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Foreign policies of the Baltic States
and the management of economic
interdependencies
Prof. Dr. Ramūnas Vilpišauskas
Director 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
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.“ (MoravcsikFind
2010,
p.
us @
5).
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Prosperity index rankings 2013 (Legatum 2014):
KOF index of globalization (2014):
KOF index of globalization (2014):
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”.
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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):
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.
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BEMIP – a test of EU involvement
Objectives:
Baltic electricity market
Natural gas market
• 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
INSTRUMENTS:
ELECTRICITY
• Legal basis
3rd EU energy package
NATURAL GAS
• 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
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ELECTRICITY
NATURAL GAS
26
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 1997-2013
1997
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 after
or
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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PPS
Rapid fall and rise in GDP
15
10
5
0
2006
2007
2008
2009
2010
2011
-5
2012
2013
2014
Lithuania
Latvia
Estonia
EU-27
-10
-15
-20
Source: European Commission Spring 2013 Economic Forecasts
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Changes in unemployment
25
20
15
Lithuania
Latvia
Estonia
10
EU-27
5
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: European Commission Spring 2013 Economic Forecasts
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Decrease of inflation
18
16
14
12
10
Lithuania
8
Latvia
6
Estonia
4
EU-27
2
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
-2
-4
Source: European Commission Spring 2013 Economic Forecasts
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Source: European Commission Spring 2013 Economic Forecasts
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120
... and state debts, % of GDP
100
80
Lithuania
60
Latvia
Estonia
EU-27
40
20
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: European Commission Spring 2013 Economic Forecasts
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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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Global Innovation Index Report (INSEAD)
2009
2010
2011
2012
2013
0
10
Rank
20
30
40
Lithuania
Latvia
Estonia
Denmark
Sweden
Finland
50
60
70
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KOF Globalization index
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
0
10
Rank
20
30
40
Lithuania
Latvia
Estonia
Denmark
Sweden
Finland
50
60
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Rank
Heritage Foundation Economic Freedom Index
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
0
10
20
30
40
Lithuania
Latvia
Estonia
Denmark
Sweden
Finland
50
60
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Baltic States – upper-middle ranking countries:
World prosperity index 2013
No.
Country
Economy
Entrepren
eurship
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 “halfforgotten 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!
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