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Last Updated: Jun 30, 2009 - 8:27:23 AM |
Portraying the Baltic states in their current mess requires more than
words and numbers. Only an old-fashioned chart, with a sea monster, a
whirlpool, or perhaps a skull and crossbones, would begin to do justice
to the plight of what were until recently the shining success stories
of the ex-communist world. Eating a meal in a deserted restaurant in
one of the fine old capital cities of Tallinn, Riga, or Vilnius gives a
sense of the collapse. So does the silence of the half-finished
construction sites, the rock-bottom rates in the glitzy hotels that
shot up during the boom years, and the fall of a Latvian government
under the weight of the current troubles. The Baltic states today are
prime candidates to be the new basket cases of Europe, with their
double-digit economic declines, beleaguered governments, and shriveling
state spending.
But 20 years ago, when I first visited what were then still the Soviet
Baltic republics, the current problems would have seemed an almost
inconceivably desirable state of affairs. The Baltic states, for almost
all intents and purposes, had ceased to exist to the outside world for
nearly half a century. As a youngster in Britain in the 1970s, I had
read of Estonia, Latvia, and Lithuania as one might read about the
mythical land of Atlantis—a fabled place of the distant past, submerged
by an unimaginable catastrophe. In the early 1980s, I huddled with
demonstrators in London, their banners reading, "Estonians out of
Siberia! Soviets out of Estonia!" It was hard to know which seemed less
likely. In London, I met elderly, dignified survivors of the Baltic
lost world in dusty rooms that reeked of irrelevance and desperation.
Even just visiting the Baltic states during their years of Soviet rule
was near impossible.
Then came the small miracle of the 1990s. When I lived in the Baltic
states for the final two years of the Soviet era, I did not just
discover Atlantis: I watched it rise out of the sea and join the United
Nations. As the editor of the English-language weekly The Baltic
Independent, I chronicled what happened next: how the reborn republics
cleaved to the West, shrugging off the economic and political legacy of
the occupation.
Today, Atlantis is buffeted again by cruel and threatening tides. One
is the sharp downturn in the domestic Baltic economies, which began two
years ago when their reckless credit bubbles began popping. These had
been inflated by the belief that the Baltic markets were rapidly
converging with Europe’s. Property prices and consumer spending
rocketed, creating huge current account deficits as Estonians,
Latvians, and Lithuanians took advantage of the easy credit offered by
banks keen to increase their market share in Europe’s most dynamic new
region. Square foot for square foot, prime apartments in the Baltic
capitals were costlier than in Copenhagen.
On top of all that has now crashed an even larger wave: the global
recession. As small, open economies, the Baltic states thrive when
their neighbors are booming, and wither when they slump. In the current
downturn, demand for Baltic products—food, furniture, tourism—is
sinking both in European markets and in Russia. That has led to
stunning gdp falls in all three countries. In the first quarter of 2009
alone, gdp dropped at a 12 percent annual rate in Lithuania, 15 percent
in Estonia, and 18 percent in Latvia. Forced to accept an imf-led
bailout in December, Latvia is now struggling to meet its loan
conditions. Public-sector salaries there were cut by at least 20
percent. Discretionary public spending is to fall 40 percent.
A third crashing tide is geopolitics. Russia looms next door to the
Baltic states as a contemptuous and even hostile neighbor that has
played out repeated military exercises based on the scenario of
reconquest. The three Baltic states are today members of nato but often
feel they are on its margins: in the alliance on paper, but lacking the
contingency planning and military presence that would bolster the
security guarantee provided by Article V of the nato treaty. Russia’s
increasingly angry rhetoric and ominous moves may seem like empty
posturing from the safety of Brussels or Washington, but from a Baltic
standpoint they are threatening—and all the more so for having thus far
prompted no clear Western response.
It used to be Belgium that was counted as the "cockpit of Europe”—the
place where great-power interests clashed and were settled. Now it is
the Baltic states. At stake is not just nato’s credibility, but also
that of the whole post-communist experiment: Is it possible for small
countries on Russia’s borders to gain durable prosperity, security, and
freedom, with their destiny determined by their own talents and
virtues? Or will the ebb and flow of economic fortune ultimately prove
that these small states are unsustainable as anything but satrapies for
more powerful neighbors?
To answer those questions, one has to start with the past. For though
the Baltic states share flat landscapes and culinary quirks (herring
for breakfast, potatoes for lunch and dinner), what they really have in
common is their tragic recent history.
