The Baltic economies: Current situation and future trends, possibilities and pitfalls

The Baltic economies: Current situation and future trends, possibilities and pitfalls Riga, 15 October 2015 Morten Hansen Head of Economics Department, Stockholm School of Economics in Riga Member of the Fiscal Discipline Council of Latvia morten.hansen@sseriga.edu

Outline Background: Where do we have the Baltics today? Short-term domestic issues Being in the Eurozone was it a wise choice? Fiscal policy and the Eurozone Competitiveness Banking External threats Grexit will Greece leave the Eurozone? Russia impact on the Baltics China slowdown. Which impact? Long run issues Employment Convergence Structural weaknesses

2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 Economic growth in Estonia, Latvia, Lithuania and EU28 10,0 5,0 0,0-5,0 EU28 Estonia Latvia Lithuania -10,0-15,0

2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 Economic growth in Estonia, Latvia, Lithuania and EU28 10,0 5,0 0,0-5,0 EU28 Estonia Latvia Lithuania -10,0-15,0 Significant slowdown and mainly due to: &

Growth ranking in EU28, 2000 2014 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Estonia 1 3 3 3 5 2 2 4 28 27 8 1 1 8 9 Latvia 6 1 1 2 1 1 1 3 27 26 27 3 2 2 10 Lithuania 21 2 2 1 3 3 5 1 9 28 16 2 3 4 9 Only now a more normal development

Ireland Netherlands Austria Denmark Germany Sweden Belgium Finland United Kingdom France Italy Spain Cyprus Malta Czech Republic Slovenia Portugal Slovakia Lithuania Estonia Greece Hungary Poland Latvia Croatia Romania Bulgaria GDP per capita, PPS, 2014, EU28 = 100 Luxembourg excluded 140 120 100 Still a long way to go 80 60 40 20 0

GDP flexibility GDP change during the financial crisis (2007 2009), 1 st axis against recovery period (2009 2014), 2 nd axis 0-25 -20-15 -10-5 0 5 10-5 25 20 15 10 5-10 -15-20 -25

EU28 GDP change during the financial crisis (2007 2009), 1 st axis against recovery period (2009 2013), 2 nd axis 25 Baltics 20 15 10 5 Poland 0-25 -20-15 -10-5 0 5 10-5 -10 Greece -15-20 -25 Cyprus

Do the Baltic countries belong in EMU? Yes and better than many existing members Very flexible labour markets In terms of wages In terms of labour migration Very open economies EEK, LVL, LTL not as credible as DKK or SEK Was always the goal what is the alternative? No more talk about possible devaluation Highly euroized before joining Hands tied may be a good approach for Latvia and Lithuania

Another way to see this: Coping with fiscal policy in the Eurozone Maastricht criteria: Max. 3% budget deficit, max. 60% debt to GDP Gross debt as % of GDP Budget balance as % of GDP

Estonia 12 10 8 6 2008 4 2 0-4 -3-2 -1 0 1 2 3 4

Estonia Star pupil!!! 100 Maastricht criteria 90 80 70 60 50 40 30 20 10 0-4 -3-2 -1 0 1 2 3 4

Latvia 45 40 35 2009 30 25 20 15 10 5 0-8 -7-6 -5-4 -3-2 -1 0 1

Latvia 100 90 80 70 Budget consolidation ( austerity ) 60 50 40 30 20 10 0-8 -7-6 -5-4 -3-2 -1 0 1

Lithuania 45 40 35 30 25 20 15 10 5 0-10 -9-8 -7-6 -5-4 -3-2 -1 0

Lithuania 100 90 80 70 60 50 40 30 20 10 0-10 -9-8 -7-6 -5-4 -3-2 -1 0

??? 100 90 80 70 60 50 40 30 20 10 0-5 -4-3 -2-1 0 1 2

Germany.. 100 90 80 70 60 50 40 30 20 10 0-5 -4-3 -2-1 0 1 2

Greece.. 200 180 160 140 120 100 80 60 40 20 0-18 -16-14 -12-10 -8-6 -4-2 0

Indeed! No short-term imbalances in the Baltic economies VERY unlike 2007.

2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 Real Effective Exchange Rate, Baltics and EU28 2005 = 100 180,00 160,00 External competitiveness 140,00 120,00 100,00 EU28 Estonia Latvia Lithuania 80,00 60,00

2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 Real Effective Exchange Rate, Baltics and EU28 2005 = 100 180,00 160,00 Losing competitiveness again? 140,00 120,00 100,00 EU28 Estonia Latvia Lithuania 80,00 60,00

Cyprus Croatia Ireland Greece Slovenia Luxembourg Spain Portugal Belgium Czech Republic Romania Bulgaria United Kingdom Netherlands Poland Finland Malta Sweden Denmark Italy France Hungary Germany Austria Slovakia Lithuania Estonia Latvia Increase in unit labour costs, 2014 6 5 4 3 2 1 0-1 -2-3 -4-5

Cyprus Croatia Ireland Greece Slovenia Luxembourg Spain Portugal Belgium Czech Republic Romania Bulgaria United Kingdom Netherlands Poland Finland Malta Sweden Denmark Italy France Hungary Germany Austria Slovakia Lithuania Estonia Latvia Increase in unit labour costs, 2014 6 5 4 3 2 1 0-1 -2-3 -4-5 Too reminiscent of 2007

30 Banking sector loans, Latvia Bill. EUR One of the leftovers from the financial crisis 25 20 15 10 5 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

External threats Grexit a Greek exit from the Eurozone???

