The Puzzle of the Baltics

It is a somewhat unorthodox theory, but many Russians of a certain bent blame the Baltics for the fall of the Soviet Union. They may have a point; reluctant at best captives of a hungry empire who worked constantly to escape their post-World War II captivity, they were the most eager and the most active in fleeing the sinking ship over twenty years ago. Today, they are some of the foremost Eastern members of the European Union, with Latvia set to join the eurozone at the New Year, Lithuania not far behind, and Estonia already one of Germany’s favorite arguments for austerity and fiscal rectitude.

But beneath the success of these individual stories is a somewhat odder truth: the Baltics only fit the European Union slightly better than they did the Soviet one.

Latvia’s accession to the eurozone is a triumph for its political class and a sore spot for almost everyone else. Its currency peg to the euro makes this inevitable and in the short run a great idea (the financial benefits will be obvious almost immediately), but the currency peg itself was a deliberate choice by the political class in furtherance of … euro accession. Its growth is predicted to be the class of the eurozone next year, with above-four percent growth in 2014 and higher beyond, a continuation of 2011-2013’s trend. Its short-term bond rating is investment grade, and its long-term rating is inching up to the same mark.

But Latvia’s poorer Russian minority, its economic weaknesses in housing and elsewhere, and its banking and structural problems are all warning signs that Riga (and the European Union) are ignoring as the country attempts to recover from its terrible crash of five years ago. Its regulatory and banking systems are disasters, and finance inside the country is a nightmare. Where the EU as a whole may be fairly described as a well-lit regulatory maze, in Latvia, it’s as if there are trap doors painted to look like floor throughout the maze.

Lithuania is expected to join the eurozone shortly, and its situation may be fairly described as Latvia-plus. Its regulatory scheme makes Latvia’s look open and clear by comparison. Its Russian minority is in little better shape. It is such a terrible investment environment that most multinationals looking for growth there see it as a bridge between Europe and Russia — and that’s it. Its bond market suffers from all of this as well as political dysfunction in Vilnius.

Then there is Estonia, the pride of place of the three, a country that went out of its way to escape its Soviet past and which has become a by-word for the virtues and profits to be had in austerity. Yet growth crashed there in 2013 as export markets dried up, domestic demand cratered, and government austerity remained in place even as financial crises vanished in the rearview mirror. Estonia faces a future similar to Lithuania’s, save that the final market for products traveling its length is Finland.

Worst for all three, growth is limited because human growth is so low. If the Baltics inherited anything from the Soviets, it is a profound belief in the irrelevance of babies. With sub-replacement fertility as far as the eye can see, it seems unlikely that these Soviet breakaways can break away from their current course.

Worse, in the example they set to Europe, they may yet be what they were to the Soviets: canaries in a collapsing mine.

Image Copyright Wikimedia Commons