foreign policies of the baltic states and the management of economic interdependencies prof. dr....

Foreign policies of the Baltic States and the management of economic interdependencies

Prof. Dr. Ramūnas VilpišauskasDirector of the Institute of International Relations and Political Science, Vilnius University

Presentation for the Intensive summer course 2014 “Small States, Regional Integration and Globalization”, University of Iceland, Reykjavik, June 22nd – July 6th, 2014

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The outline:

• The main concepts and background information;• The instruments of managing interdependencies;• Regional integration (EU) as an instrument:

• Examples of energy and transport sectors;• Baltic States reacting to financial crisis of 2008-2009:

• The main decisions and lessons;• Lessons from 25 years of openness to global economy.


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The main concepts of international trade (I):

• International trade as technological progress (saving resources which could be used more productively – H. Martyn, 1701);• Absolute advantage – ability to produce the same good as competitor in another country by using less resources (A. Smith, 1776);• Comparative advantage – ability to produce a product at a lower marginal or opportunity cost compared to competitor in another country (D. Ricardo, 1817);

– “If a country is relatively better at making wine than wool, it makes sense to put more resources into wine, and to export some of the wine to pay for imports of wool. This is even true if that country is the world's best wool producer, since the country will have more of both wool and wine than it would have without trade.” (WTO);

– A proposition which is “both true and non-trivial” (P. Samuelson (1969).


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The main concepts of international trade (II):

• “Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular” (T. B. Macaulay, 1824);•“…the doctrine of free trade, however widely rejected in the world of politics, holds its own in the sphere of the intellect” (F. Taussig, 1905);•“The proposition that freedom of [international] trade is on the whole economically more beneficial than protection, is one of the most fundamental propositions economic theory has to offer for the guidance of economic policy” (H. Johnson, 1971).


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On the size of the countries (I):

• “whether country size matters for economic prosperity depends on a country’s degree of economic integration with the rest of the world”. (The Size of Nations, A. Alesina, E. Spolaore 2005, MIT, p. 81)


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On the size of the countries (II):

• “As states become connected by market forces, they seek to structure their interdependence both to achieve joint gain and to create asymmetries that provide a larger share of the gain and power for other purposes. “interdependence” involves short-run sensitivity and long-term vulnerability. “Sensitivity” refers to the amount and pace of mutual dependence; that is how quickly does change in one part of the system bring about change in another part? […] “Vulnerability refers to the relative costs of changing the structure of a system of interdependence” (The Future of Power, J. Nye, 2011, p. 54-55)


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Smaller – more vulnerable?:

• Small states are usually asymmetrically interdependent and therefore relatively more sensitive to outside world (benefitting relatively more from external economic relations and therefore more interested in preserving or expanding them);• However, this does not necessarily mean that small states are more vulnerable to outside shocks or manipulations of asymmetrical interdependences;• “Small states can often use their greater intensity, greater focus, and greater credibility to overcome vulnerability in asymmetrical interdependence”. […] “The asymmetry in resources is sometimes balanced by an opposite asymmetry in attention and will” (Nye 2011).


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Larger states – more powerful?Or why Germany, France and UK are usually analyzed by

scholars?


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Asymmetries of interdependence as a source of power:• “It is asymmetries in interdependence that are most likely to provide sources of influence for actors in their dealings with one another” (Keohane, Nye 1987, p. 728);• “Interstate power stems not from the possession of coercive power resources, but from asymmetries in issue-specific interdependence” (Moravcsik, 2009, p. 249);• „All other things equal, the more interdependent a state is, the more intense its preference for a given outcome, the more power others potentially have over it; while the less a state wants something, the less a state cares about outcomes, the less intense its preferences, the less power others have over it. Situations of asymmetrical interdependence, where one state has more intense preference for an agreement than another, create bargaining power.“ (Moravcsik 2010, p. 5).

