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Transcript of Havekost Masters Dissertation
The Baltic Tiger – How labor market liberalization
led Estonia to become the model post-Cold War
transition country of the Baltic region by the 2004
round of EU enlargement
Alexander Havekost
London School of Economics - September 2014
MSc International Political Economy – Alexander Havekost – September 2014
1
Contents
Introduction ................................................................................................................................................... 2
Theoretical Presentation ................................................................................................................................ 5
Pre-independence environment ..................................................................................................................... 9
Poland ................................................................................................................................................... 9
Estonia................................................................................................................................................. 10
Latvia .................................................................................................................................................. 11
Lithuania ............................................................................................................................................. 12
Commonalities .................................................................................................................................... 13
Resultant Politics and Society ..................................................................................................................... 14
Political stability ................................................................................................................................. 14
Democratic Disenchantment ............................................................................................................... 15
With Regards to Labor Market Liberalization ............................................................................................ 17
Legislative Capacity, Trade Unions, and Civil Society ...................................................................... 17
Wages .................................................................................................................................................. 20
Contracts and Mobility........................................................................................................................ 23
Welfare ................................................................................................................................................ 25
The “Run-Up” to EU Accession ................................................................................................................. 29
Domestic ............................................................................................................................................. 29
International Interaction ...................................................................................................................... 33
Hard work pays off ............................................................................................................................. 36
Conclusion .................................................................................................................................................. 39
Bibliography ............................................................................................................................................... 41
MSc International Political Economy – Alexander Havekost – September 2014
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Introduction As the Soviet Union (USSR) teetered toward collapse during the late-1980s and eventually fell in
19911, the Baltic region, composed of Poland, Estonia, Latvia, and Lithuania, were able to regain
total independence for the first time since the start of World War Two (WWII)2. Demonstrating a
renewed vitality, this region exceeded, to varying degrees, the successes of most other post-Soviet
regions. Thrust into capitalism, these four republics enjoyed starting points similar to every new
democracy: a plethora of new politicians, national output concerns, social protection issues, and
an uncertain future as individual nations.
Often overlooked, the new democracies of the Baltic region were themselves diverse, with
linguistic, cultural, and historical differences. Political stability, implemented legislation, and
societal concerns in the post-Soviet era varied greatly within the region and led each republic down
its own divergent path of reform. How was it possible for the country of Estonia, comparatively
small in population and industrial capacity, to surpass its two southern neighbors and significantly
larger Poland in reaching Western economic modernity? Of all the reforms made during the
transition, this paper will serve to identify and assert that Estonia’s labor market liberalization
(LML), from its 1991 post-communist independence to 2004 European Union (EU) accession, was
the key policy that elevated its status to the model post-Soviet state. LML acted as a locus – a
convergence of national policies so essential that once effectuated, was instrumental in
determining the pace and path of transition leading to EU accession.
For the purposes of this investigation, “model transition country” assumes a Western, neoliberal
sense of the phrase, due to its status as the dominant global consensus. Neoliberal is a somewhat
1 Miyamoto, Katsuhiro. "The Carrot and the Stick of The Socialist Economy." Bulletin of University of Osaka
Prefecture. 39.(1995).p.1 2 Hiden, Johan and Patrick Salmon. The Baltic Nations and Europe (Revised ed.). Harlow, England:
Longman.(1994).p.189
MSc International Political Economy – Alexander Havekost – September 2014
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vague term that has been defined by many; for the purposes of this paper, two parts from Thorsen
and Lie will be used, one of which paraphrases Friedman’s take in 1960. Thorson and Lie posit
that neoliberalism is “a loosely demarcated set of political beliefs…[that] include the conviction
that the only legitimate purpose of the state is to safeguard individual, especially commercial,
liberty, as well as strong private property rights.”3 Secondly Friedman notes that neoliberalism
“includes the belief that freely adopted market mechanisms is the optimal way of organizing all
exchanges of goods and services.”4
Distinguishing each country is essential for the purposes of this paper. To accomplish this, an
investigation of historical institutionalism and path dependency theory will first be presented to
provide an explanatory framework for LML. Following this, a brief pre-independence context for
each country will first be stated in order to identify the drivers that led to independence. Next,
domestic societal and political situations at the outset of independence will be investigated,
denoting the institutional formation of the new states. From this point of institutionalization and
using five specific determinants of LML, Estonia’s policies and their implications will then be
evaluated in comparison to the rest of the region. Such policy determinants include legislative
capability, trade union presence, and civil society; wages; contracts and mobility; and welfare.