For each Baltic state, Soviet rule effectively brought a cultural
revolution. National elites were murdered or exiled. Hundreds of
thousands were deported, executed, or starved to death.
Collectivization destroyed the peasant farms that had been the backbone
of Baltic economies and societies. Finally came the suffocation of
national identity through mass immigration of Russian-speakers from
other parts of the Soviet Union and the purging of books that might
portray the era of Baltic independence in favorable terms. Estonia’s
leading novelist, the late Jaan Kross, remembered watching books from
his country’s main university library destroyed by an ax-wielding
apparatchik.
What particularly aroused Russian ire (and still does) was that after
the 1940-1941 Soviet occupation, Estonians and Latvians did not see the
prospect of another one as "liberation." Indeed, from 1944 onward, many
Baltic citizens fought hard against Soviet forces, even shoulder to
shoulder with the Nazis at times. The bad blood still lingers, as seen
two years ago when Estonia (or eSStonia, as Russian propagandists still
call it) decided to relocate a Soviet war memorial from the center of
Tallinn to a military cemetery on the outskirts of town. For Russians,
the bronze statue was "Alyosha the Liberator”; for Estonians, it was
"The Unknown Rapist." The result was a fierce diplomatic spat, the
besieging of the Estonian Embassy in Moscow, and a mammoth cyberattack
that briefly disrupted public services.
The bleakness of life inside the Baltic states during the occupation
era was matched by overseas apathy, even hostility, toward their fate.
Britain handed over to the Kremlin the Baltic gold reserves, which had
been entrusted to the Bank of England for safekeeping. Dusty embassies
in Washington and elsewhere maintained the vestiges of legal existence,
and a dwindling band of elderly Baltic diplomats would gather for
occasional meetings at the U.S. State Department, where their flags
still hung in the lobby. It was a good way to annoy the Kremlin, but
the cause of Baltic independence was all but dead. Those who persisted
in raising it were seen as eccentric, out of touch, and irrelevant.
Czeslaw Milosz, the Polish émigré poet and Nobel Prize winner, wrote in
his seminal work on totalitarianism, The Captive Mind, that he could
not stop thinking about the Baltic states, which he described as being
"boiled down" in a pot with a "tightly closed lid." But he also said
that others regarded his preoccupation as the epitome of futility: It
would waste his life and awake the "wrath of Zeus."
After regaining independence in the early 1990s, the Baltic countries
could easily have turned out like Moldova: semifailed states on
Europe’s periphery, corrupt, geopolitically hamstrung, and surviving on
remittances. Their foreign trade was entirely tied to the collapsed
Soviet economy. They had no independent institutions and no civil
servants capable of running a modern state. Their politicians were a
mix of wily but untrustworthy Soviet holdovers, unworldly professors
(Lithuania’s first post-Soviet president, Vytautas Landsbergis, was a
musicologist), and inexperienced youngsters (Juri Luik, Estonia’s
representative to nato, entered high office at 26). All the while, the
kgb used its cash, connections, and intimate knowledge of "the lives of
others" to preserve and expand its influence—a task made easier by the
unsolved question of how to deal with the hundreds of thousands of
Soviet-era migrants and their descendants.
That combination of problems meant that few saw the Baltic states as
future members of serious Western clubs. They were too flaky for the
European Union, too geopolitically sensitive for nato, and too poor for
the oecd. And many in the West told them so. As the Cold War wound
down, Baltic leaders aspiring to independence received not warm words
of encouragement from the West, but rebukes. Why were they so
impatient? Why were they impeding Soviet leader Mikhail Gorbachev’s
reforms with their hard-line nationalism? A Finnish official even told
me once that Estonian independence would be an economic and political
disaster that would prove a "catastrophe”—for Finland! Such points went
down badly in the Baltics, and not surprisingly. It was akin to telling
a prisoner to consider his captors’ feelings, rather than trying to
escape.
So how did the Baltic countries do it, succeeding so brilliantly and so
quickly? Part of it was luck: Russia was weak, and its potential for
mischief was initially quite limited. In addition, the Baltic diasporas
provided a serendipitous assortment of unlikely leaders. Lithuania’s
president, Valdas Adamkus, spent most of his life as a civil servant in
the U.S. Environmental Protection Agency. His Estonian counterpart,
Toomas Hendrik Ilves, was raised in the United States and educated at
Columbia University. Former Latvian President Vaira Vike-Freiberga
spent most of her life in Canada as a psychology professor. Hundreds of
lesser-known others in the 1990s helped rebuild everything from the
diplomatic service to business.