Prosperity index rankings 2013 (Legatum 2014):

KOF index of globalization (2014):


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The instruments of managing interdependences:

• Make or trade… (economic independence or diversification of supply and flexibility of the national market); •International agreements between states, setting the rules of interactions, defining property rights, dispute settlement mechanisms (WTO, etc.);• Bilateral voluntary agreements (between private actors, NGOs, sectoral, professional and other actors);• Supranational agreements replacing competences of nation states by supranational competences (EU).


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Foreign policy priorities of the Baltic States until 2004 (after a return to international community):

• EU membership;• NATO membership;• Good neighborly relations.


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Foreign policy priorities after 2004:

• Eastern neighborhood (managing interdependence);• Energy security (managing interdependence);• Dealing with “left-overs” (Schengen, EMU membership);• Completing the common market.


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The case study: restructuring energy and the role of the EU

• What effects EU membership had on the areas of economy of the Baltic States which after the accession remained either relatively closed or/and asymmetrically interdependent with the third countries rather than other EU Member States?


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Reform of the energy sector in the Baltics:First five years of EU membership

• Continuous very high dependence on supplies from the third countries (Russia);• Active interest groups, benefiting from existing energy links with external supplier and using rents to influence policy makers;• Comparatively high price paid for energy resources (especially natural gas – among the highest in the EU);• Frequent delays and political disagreements among countries in the region regarding the implementation of energy projects to introduce competition and alternative sources of supply;• Adoption of EU law regulating energy market was a case of “dead letters world”.

Russian gas in the total gas consumption in the EU-28 in 2012

(CEPS 2014):

Vulnerability of EU member states to trade with Russia/Ukraine (Danske

Bank 2014):

Wholesale gas prices in the EU – 2nd q 2013 (EUISS 2014):

Innovation trends in the US (The Economist March 16, 2013):

Shale gas basins in Europe (The Economist, Feb. 2013):


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Baltic Energy Market Interconnection Plan (BEMIP):

• In 2008-2009, after initial attempts of Lithuania to renegotiate the closure of Ignalina nuclear power plant, European Commission proposed BEMIP;• It provided for coordination and monitoring of agreed sub-regional projects, some funds for the implementation.

BEMIP – a test of EU involvement

Objectives:

Baltic electricity market

Natural gas market

INSTRUMENTS:

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ELECTRICITY NATURAL GAS

• Legal basis 3rd EU energy package

• Legal basis 3rd EU energy package

• Market: Baltic States region, integration into the NordPool.

• Infrastructure: linkages with Northern and continental Europe, generation capacities.

• Market: Baltic States region.

• Infrastructure: links with Poland, LNG terminal, underground gas storage

• The internal market should be completed by 2014 so as to allow gas and electricity to flow freely.

• No EU Member State should remain isolated from the European gas and electricity networks after 2015 or see its energy security jeopardized by lack of the appropriate connections.

European Council (4th February, 2011) conclusions

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ELECTRICITY

26

NATURAL GAS


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The current state:

• Baltic electricity exchange has started functioning (to be connected with the Nordpool);• Interconnection projects are advancing (especially electricity);• LNG terminals have been implemented separately;• Each Baltic States has chosen its own version of the implementation of EU 3rd energy package;• The future of a new nuclear power plant is still uncertain.


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The concluding remarks:

• The case of BEMIP shows how EU institutions can solve coordination problems between Member States of particular sub-region and time inconsistency due to political cycles;• By facilitating the implementation of infrastructure projects in can contribute to economic openness and competition, and eventually economic growth;• BEMIP might also serve as an example for other sub-regions of the EU as an instrument of market integration when national preference diverge and as a result EU norms (3rd energy package) reflect a broad compromise with different alternatives that are likely to keep the Single Market fragmented;• Similar instruments could be used in other areas like transport or broadband.


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Another case – Rail Baltica (The Economist 2014):

• What are the main obstacles to strengthening transport links with the rest of the EU?• How the Baltic States can increase their bargaining power vis-à-vis Russia?