Finally, this paper will discuss the subsequently unique paths and successes determined by the
LML implemented in each republic; comparative levels of LML acted in a dichotomous fashion,
either as a catalyst for positive reform or as indicator of domestic struggles with transition. By
2004 Estonia had succeeded in making the swift adoption of free-market ideals, more so than any
other in the Baltic region. Although the population and Gross Domestic Product (GDP) of Estonia
3 Thorsen, Dag, and Amund Lie. "What is Neoliberalism?."(2006).p.14 4 Ibid
MSc International Political Economy – Alexander Havekost – September 2014
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were comparatively small, the 1.34 million5 people residing in Estonia had overseen significant
reductions in the welfare state, employment protection, union relevance, and barriers to investment
and trade, whilst improving fiscal responsibility, wage and contract flexibility, rule of law, and
overall employment. The support for, and lack of opposition toward, an all-compassing adoption
of free-market capitalism permitted Estonia to avoid the discordance experienced by others in the
Baltic region who struggled with reforms often designed to remove social protections, and
moreover avoid a general disenchantment with the shift to capitalism.
As a point of clarification, this paper will utilize the phrase “Baltic region” or “the region” to
include all four republics in order to facilitate the discussion of the region as a whole. Although
Poland is not considered a Baltic State, it has a major border on the Baltic Sea. For further
explanation, when discussing Estonia, Latvia, and Lithuania as a singular unit this paper will refer
to them simply as the “Baltic States.”
5 United States America. CIA. CIA Factbook 2004.(2005)
MSc International Political Economy – Alexander Havekost – September 2014
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Theoretical Presentation The scope of this paper covers a significant timeframe of the Baltic region’s politics, economy,
and society, requiring theoretical approaches that cover a rich level of detail: historical
institutionalism (HINT) will be the dominant framework to understand the formation and evolution
of Baltic institutions, and path dependency (PDP) will complement this framework as the
discussion of the region moves toward EU accession and Estonia’s successes. It would be wholly
incorrect to assume some sort of institutional void following the collapse of communism. Rather,
inherent informal institutions persisted, complementing what Stark and Bruszt note as the
systematic “reconfigurations of institutional elements rather than their immediate replacement.”6
These institutional approaches hold great explanative power over the fundamental changes in the
Baltic region, and particularly those of LML in Estonia.
Utilizing Ikenberry’s explanation, HINT describes how the “limits and possibilities of policy and
political change within a polity is shaped by the structural setting in which individuals and groups
find themselves.”7 Steinmo similarly notes how HINT’s attention is on “the ways in which
institutions structure and shape political behavior and outcomes.”8 Moreover, historical
institutionalists believe that the institutional organization of the economy and society clash to
advantage some and handicap others in the decision-making process. Asymmetrical power
relations was an invaluable tool in Estonian policy-making; minimal civil society and union
presence permitted new politicians to quickly implement sweeping neoliberal reforms. Institutions
go far beyond those of bureaucracy, too; they include informal institutions such as social norms,
6 Stark, David and Laszlo Bruszt. Postsocialist pathways: transforming politics and property in East Central
Europe. Cambridge. Cambridge University Press.(1998).p.83 7 Ikenberry, G. John. "History’s Heavy Hand - Institutions and the Politics of the State." New Perspectives on
Institutions. University of Maryland.(1994).p.29 8 Steinmo, Sven. "What is Historical Institutionalism?.".(2008).p.150
MSc International Political Economy – Alexander Havekost – September 2014
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procedures, and culture. Estonia was able to capitalize on the informal norms, notably the
widespread democratic disenchantment of its population, to further its own economic policies.
