in this case resulting in an unprecedented collapse of its financial sector over a few days.

International organizations are analysed, especially in cases where international financial institutions and the EU act as neutral advisors to member states, with emphasis on their behaviour vis-à-vis small states. International organizations such as the Bretton Woods institutions maintain research departments and publish analytical work. Are small states at risk, for example, when dealing with international organizations that also include larger, richer and more powerful states which have an agenda that they can potentially impose on international organizations and therefore also on other less powerful, weaker member states? Can small states benefit while working with a group of countries when they chair the group and hold an important position on behalf of other countries such as at the World Bank and the International Monetary Fund (IMF) or in the EU?

The relationship between the Nordic welfare model and the Anglo-Saxon model is analysed in the context of the Nordic countries and the Baltic States. Sharp differences exist between the welfare model that the Nordic countries have adopted compared to the current neoliberal laissez-faire approach in the Baltic States, resulting in relatively friendly business environments, but weaker welfare systems. Democracy is also discussed, employing theories on ‘Exit, Voice and Loyalty’ (Hirschman 1970) to explain the different behaviour of individuals in the Nordic region versus the emerging Baltic region and how it may affect those countries. The focus here is mainly on the Baltic States, whose democracy is evolving and may still be fragile. The challenge of outward migration from the Baltic States is analysed as well as their social performance, using indicators measured by Eurostat such as: the Gini coefficient, the income quintile share ratio, the at-risk-of-poverty rate and, finally, the proportion of people at risk of poverty or social exclusion.

The methodology used in the book is the case study method, i.e., multiple case studies and comparative analysis. Compared to other research methods, a case study enables the researcher to examine the issues involved in greater depth. Among the sources of evidence used for analysis in the book are secondary data, including reports¹ and scholarly literature such as articles and books. The author also conducted interviews and exchanged emails with many scholars, mainly in the field of economics, international finance, political science, and public administration. This consultation also included interviews at the European Central Bank in June 2015, the EU and the European Free Trade Association in July 2015, the IMF in July and December 2016, in Latvia and Lithuania in February and April 2017, at the University of Cambridge in August and September 2017 and at the London School of Economics in October 2017.

The author made an open presentation at the University of California, Berkeley on 10 November 2016 and benefited greatly from the discussion². The author also made a presentation on this topic at an international conference in Riga in June 2017 followed by a lively debate. The author has also engaged in discussion and dialogue with students and scholars from many universities³ over the last 10 years, as recognized in the acknowledgements section.

Direct observation also plays a role in this book, as the author draws on his experience and observations while living in Iceland prior to and during the 2008/09 economic and financial crisis. The author also worked for the World Bank office in Riga, Latvia, for four years, from 1999 to 2003 and travelled extensively throughout the Baltic States during this period. Since 2006 he has lectured as a professor at many universities in all three Baltic States. In addition, he has lectured at universities in Denmark and Finland and was a visiting scholar at the Stockholm School of Economics in Riga during the fall semester of 2013. He was also a Special Advisor to the Icelandic Minister for Foreign Affairs from 1995 and 1999 and was Iceland’s representative in the Nordic-Baltic World Bank co-ordination group, which, among other issues, discussed Scandinavia’s response to its 1990s crisis and lessons learned.

Case studies, such as those that appear in this book, can hardly present results that can be evaluated on the basis of statistical significance. Therefore, caution is called for before generalizing or projecting the findings of one case study onto another case or situation (see for example Yin 2009). However, the study will refer to empirical studies by other researchers in academic institutions, as well as at institutions such as the IMF, the World Bank Group and the EU. Data from these and other institutions are used in tables and graphs to make sure that they can be compared across the countries discussed.

Some lessons from this book could have wider relevance than for the Nordic countries and the Baltic States only. This is especially true of small countries with a large cross-border banking sector with limited fiscal space to support banks during a financial crisis.

The case study method has been used before in analysing crisis and post-crisis issues. For example, Stiglitz (2016) claims, in his book The Euro—How a Common Currency Threatens the Future of Europe: ‘This book is about economics and economic ideologies and their interactions with politics: it is a case study of how, even with the best of intentions, when new institutions and policies are created on the basis of oversimplified views of how economies function, the results can be not only disappointing, but even disastrous’ (Stiglitz 2016, p. 7). Similar statements could also be made concerning the Baltic States and their move to orthodox free market policies, as well as the nature of Swedish cross-border engagement, not only within the continental Nordic region but even more so in the Baltics.

When attempting to explain the crisis response of the Nordic countries and the Baltic States and post-crisis results, it would be insufficient to rely on economic and financial analysis only. Focusing on typical variables of economic performance such as economic growth, unemployment, inflation, fiscal or current account balance, and debt would produce an incomplete analysis. In addition to such indicators, it is also important to consider social or welfare indicators, including those on poverty, social exclusion, income inequality and migration, to name just a few. Indicators that evaluate the business and investment environment in the Nordic-Baltic group are also referenced. Data on national accounts are mainly from the IMF’s World Economic Outlook database, and data on social and welfare indicators from Eurostat.

