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The Political Economy of Latvia’s
Economic Development: The
Twin Roles of the Natural
Resource Curse and Ethnic
Fragmentation
Vyacheslav Dombrovsky
May 24, 2011
Plan of the talk
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Latvia 20 years ago and today
The political economy of development
Application #1: Accession to the EU
Application #2: The natural resource
curse
• Application #3: Ethnic fragmentation
Latvia 20 years ago
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1990-1993: Latvia’s GDP fell by
half
1992: inflation 958 % per annum
1990-2004: about one government
per year on average
Latvia Today
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A market economy
A parliamentary republic based on
political competition
Member of NATO
Member of the European Union
Member of the World Trade
Organization
The Baltic Miracle
What’s really interesting:
Latvia vs Estonia
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Very similar starting positions (except Finland?)
Divergence in GDP growth that is already
substantial and growing
Estonia has more industry (28.7% of GDP), than
Latvia (20.6%)
Estonia’s Summary Innovation Index is above
European average, Latvia’s is first from the bottom
Estonia is less corrupt (26th place in the world),
than Latvia (59th), based on Transparency
International
Estonia is home to Kazaa, Skype, SMS parking,
internet voting, etc.
Estonia handled the crisis differently, and now has
the euro
The questions and the
theoretical framework
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What explains Latvia’s performance vs.
ex-Soviet republics?
Latvia vs. Estonia?
These are the big questions of
development, we need to invoke some
theories.
One is the institutional view: rule of law is
what matters, but there is a commitment
problem; societies create institutions as a
cobwebs of checks and balances to
ensure protection of property rights.
Another is the theory of active, meddling
state that must tackle a variety of countryspecific market failures (e.g. Rodrik,
2006).
Application #1: Latvia
vs fSU
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Latvia implemented the standard
‘Washington Consensus’ + full
transposition of the European
institutional matrix (aquis communaire)
That doubtlessly hurt many domestic
(special) interests
Where did the ‘political will’ come
from?
My guess is that the ‘Russian card’
has been crucial (as in Georgia more
recently?)
App #2: The Natural
Resource Curse
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The rule of law is crucial to the economic
development
In nascent polities, however, economic
power means political power, and vice
versa – i.e. limited access orders (North,
Wallis, Weingast, 2006)
Substantial literature has established
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Natural resources tend to be negatively
correlated with economic growth (e.g. Sala-iMartin, 1997)
The quality of institutions is decisive whether
natural resources are a blessing or a curse
(e.g. Cabrales and Hauk, 2011)
Discovery of natural resources tend to make
states less democratic (e.g. Tsui, 2011)
NATURAL RESOURCE
OWNERSHIP
POLITICAL POWER
NATURAL RESOURCE
OWNERSHIP
EXCESS
PROFITS
Switzerland, etc.
POLITICAL POWER
NATURAL RESOURCE
OWNERSHIP
POLITICAL POWER
Enhancing returns
EXCESS
PROFITS
Switzerland, etc.
FIRM 1
FIRM 2
…
FIRM N
Investments
NATURAL RESOURCE
OWNERSHIP
POLITICAL POWER
Enhancing returns
EXCESS
PROFITS
Switzerland, etc.
FIRM 1
FIRM 2
…
FIRM N
Investments
RULE OF THE LAW
NATURAL RESOURCE
OWNERSHIP
POLITICAL POWER
Enhancing returns
EXCESS
PROFITS
FIRM 1
FIRM 2
…
FIRM N
Investments
Switzerland, etc.
RULE OF THE LAW
PRIVATE SECTOR DEVELOPMENT
ECONOMIC GROWTH
FOREIGN DIRECT INVESTMENT
Latvia’s Natural Resource Curse…
Latvia’s Natural
Resource Curse is…
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A combination of geographic position and
incompatibility of railroad tracks between
fSU and Europe – the port of Ventspils
In 1990s, Mr. Lembergs (then mayor of
Ventspils), with some enterprise directors,
‘privatized’ the port largely to themselves
He then took control of some media (e.g.
NRA)
A political party (e.g. Union of Greens and
Farmers)
And sought to use his influence to gain
ownership of other assets (e.g. Latvian
Shipping Company)
A culture of ‘rent-seeking’?
Estonia seems to have
no ‘oligarchs’
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Somehow, there are no clearly
identifiable ‘oligarchs’ in Estonia
No clearly politically controlled
media or political parties
One theory is that the absence of
oligarchs is due to the choice of
privatization methods, i.e. selling to
foreigners
This may have contributed to better
protection of property rights
App #2: Ethnic divisions
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Also seems to be a blessing for some
countries (U.S.?), and a curse for
others (e.g. Africa)
Both Latvia and Estonia have large
ethnic Russian-speaking minorities
However, ethnic voting seems to be
much stronger in Estonia, rather than
in Latvia
To date, a ‘Russian’ party has never
been admitted to a ruling coalition in
Latvia
Decision making in groups
MORE DEMOCRATIC
Dictatorship
1
Simple majority
Unanimity
(N/2)+1
N
MORE EFFICIENT
Example #1: 2002 elections
Political party
# of seats in the
parliament
New era party
26
‘Russian party’
25
People’s party
20
Greens and farmers
12
First party
10
Fatherland and freedom
7
Example #1: 2002 elections
Political party
# of seats in the
parliament
New era party
26
‘Russian party’
25
People’s party
20
Greens and farmers
12
First party
10
Fatherland and freedom
7
Number of possible (minimum size) majority
coalitions without the ‘Russian’ party
4
# majority coalitions with ‘Russian’ party included
9
Example #2: 2010 elections
Political party
# of seats in the
parliament
National unity party
33
‘Russian party’
29
Greens and farmers
22
For good Latvia
8
Fatherland and freedom
8
Example #2: 2010 elections
Political party
# of seats in the
parliament
National unity party
33
‘Russian party’
29
Greens and farmers
22
For good Latvia
8
Fatherland and freedom
8
Number of possible (minimum size) majority
coalitions without the ‘Russian’ party
1
# majority coalitions with ‘Russian’ party included
3
Ethnic fragmentation:
implications
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One implication is that the decision
rule, effectively, is somewhere
between qualified majority and
unanimity.
Unanimous decision making in the
parliament (liberum veto) likely
crippled Poland’s development in 17th18th centuries.
Ethnic fragmentation may make it
difficult to create good governance, i.e.
Rodrik’s ‘meddling’ state
Ethnic fragmentation:
implications
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Another implication is that ethnic
fragmentation may have helped oligarchs
to exercise influence, thus, undermining
the rule of law.
For oligarchs, political influence implies
substantial campaign finance investment
to woo ‘impressionable’ voters.
The return on investment depends on the
chances to get into the ruling coalition.
Ethnic fragmentation increased the
chances of oligarchs’ pocket parties
having the ‘golden share’.
THANK YOU!