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Baltic States before and after EU accession:

• Baltics experienced three crisis during two decades since 1990:• 1990-1995 (systemic transition);• 1998-1999 (effects of financial crisis in Russia);• 2008-2009 (effects of global financial crisis);• The recent crisis has been managed by defending the fixed exchange rates, domestic adjustment measures (wage, price decreases) and the introduction of euro used as an exit from the crisis strategy:• Estonia introduced euro in 2011;• Latvia introduced euro in 2014;• Lithuania is set to introduce euro in 2015;• The debate on joining the EMU is strongly influenced by geopolitical arguments.


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Baltic States after a decade in the EU:

• Baltics have been among the fastest growing and converging member states of the EU in 2004-2013; • Outflows of migrants from Latvia and Lithuania has probably been one of the least expected consequences of the EU membership.


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Strong convergence since 2000 till 2008, again after 2009:Relative GDP per capita in PPS in 1997-20131997 2000 2004 2008 2009 2010 2012 2013

EU-27 100 100 100 100 100 100 100 100

EU-15 115 115 113 111 110 110 108 -

Estonia 42 45 58 69 64 64 71 72

Latvia 35 37 47 59 54 55 64 67

Lithuania 39 39 52 65 58 62 72 74

Denmark 133 132 126 125 124 128 126 125

Finland 110 117 117 119 115 114 115 112

Sweden 124 128 127 124 120 123 126 127

Source: Eurostat, 2014


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Annual average net migration balances 2010-2012, % (Bruegel 2014)


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The crisis and afteror

are the “Baltic tigers” alive again?


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Convergence interrupted in 2008 by the global crisis and domestic

factors with resulting swings in the key indicators


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-20

-15

-10

-5

0

5

10

15

2006 2007 2008 2009 2010 2011 2012 2013 2014

PPS Rapid fall and rise in GDP

Lithuania

Latvia

Estonia

EU-27

Source: European Commission Spring 2013 Economic Forecasts

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0

5

10

15

20

25

2006 2007 2008 2009 2010 2011 2012 2013 2014

Changes in unemployment

Lithuania

Latvia

Estonia

EU-27



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-4

-2

0

2

4

6

8

10

12

14

16

18

2006 2007 2008 2009 2010 2011 2012 2013 2014

Decrease of inflation

Lithuania

Latvia

Estonia

EU-27



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0

20

40

60

80

100

120

2006 2007 2008 2009 2010 2011 2012 2013 2014

... and state debts, % of GDP

Lithuania

Latvia

Estonia

EU-27



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The political economy of crisis management (I): Krugman or Ilves?

• Pros and cons of defending fixed exchange rates in small open states?


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The political economy of crisis management (II): Timing is everything?

• Estonia was first to adopt fiscal adjustment measures in 2008;• Latvia’s reaction was characterized by coalition politics, in 2009 leading to the change in Government, and Parex bank collapse;• Lithuanian reaction was to a large extent influenced by Parliamentary election schedule (October 2008) ranging from crisis denial in the pre-election period to an after-election “discovery” of deteriorating situation, panic and rapid review and adoption of 2009 budget.


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The political economy of crisis management (III): Fiscal consolidation events 2008-2012(Vilpišauskas, Nakrošis, Kuokštis 2014, p. 46)


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The political economy of crisis management (IV): Hangovers from excessive spending

• Estonia managed to adjust quickly by using its budgetary reserves accumulated during the times of economic growth;• Lithuania undertook significant adjustments on both tax (20 % of adjustment) and expenditure (80 percent) sides in several rounds of budget revisions in 2009 to maintain investor confidence;• Latvia applied for financial assistance from IMF and EU, mostly to solve the issue of Parex bank and maintain fiscal stability.


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The political economy of crisis management (V):Scared of IMF?

• Why countries ask for IMF assistance (Žemaitytė 2013):

• Worsening economic situation (economic decline, growing budget deficit, growing CDS rates, foreign currency reserves);

• Political institutional factors (proximity of elections, position of veto players, lobbying from interest groups (banks));

• International pressure;• Former experience of cooperation with IMF.

• Analysis of Latvia, Estonia, Lithuania, Bulgaria, Romania and Hungary shows that:

• Worsening economic situation and the need to borrow to cover budget deficit is a necessary but insufficient condition;

• The favorable position of veto players was required in addition.


