sexta-feira, agosto 17, 2012

Rosler holds up Estonia example

Debt workout 101 - part 14
Estonia is the very model of  modern fiscal policy to follow, according to Philipp Rösler, Germany's Vice  Chancellor and Economy Minister, whose economic prescriptions may reflect the fact that he's a medical doctor rather than an economist.  
Estonia and the other Baltic countries, which had pegged their currency to the EURO,  came under severe balance-of-payments pressure in the years of 2008-2009 and are now recovering to varying degrees,  with Estonia well ahead.
According to a must-read paper by  Kuokötis & Vilpiöauskas, the Baltic  countries resisted  pressures to adjust with hrough an (external) devaluation of their currencies  and chose instead to undertake the then unorthodox remedy of internal devaluation, despite routine expert economic advice to the contrary.  Estonia was the most successful  in fiscal consolidation and restoring investors' confidence, thanks in part to stronger political consensus regarding economic policy.    

Historical Data ChartThe choices were dire.  Both external and internal devaluation would have meant severe economic contraction, and all could recall earlier pegging failures,  including Russia in 1998. In fact all three countries reported sharp drops in GDP, including a cut of -18.9% in Estonia in 2009, in nominal terms.

How and why did this "internal devaluation" work:
  • Broad domestic consensus among policy-makers regarding the maintenance of fixed exchange rates, which were associated with political independence 
  • Significant foreign currency reserves
  • Highly flexible labour markets allowing for faster downward adjustment in wages and therefore less protracted and painful period of deflation
  • Local banking  sectors are dominated by strong Swedish banks, in turn backed by the Swedish Government, which could be seen as the equivalent of an "external deposit deposit guarantee"  
  • Financial support from Sweden, the EU and the IMF
  • Culture of patience and low protests, which allowed democratization and market-building  even in the face of severe economic hardships
  • Coalition governments and depoliticization of economic policy  
All through it, the countries kept their eye on the prize, entrance into the Eurozone, where their painful learning experience in  economic adjustment under fixed exchange rate pegs will certainly come in handy.  Most, if not all of the debt workout costs were borne mostly by the debtors, though with some facilittion by the creditors.

Economic Adjustment to the Crisis in the Baltic States in Comparative Perspective
Vytautas Kuokötis, Ramūnas Vilpiöauskas
Institute of International Relations and Political Science, Vilnius University
Prepared for 7th Pan-European International Relations Conference
September 2010, Stockholm