More generally, HINT excellently accounts for the transformational nature of institutions in the
independent Baltic region: actors intermingled within persistent post-USSR norms, longstanding
cultures, and the burgeoning formal institutions to determine levels of LML.
To lend more weight to the relevance of HINT in the post-communist Baltic region, a counter-
approach will be presented and refuted. Transitology, an approach founded in the 1970s9, is a
relatively amorphous, actor-centric theory that was developed to account for democratic transition
in Latin America and Southern Europe. The primary causal variable in Transitology’s analysis of
transition is elite bargaining, only after which political parties and civil society later gain
importance.10 This differs from the Baltic region, whose independence was largely ignited by the
popular protest and policy change at the USSR-level. With the benefit of hindsight, it is evident
that the democratization that the Baltic Region runs counter to arguments posited in Transitology,
which state that “revolutionary transitions and high levels of mass mobilization endanger, rather
than abet, the process of democratization.”11 Academia has tended to agree with the inapplicability
of Transitology for post-USSR cases, with Tokes claiming, “The negative side...diminishes
analytical benefits that Transitology might offer for a deeper understanding of what took place…in
the communist world in 1989-1990.”12 It can be concluded that HINT better illuminates the
region’s transition because it explains levels of policy continuity over time during periods of great
transformation. In other words, instead of institutions coordinating and “holding together a pattern
9 Gans-Morse, Jordan. "Contemporary Theories of Post-Communist Transitions and the Myth of a Dominant
Paradigm." Post-Soviet Affairs. 20.4.(2004).p.325 10 Ibid. p.326 11 Ibid. 12 Tőkés, Rudolf. "Transitology: Global Dreams and Postcommunist Realities."(1999).p.17
MSc International Political Economy – Alexander Havekost – September 2014
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of politics,”13 institutionalists claim that political and social contexts give rise to and sustain
institutions. This is particularly the case during initial years of Baltic independence, in which
reform-minded actors and civil society gave rise to restructured institutions and paths of transition.
Supplementary to the core HINT idea that “founding moments of institutional formation…send
countries along broadly different developmental paths,”14 the concept of PDP is also incredibly
relevant by suggesting that institutions “continue to evolve in response to changing environmental
conditions and ongoing political maneuvering but in ways that are constrained by past
trajectories.”15 Levi also presents this concept, understanding PDP as how the “entrenchments of
certain institutional arrangements obstruct an easy reversal of the initial choice.”16 To restate, paths
of progress are dependent on specific political, economic, or societal junctures, irrespective of size
or importance. Pierson also develops explanation of PDP, likening it to the economic concept of
“increasing returns-to-scale.”17 Ikenberry describes these critical moments as established logic,
after which any changes “tend to be variations or extensions on that logic.”18 This concept of PDP
conforms to HINT, particularly in that institutions are relatively persistent features and push
“historical development along a set of paths.”19 A counter to the concept of PDP would be that
forces in society engender similar outcomes, no matter the context or country. This alternative idea
may have traditionally held greater theoretical stature, however its largely one-dimensional
understanding of effects being uniform precludes any substantial explanative power when looking
13 Thelen, Kathleen. "Historical Institutionalism in Comparative Politics." Annual Review of Political Science.
2.(1999).p.384 14 Ibid. p.387 15 Ibid. p.387 16 Levi, Margaret. Consent, dissent, and patriotism. Cambridge: Cambridge University Press.(1997).p.28 17 Pierson, Paul. "Increasing Returns, Path Dependence, and the Study of Politics." American Political Science
Review. 94.2 (2000).p.251 18 Op.Cit.Ikenberry. p.16 19 Hall, Peter, and Rosemary Taylor. "Political Science and the Three New Institutionalisms." Political Studies.
