Baltic experience. 2011

1. Baltic Blues
Exporting Your Way Out Of Trouble Under A Currency Peg
Edward Hugh - Barcelona: May 2011

2. In this presentation I will argue that
• Despite some early encouraging signs, it is far from self-evident
that the so called “BELLS” (Bulgaria, Estonia, Latvia and Lithuania)
are going to be able to export their way out of trouble.
• Unresolved issues may leave a legacy. One which could weigh
down any recovery and lead to more serious problems during the
next recession
In particular:
a) The Existence of a Debt Overhang
b) The Impact of Ageing and Declining Populations
• The “internal devaluation” process may have been underambitious
and allowed to come to a halt far too soon.

3. Worrying Signs In Latvia
Despite a substantial increase
in exports

4. GDP Growth Is Now Slowing

5. Consumer Demand Fails To Recover

6. While Industrial Output
Languishes
And Investment
Also Fails To
Recover

7. So What Is The Problem?
Well the first
problem is debt.
How can heavily
indebted societies
claw their way
back to sustainable
growth.
The Key Point To Grasp – This Process Is Structural, Not Cyclical

8. Cheap Interest Rates Supported by the Peg Meant Latvian
Households and Corporates Got Themselves Heavily Into Debt
But Now The Latvian Economy
Is Caught In The Vice Of A Credit
Crunch

11. The Problem Now Is That The Credit Bust Economies
Are Now Totally Export Dependent For Growth
Simplifying:
GDP = Consumption + Investment + Government
Spending + Net Trade
Which means growth in GDP = Growth In the sum of
these factors
Growth in Net Trade = Growth In Exports – Growth in
Imports

12. Exports Can Grow Rapidly After A Sharp Drop
But Once The Former Level Is Recovered It Gets Harder To Obtain
Enough Growth To Drive GDP Forward

13. In Addition Workforces And Population In These Countries Are
Shrinking and Ageing

14. Why Is This A Problem?
It Is A Problem Because Your Underlying Trend Growth
May Start To Slow And You Still Have To Service The Debts
Accumulated When You Were Growing More Quickly.

15. It Is Also A Problem Because Growth In A Modern
Economy Either Comes From Credit Expansion (internal
demand) or Exports (paying the credits back).
Consumption out of current income isn’t a huge part of
the picture.

20. Population Ageing – A Unique Historical Challenge
The economic and social implications of the ageing
process are going to be profound. According to a recent
report from credit rating agency Standard & Poor’s:
• the process is seemingly irreversible.
• No other single force is likely to shape the future of
national economic health, public finances, and
policymaking over the coming decade
Strangely, the issue receives only a fraction of the
attention that has been devoted to global climate
change, even though, arguably, ageing is a problem our
social and political systems are, in principle, much
better equipped to deal with.

21. As far as we are able to understand the issue at this
point, population ageing will have major economic
impacts and these can be categorised under four main
headings:
i) ageing will affect the size of the working age population, and
with this the level of trend economic growth in one country after
another
ii) ageing will affect patterns of national saving and borrowing, and
with these the directions and magnitudes of global capital flows
iii) through the saving and borrowing path the process can
influence values of key assets like housing and equities
iv) through changes in the dependency ratio, ageing will influence
pressure on global sovereign debt, producing significant changes in
ranking as between developed and emerging economies.

22. While population ageing is universal the short term impact
will be much more localised. The pace of aging varies
greatly across countries and regions.
The effects of the process are expected to be most
pronounced in those countries that remained complacent
in the face of ultra-low fertility rates (total fertility rates of
1.5 and under), which in effect means Japan, the German
speaking countries and much of Southern and Eastern
Europe.

23. Another way of looking at these demographic
changes is in terms of the dependency ratio, which
can be defined in a number of different ways
depending on the problem being addressed.

24. Eastern Europe Will Be Very Hard Hit
Among emerging economies, the East of Europe stands out
as by far the worst case in the short term. In 2025, more than
one in five Bulgarians will be over 65 - up from just 13
percent in 1990. Ukraine’s population will shrink by a fifth
between 2000 and 2025. And the average Slovene will be
47.4 years old in 2025 – one of the oldest populations in the
world.

25. The Demographics Of Export Dependency
As I have been arguing, if economies transit from being
consumption driven to export driven, and it would appear
that the process is not merely random, then we are not
talking about choosing between options or “growth
models”. There is not a choice here, since there are deep
underlying structural dynamics at work, and these dynamics
seems to be intimately associated with the dynamics of the
demographic transition

26. Time To Act – What Can Be Done?
Short Term:
- Continuing and Continuous Structural Reform
• Labour Market Reform
• Pension Reform
• Heath System Reform
• Immigration Longer Term
• Raise Fertility Rates
• Global Rebalancing Initiatives
• Acceptance that the Modern Growth
Era – like modernity itself – doesn’t
last forever.