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The political economy of crisis management (VI):“Europe’s unsung heroes” (S. Forbes 2010)

• The Baltic States adjusted in similar ways, although by somewhat different speed and scale, with some public protests in Latvia and Lithuanian in winter 2009;• Estonia managed to sustain public trust in institutions (“loyalty”), while in Latvia and Lithuania public responded by moving into the shadow economy and emigrating abroad (“exit”);• The fiscal stability was maintained by adjustments on tax and expenditure sides – VAT, excise and some other taxation increases, cutting public sector wages, social expenditures, contributions to the private pension funds; • In 2010, Baltic States’ CDS returned to pre-crisis levels;• Huge fiscal adjustment by historical standards (12 % of GDP in 2009-2010 in Lithuania and another 5 % to be made in 2011-2012).


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The political economy of post-crisis period:

• All three Baltic States came from the crisis with the economic recovery in 2011 exceeding significantly EU average recording the highest growth in the EU in 2012-2014; • The Baltic States have not only surprised outsiders by rapid adjustment of prices and wages, but also by post-crisis election results in Estonia and Latvia bringing the same coalitions to power, while in Lithuania coalition changed in 2012;• EC, ECB and IMF present the Baltic experience as a good practice example to the euro zone countries.


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Can Baltic experience be transferred to other EU member states?

• Structure of international relations (export diversification);• Flexibility of the economy (labor market);• Public administration capacity (to implement internal adjustment);• Societal values (trust in public institutions, level of corruption, “culture of patience”?).


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How Baltics are ranked compared to the Nordics and the rest of the

world?


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70

2009 2010 2011 2012 2013

Ran

kGlobal Innovation Index Report (INSEAD)

Lithuania

Latvia

Estonia

Denmark

Sweden

Finland


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10

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40

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60

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Ran

kKOF Globalization index

Lithuania

Latvia

Estonia

Denmark

Sweden

Finland


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10

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40

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60

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Ran

k Heritage Foundation Economic Freedom Index

Lithuania

Latvia

Estonia

Denmark

Sweden

Finland


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Baltic States – upper-middle ranking countries: World prosperity index 2013

No. Country Economy Entrepreneurship

Governance Education Health care

Security Personal freedom

Social capital

4 Sweden 6 1 4 14 12 3 4 10

6 Denmark 23 2 3 18 14 8 9 3

8 Finland 26 3 5 6 16 4 17 7

36 Estonia 65 28 25 35 41 35 71 40

43 Lithuania 94 40 45 28 43 34 101 54

48 Latvia 73 37 41 29 45 45 96 93

Source: Legatum Institute, 2014


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Litva (Grand Duchy of Lithuania) – in “half-forgotten Europe”


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So… will Lithuania be less forgotten, or what are the benefits of EU Council Presidency?

• More capable public service in Lithuania;• More information about Lithuania in the EU and outside world;• Some benefits to some economic sectors;• Somewhat more awareness of EU membership in Lithuania.


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Searching for the reasons of the effective EU Council Presidency:

• Early preparations (planning of logistics, trainings of civil servants, aligning rotation schedules, increasing the capacity of the Permanent Representation to the EU, etc.);• Political consensus among the parliamentary parties regarding the continuity pf the Presidency preparations after the elections;• The choice of the ‘Brussels based’ model of the Presidency with most responsibilities delegated to the PermRep.;• The support of the highest level of political leadership and involvement when necessary;• The emphasis on the role of mediator and the neutral negotiator advancing the legislative agenda of the EU.


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Concluding comments:

• Political consensus, consistency of policies and stability of legal framework (quality of governance) are crucial for the success of sovereign policies, effective management of interdependencies and popular support;• Small countries can increase their bargaining power by relying on international norms and by uploading their concerns onto the EU agenda; • Economic openness, which is crucial for growth, should be supported by stable domestic legal framework and sound institutions.

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Thank You!

foreign policies of the baltic states and the management of economic interdependencies prof. dr....

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