But the biggest reason for the success of the Baltic states was good
policymaking, usually introduced first in Estonia and then copied by
the other two. In barely two years, from 1992 to 1994, the radical
reforming Estonian government of Mart Laar introduced a flat tax,
privatized most national industry in transparent public tenders,
abolished tariffs and subsidies, stabilized the economy, balanced the
budget, and perhaps most crucially, restored the prewar kroon and
pegged it to the rock-solid deutsche mark. As a result, Estonia became
one of the most open and transparent economies in Europe, and with
growth came political stability: Russian troops left the Baltic region
by 1994, fears of Balkan-style ethnic conflicts receded, and Soviet
noncitizens in Estonia and Latvia began to assimilate.
Competitive advantage began to emerge. The first business to boom was
transit. Then, though the Baltic states had practically no indigenous
metallurgical industry, they became major players in the metals trade.
Next came manufacturing, thanks to outsourcing from old Europe. Foreign
investment poured in, and with it technology and know-how. Productivity
soared, and tourism took off, as foreigners discovered the
chocolate-box charms of Tallinn, the vistas of Jugendstil buildings in
Riga, and the baroque splendors of Vilnius.
Estonia did particularly well. High-tech companies set up there and
became some of the country’s largest employers. Estonian geeks in 2002
invented Skype, a peer-to-peer Internet telephony software that now has
more than 400 million users worldwide. The state also pioneered
"e-government," the idea of putting public administration online. At a
time when these innovations were unheard of elsewhere in Europe,
Estonians could file their taxes on the Internet, vote electronically,
and even watch a live Webcast of their prime minister’s official
waiting room. Visitors the world over came to study the Estonian model
of flat taxes, lean government, and rapid innovation, which inspired no
little envy among Lithuanians and Latvians, not to mention resentment
from the Russians next door.
As the new millennium dawned, Atlantis was back in business, free and
democratic. But it was not secure. That seemed to change in 2004, when
after frustrating false starts and Western foot-dragging the Baltic
states gained membership in the European Union and nato. The change was
partly nominal. The states passed huge lumps of eu regulation into law,
often with only cursory scrutiny of their implementation. nato, for its
part, fudged the question of whether it would really be willing to
defend its new Baltic frontiers against Russia. The alliance’s presence
to this day in the Baltic states consists of a small squadron of
fighter planes, provided by other countries on a rotating basis.
Still, the Baltic states seemed set for their happiest period ever.
They were useful allies, the epitome of post-communist success, and an
integral part of the Euro-atlantic world. They were secure and
prosperous as never before. And they had begun to lose the "ex-Soviet"
label; that was for basket cases like Georgia and Ukraine.
It took the collapse of the Latvian government in February, amid
fevered speculation about devaluation and political unrest, to bring
the Baltic states’ problems to the world's attention. Signs of trouble
had been visible much earlier, however. For those who knew the
countries well, the sense of hubris in the years of the post-2004 boom
was almost stifling. Growth in Latvia, for example, was an
unsustainable, debt-fueled 11.9 percent in 2006 and 10.2 percent in
2007. Current account deficits—a good sign of how far beyond its means
a country is living—soared too, reaching nearly 25 percent of gdp. That
made all three countries completely dependent on outsiders’ willingness
to keep lending them money. As upsets elsewhere in Europe from Iceland
to Ireland have proved, the trouble with this model is that borrowing
money is easy when you don’t need it, but difficult when you do. In
past years, the inflows inflated the bubble. Now, national survival
depends on the willingness of Swedish taxpayers to guarantee banks that
so unwisely overextended themselves.
The boom years in the Baltics—as in so many other fast-growing emerging
markets—turned out to have been wasted. Instead of firmly applying the
brakes, running large budget surpluses, tightening control of the
banking system, and taking urgent action to preserve competitiveness,
politicians harvested the proceeds and ignored the risks, thinking that
the growth was the result of their own good decisions. Calls for
caution were brushed aside. Rather, the impulse was, as Latvian
tycoon-turned-politician Ainars Slesers put it, to "put the pedal on
the metal."