It is also important to consider the political realities that have shaped these countries, with the Baltics having been part of the Soviet Union, which did not allow them freedom to protest or the possibility to migrate to other countries. These options did not re-emerge until the Baltics became EU member states, so that their citizens can again do both: criticize and/or exit across borders. In contrast, the Nordic countries are democracies and welfare states and did not suffer occupation after the Second World War.

Furthermore, we also need to consider security concerns when attempting to explain the behaviour of small states. The choice of a country to enter the euro area cannot be explained by economic integration theories only. Euro area membership is not only about belonging to a common currency area. It can also be viewed as a security alliance that comes in addition to—or perhaps to some extent replaces—the assurances that NATO provides or has provided. This is especially the case when the commitment of the largest contributor to NATO, namely the USA, has become uncertain. Given the complex economic, political and security environment which the Nordic-Baltic region faces, the multiple theoretical and methodological approaches used in the book are thus essential for the analysis.

Notes

1    Including from institutions such as the IMF, the World Bank Group, the EU, and the European Central Bank.

2    The Institute of European Studies and the Clausen Center at UC Berkeley hosted this event, also supported by the EU Center; the Institute of Slavic, East European and Eurasian Studies; and the Nordic Studies Programme.

3    These include: Aalborg University (Denmark), the American University, Washington, DC (USA), Bifröst University (Iceland), Bucharest Academy of Economic Studies (Romania), Copenhagen Business Academy (Denmark), Cornell University (USA), Georgetown University (USA), Haaga-Helia University of Applied Sciences (Finland), Kaunas University of Applied Sciences (Lithuania), Klaipeda University (Lithuania), Odessa National Academy of Food Technologies (Ukraine), Pacific Lutheran University (USA), Riga Stradiņš University (Latvia), Stockholm School of Economics (Latvia and Sweden), Södertörn University (Sweden), Tallinn University of Technology (Estonia), the University of Akureyri (Iceland), the University of the Basque Country (Spain), the University of Iceland, the University of Illinois at Chicago (USA), the University of Latvia, the University of Mauritius, the University of Porto (Portugal), the University of Tartu (Estonia), the University of Washington (USA), the University of California, Berkeley (USA), the University of California, Los Angeles (USA), the University of York (UK), Vytautas Magnus University (Lithuania) and Yale University (USA).

References

Hirschman, A. O. (1970). Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations, and States. Cambridge, MA and London: Harvard University Press.

Stiglitz, J. E. (2016). The Euro—How a Common Currency Threatens the Future of Europe. New York and London: W. W. Norton & Company.

Yin, R. K. (2009). Case Study Research. Design and Methods (4th ed., Vol. 5). California: SAGE Inc.

2 Pre-crisis and post-crisis economic and social performance of the Nordic countries and the Baltic States: an overview

The purpose of this chapter is to provide an overview of the pre- and post-crisis economic performance of the Nordic countries and the Baltic States. The period covered is 2005 to 2016. This can be a useful background for the chapters that follow, which will provide a greater in-depth analysis of the issues involved. Among the questions asked in the introduction to the book were the following:

• How did the Nordic countries and the Baltic States respond to the 2008/09 global crisis and what are the economic and social post-crisis consequences?
• How did banking, investment and trade linkages affect crisis response in the Nordic-Baltic region?
• How did the Baltic States respond to the 2008/09 crisis compared to the crisis response in Finland and Sweden in the 1990s?
• How have the welfare and tax systems in the Baltic States developed in recent years as compared to the Nordic welfare and tax systems?
• How are the austerity programmes implemented in the Baltic States, and the associated human costs, likely to affect long-term growth potential in the Baltic States?
• What are the opportunities and challenges of economic integration in the Nordic-Baltic region, given the different levels of involvement of those countries in EU institutions and systems, including financial sector integration?

This chapter will touch upon these questions but, as we shall see, the following chapters will analyse them in more detail until conclusions are reached in the final chapter of the book.

Crisis response and the economic and social post-crisis consequences

The economic and financial crisis that hit in the fall of 2008 was a global crisis affecting every corner of the world. All the Nordic countries (Denmark, Finland, Iceland, Norway and Sweden) and the Baltic States (Estonia, Latvia and Lithuania) faced negative growth rates in g...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of illustrations
• The Author
• Acknowledgements
• Preface
• Abbreviations and Acronyms
• Introduction
• 1. Theories employed and methodology applied in this book
• 2. Pre-crisis and post-crisis economic and social performance of the Nordic countries and the Baltic States: an overview
• 3. The Nordic countries and the Baltic States—small states and multilateralism
• 4. European integration and the Nordic-Baltic region, Schengen and NATO
• 5. Exchange rate policy: fixed or floating?
• 6. The challenges of euro area membership: Economic benefits versus security concerns, and the euro area versus NATO
• 7. Nordic–Baltic banking interconnectedness and its consequences
• 8. International organizations as economic policy advisers for small states: the Baltics as victims?
• 9. The Nordic welfare model and the Baltic States’ Anglo-Saxon bias
• 10. Fragile Baltic democracy and the challenges posed by outbound migration
• 11. The extreme cases of Iceland and Latvia during the global economic and financial crisis 1
• 12. The Nordic–Baltic region: successes, failures, lessons learned and future challenges
• 13. The Nordic countries and the Baltic States—the need for further research
• Index