Evidence from Europe
Edited by Daniel Vaughan-Whitehead
Chapter 2: Mixed Adjustment Forms and Inequality Effects in Estonia, Latvia and Lithuania
2. Mixed adjustment forms and inequality effects in Estonia, Latvia and Lithuania Jaan Masso and Kerly Krillo 1. INTRODUCTION The recent economic and financial crisis has hit the Baltic states particularly hard: their declines in annual GDP exceed even those seen at the beginning of the transition (see Table 2.1). There are several reasons for this. During the years preceding the crisis (2004–2007), all three countries experienced the highest growth in the European Union: average growth rates were 8.2 per cent in Lithuania, 8.5 per cent in Estonia and 10.3 per cent in Latvia. However, there were serious imbalances behind this growth that made it unsustainable. Wage growth – that compensated for wage fall in early transition – exceeded productivity growth, causing a loss of competitiveness in the private sector (especially in certain branches of manufacturing; Estonian Development Fund 2008). The large current account deficit (occasionally more than 20 per cent of GDP – it was around 22 per cent in Latvia in 2006–2007) was to a large extent financed by credit inflows, and so it was no longer possible to maintain external imbalances when the crisis broke out. While during 2003–2007 easy access to credit and low interest rates helped to fuel economic growth, in 2008 and 2009 bank lending contracted significantly due to banks’ sharply diminished appetite for risk and fear of loan default. Economic growth slowed in the Baltic states earlier than in the rest of Europe: Estonia and Latvia faced strong negative growth (–3.6 per cent...
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