The detrimental effects of this mentality were clear. A tight labor
market sent standards in service industries plunging. At the region’s
premier security thinkfest, the Lennart Meri Conference in Estonia in
2007, startled delegates turned up for breakfast on Sunday morning at
Tallinn’s Radisson hotel to find that nothing was on offer. The staff
simply hadn’t turned up; the manager shrugged, "Who wants to work on a
Sunday morning?" Foreign tourism operators began complaining. Once a
bargain destination for those seeking a quick break, the Baltic states
became pricey before they became good.
The smugness not only fueled the boom, but it allowed for the dodging
of decisions on issues ranging from corruption and cronyism in politics
to structural economic problems. In Latvia and Lithuania particularly,
politics stank. Lithuanian President Rolandas Paksas was forced out of
office in 2004 amid allegations of extortion and links with Russian
organized crime. Another high-ranking Lithuanian politician, Viktor
Uspaskich, fled to Russia when his bookkeeper turned over evidence to
the authorities of serious breaches of party finance laws. Latvia was
run by a bunch of party bosses with strong business ties, irreverently
dubbed the "Politburo." On repeated occasions they tried to fire the
heads of autonomous public bodies, such as the chief of the
anticorruption authority, who had come dangerously close to uncovering
how the country was run behind the scenes.
The first clear sign of trouble came when the one big bank in the
region not owned by a foreign parent, Latvia’s Parex Bank, got into
difficulties in mid-2008. Parex had always been a questionable success
story. In the late 1990s the bank used to advertise on Russian
television with a spot showing a $1 bill and the slogan "We are closer
than America." The clear implication was that Parex was a convenient
means for rich Russians to get their money out of the country. Parex
strongly denies that it ever broke any Latvian law, and it has never
been prosecuted. However, the bank has come under intense scrutiny from
international officials seeking to combat money laundering.
Parex’s weakness was that its depositors were mainly offshore and
highly mobile, while its lending had mostly been to construction
projects inside Latvia, many of which soured simultaneously. After
depositors withdrew nearly $430 million in the course of six weeks, the
bank was nationalized in November for the token price of a couple of
dollars. It also received a bailout in excess of $380 million from the
Latvian state and the European Bank for Reconstruction and Development.
The incident dented Latvia's reputation hugely. The country's
institutions had so far done an impressive job in seeming to insulate
the running of the country from the political shenanigans of the elite.
Now they had failed glaringly to supervise the country's best-known
financial business, with near-catastrophic consequences. Latvia's
financial weakness suddenly revealed the hollowness of past success.
The crisis has not spared Estonia and Lithuania either. A vivid
illustration of that is the loss of air links with the outside world.
Flying direct to Tallinn or Vilnius from main European destinations has
become difficult or outright impossible. Estonia's national carrier,
Estonian Air, has cut back its routes sharply. Lithuania's FlyLAL went
bust amid an acrimonious dispute with the owner of the Vilnius airport,
endangering the country's role as the intellectual and diplomatic hub
of the Baltic. Also at risk is Lithuania's cherished prize—its yearlong
celebration of the selection of Vilnius as the "European Capital of
Culture" for 2009. Faced with a time-consuming and costly stopover in
Copenhagen, Helsinki, or Frankfurt, many potential visitors may simply
decide to stay away. Once again, the Baltic states feel they are fading
from the map.
The three countries face this round of economic hardship with many
important policy levers out of reach. The obvious step would be to
devalue their currencies, but because they are guarded by the banks,
that move would shake each country to its foundations while also
bankrupting the many households and firms that have loans in euros and
Swiss francs. The Baltic states have no room to relax monetary policy.
Nor can they use fiscal policy to ease the pain—borrowing money to
boost state spending—because all three countries are trying to meet the
euro area's 3 percent budget deficit criterion.
Instead, the Baltic states are pushing through an "internal
devaluation," cutting wages and pruning bureaucracy in the hope that
these measures will boost their exports and attract renewed foreign
investment. The sole cushion is money from the European Union and other
international lenders. It could work. The three Baltic economies have
already shown that they can turn on a dime. They did this in 1991 under
far harder conditions and again in 1998, after the Russian financial
crisis. Still, these austerity measures require extraordinary patience
and a high tolerance for pain among voters who will see their living
standards plunge for the next two years. It also requires Swedish and
other foreign banks to stay the course on their bad loans, even as they
will lose money hand over fist.