No Grexit. The EU and Eurozone is like James Bond

Russia Recession Oil prices Sanctions Impact on the Baltics?

Growth rates, Baltics and Russia 15 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 10 5 0-5 Estonia Latvia Lithuania Russia -10-15 -20

Growth rates, Baltics and Russia Zooming in.. 6 5 4 3 2 1 0-1 -2-3 -4-5 2012 2013 2014 2015 Estonia Latvia Lithuania Russia

Growth rates, Baltics and Russia Zooming in.. 6 5 4 3 2 1 0-1 -2-3 -4-5 2012 2013 2014 2015 It is recession in Russia that mainly affects the Baltics, not so much sanctions Estonia Latvia Lithuania Russia

Slowdown in China what to expect? Impact on GDP and trade Impact on financial markets

Five largest economies in the world Bill. USD, 2014, market exchange rates 20 000,00 18 000,00 16 000,00 About 15% of world GDP 14 000,00 12 000,00 10 000,00 8 000,00 6 000,00 4 000,00 2 000,00 0,00 USA China Japan Germany UK

Some back-of-the-envelope calculations China s imports: app. 3% of rest-of-world GDP If, say, China s GDP drops 5%, its imports are likely to drop by about 10% - but that is just 0.3% of rest-of-world GDP China is just not that important..

Much more important might be the following: Impact on exchange rates: Exporters of raw materials to China may see pressure on their exchange rates Possible contagion a la the Asian financial crisis 1997

Employment, 1000s, Baltics, 2000 2014 1 600,0 Long-run issues 1 400,0 1 200,0 1 000,0 800,0 600,0 Estonia Latvia Lithuania 400,0 200,0 0,0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Employment, 1000s, Baltics, 2000 2014 Index, 2000 = 100 115 110 105 100 95 Estonia Latvia Lithuania 90 85 80 The impact of bad demographics and migration 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Unemployment rates, Baltics 25,0 20,0 15,0 10,0 Estonia Latvia Lithuania 5,0 0,0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Unemployment rates in the EU March 2015 30 25 20 15 10 5 0

Population projection, Baltics 3 500 000 3 000 000 2 500 000 2 000 000 1 500 000 Estonia Latvia Lithuania 1 000 000 500 000 2015 2020 2030 2040 2050 2060 2070 2080

EU28 Slovakia Slovenia Czech Republic Sweden Netherlands Finland Belgium Austria Denmark Malta Hungary Germany Ireland France United Kingdom Luxembourg Poland Croatia Cyprus Italy Estonia Spain Romania Portugal Greece Lithuania Latvia Bulgaria Inequality: Gini coefficient, 2013*, EU 28 40 35 30 25 20 15 *2014 data available for only some of the countries

Inequality: Material deprivation, EU28, 2013

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Catching-up GDP per capita, Baltics and Greece, Italy and Portugal, 1992 2014 40 000,00 35 000,00 30 000,00 25 000,00 20 000,00 15 000,00 10 000,00 Estonia Greece Italy Latvia Lithuania Portugal 5 000,00 0,00

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 but with the wrong countries. Significant gaps still to be closed 50 000,00 45 000,00 40 000,00 35 000,00 30 000,00 25 000,00 20 000,00 15 000,00 10 000,00 Denmark Estonia Germany Latvia Lithuania Sweden 5 000,00 0,00

Structural weaknesses Country capacity to retain talent: EE 97 LV 94 LT 119 Country capacity to attract talent: EE 94 LV 107 LT 129

EU28 Finland Sweden Denmark Germany Austria Slovenia Belgium France Netherlands Czech Republic Estonia United Kingdom Ireland Hungary Portugal Italy Spain Luxembourg Lithuania Poland Malta Slovakia Croatia Greece Bulgaria Latvia Cyprus Romania R&D spending, share of GDP, EU28, 2013 LV, LT: Pathetic. 3,5 3 2,5 2 1,5 1 0,5 0

The Baltics in the Eurozone EZ19: Growth of GDP per capita, 1999 2014 140 120 100 But one should always finish on a more positive note.. 80 60 40 20 0-20

EZ19: Growth of GDP per capita, 1999 2014 140 120 Catching up/partial convergence 100 80 60 The troubled southern Europe 40 20 0-20

Some conclusions The Baltic countries are model citizens in the Eurozone And they face no short-term imbalances (but watch out for competitiveness!!) Problems are of a long-run nature Some of which have been there for a very long time but with little policy action (brain drain) And some of them are getting more problematic (employment, labour force) And, worse still, don t have obvious solutions..

Thank you for your attention!