The big hope is that the crisis will prompt the reforms that Baltic
politicians so smugly skipped during the boom years. It is a scandal,
for example, that higher education in all three countries is so
second-rate. At least one of their universities should have turned
itself into a strong competitor for students and faculty frustrated
with the lumbering state-run universities of old Europe. Health,
transportation, local government, and criminal justice still retain
striking levels of Soviet-style producer power, corruption, and
inefficiency. Progress on these fronts would not just reassure voters
that the state was doing its job properly—it would also encourage
external lenders, such as the European Union, to help keep the Baltic
states afloat. If none of this happens, though, the water level will
just keep going up.
The Baltic states' current fate epitomizes the wider story in Eastern
Europe, of half-baked reforms pursued with more enthusiasm than
judgment. Looking back on the 20 years since the Berlin Wall fell, it
is clear that the economic difficulties facing the former captive
nations were overestimated. Solidarity leader Lech Walesa once said
that turning a capitalist economy into a communist one was as easy as
turning an aquarium into fish soup. The difficulty was reversing the
process. In fact, creating a thriving capitalist system on the ruins of
a planned economy has proved the easier part. The difficulty has been
in building strong institutions with the political supervision
necessary for them to stay healthy.
A prime example is the currency regimes: To create credibility, all
three countries adopted strictly fixed exchange rates. These gained
totemic significance: The central banks that administer the currency
pegs to the euro are the most trusted institutions in each country. Yet
by 2004, it would have been far better to have the exchange rates more
flexible. A revaluation in the boom years would have cooled
overheating; a devaluation now would stave off hypothermia.
The big question today is whether the Baltic states' extraordinary
flexibility and determination will allow them to recover as quickly as
they toppled. The danger is twofold. One is that the critical mass of
patriotism and solidarity that helped them overcome past difficulties
has dissipated. The most able people have another choice now: They can
leave. Of my most impressive Baltic friends, one is married to a Dutch
diplomat and lives in Asia; several have jobs in the comfortable
bureaucracies of the European Union or nato. A sprinkling work in
London or for multinational companies. When they see the mess back
home, they are torn: Should they abandon their careers and return, or
stay on the comfortable sidelines? The members of the Baltic diaspora,
"who in their freedom had no homeland," had spent half a century
waiting for the chance to help their cousins, "who in their homeland
had no freedom," as the old toast goes. But it's unclear whether that
romantic history will repeat itself. Undoing the consequences of
foreign occupation was a lot more glamorous than unraveling the
consequences of a property boom or haggling about swap arrangements
with other central banks.
Second, the Baltic states' future is not just in their own hands. The
economic crisis coincides with the rise of a resurgent, revanchist
Russia and its alliances with a divided and demoralized Europe. The
most threatening prospect for Estonians, Latvians, and Lithuanians is
the "Schroederization" of German foreign policy—derived from former
Chancellor Gerhard Schroeder, whose conspicuous friendship with Russian
leader Vladimir Putin while in office morphed into the chairmanship of
a controversial Russian-German gas pipeline consortium within months of
his stepping down. The Baltic states feel squeezed. Who will defend
their economic and political interests when big countries once again
make decisions over their heads?
Those fears are a little overblown for now. Poland and Sweden are two
European heavyweights determined to prevent a Russian-German axis from
developing further. Russia's own economic problems have somewhat
lessened its bilious outpourings against the Baltic states. Yet the
danger remains. As unemployment rises and social strains increase, the
risk of local Russian-speakers feeling victimized—or the indigenous
populations blaming them—also increases. Russia has said on repeated
occasions that it reserves the right to intervene, even militarily, to
defend the (unspecified) interests of its "compatriots" elsewhere in
the former Soviet Union. After the 2008 conflict in Georgia, few can
doubt their resolve to do so. Russia is also passing a law that will
make illegal any attempt to equate Hitler and Stalin, which will
criminalize the Baltic states' own version of their history.
Russia can exert other kinds of leverage, too. Lithuania will be almost
totally dependent on Russian gas, for example, when it has to close its
nuclear power station at Ignalina at the end of the year. Latvia's
lucrative east-west transit trade is one of the few bits of the economy
that is still thriving. This creates potential for political pressure.
Until the Baltic states have developed not only their economies but
also their political institutions fully to Nordic levels, and completed
their reintegration into the Western world, they will not be completely
secure. And at present, the combination of a nationalist Russia and an
economic downturn is alarming.
"We needed another 10 years," says Asta, one of my oldest Lithuanian
friends. She's right. Atlantis rose from the depths. But the sea walls
are still too low. And now the water is rising again.
Source:Ocnus.net 2009
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