(1996).p.941
MSc International Political Economy – Alexander Havekost – September 2014
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at post-communist changes in the Baltic region. Each republic was similar in developing a new
fledgling democracy and similar in evolving from state planning to capitalism, yet entirely unique
by 2004, fundamentally supporting PDP as the correct approach. Seemingly broad-based, PDP
includes a defining characteristic that precisely matches what LML was for Estonia: a locus, or
“critical juncture.” Hall and Taylor’s paraphrased description of the term will be used for the
purposes of this paper, understood as the instances when institutional changes occur, which thus
create a “branching point”20 from which transition moves in a new direction. Although not static
enough to be pinned down to a specific time or piece of legislation, the choice of high LML in
Estonia was critical in determining its path to EU accession and a vivid indicator of Estonia’s
comparative success
When applied in the Baltic region context the intermingling of these sets of concepts adopts the
precise outlook that this paper also uses to address the relative importance of Estonia’s LML. To
provide greater clarity for the impact of LML, Neoclassical Endogenous Growth Theory best
explains the economic causality. A dominant strategy employed by World Bank conditionalities
in the early 2000s, it was necessary to clear the labor market of rigidities in order to encourage
foreign direct investment (FDI), entrepreneurship, and financial risk-taking; internal policy
reforms included areas such as labor code amendments and pension reform, and it was generally
noted that collective labor interests limited the ability to obtain liberated labor markets.21 Such
developments fit well within the HINT and PDP framework, with Estonia exhibiting success in
adhering to the Neoclassical Endogenous Growth Theory.
20 Op.Cit. Hall and Rosemary.p.942 21 Upchurch, Martin. "The IFIs and Labour Reform in Post-Communist Countries." Globalizations. 6.2 (2009).p.298
MSc International Political Economy – Alexander Havekost – September 2014
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Pre-independence environment Like a dark shadow, the Soviet-influenced past of the Baltic region was deeply engrained in the
politics of transitional reforms. Essential to understanding the progress of each country, one must
acknowledge the key political and socioeconomic drivers during the Soviet era. Below is a brief
country-by-country description of the relationship with the USSR, arguably one of the most
significant influences on post-independence behavior. Following this will be a more general
discussion of common features shared by the Baltic region.
Poland
After the Yalta Conference in 1945, the Soviet Union extended its sphere of influence to include
Poland22, which by 1947 had undergone rigged elections to place Communists into power.23 The
following 1952 elections permitted no other party to challenge communist rule24, finalizing the
status of Poland as a Soviet Union satellite state. For nearly a half-century, Poland was controlled
by a USSR-led puppet government, but was able to have limited interaction with the West,
garnering attention from governments and investors due to its large population and economic
potential.25 Shifting further in time, the Polish were the first satellite state to revolt against and
attain independence from the USSR in 1989. Making this possible was the widespread use of civil
resistance and popular engagement, which were focal characteristics that persisted throughout
Poland’s development as an independent nation as well. Societal engagement will prove to be a
central point in this paper, be it in the form of trade unions, non-governmental organizations
(NGOs), or general social power.
22 Brown, Thomas. "The Soviet Union as a Great Power: The Need for Reform." The American Economist. 36.1
(1992).p.78 23 Staar, Richard. "Elections in Communist Poland." Midwest Journal of Political Science. 2.2.(1958).p.210 24 Ibid. p.212 25 Clemens, Walter. The Baltic transformed: complexity theory and European security. Lanham: Rowman &
Littlefield Publishers.(2001).p.1
MSc International Political Economy – Alexander Havekost – September 2014
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The Polish government declared martial law in 1981 to quell disorder from organized labor,
however several years later organization was permitted once more. By 1989 the trade union
Solidarność (Solidarity) had led the charge in rebellion and the country elected the first non-
communist prime minister in over 40 years, Tadeusz Mazowiecki.26 Applebaum notes that what
mattered for post-1989 success was the relevance of pre-independence active opposition: Poland
had an inefficient dictator, General Jaruzelski, who “produced more active citizens than those who
still used terror to suppress their critics.”27 In line with this societal concept, Cook identifies Polish
representative institutions as one of the strongest in the region, having produced labor movements
and “autonomous organizations”28 even before Poland attained independence.
Estonia
Guaranteed as part of the Molotov-Ribbentrop Pact29, Estonia found itself forced to accept Soviet
occupation by mid-194030, becoming the Estonian Soviet Socialist Republic (ESSR). Unlike
Poland, Estonia was unable to retain its own government and was instead annexed directly into the
Soviet Union. 50 years of direct rule developed industry so that over 90% of trade was not only
conducted with the Soviet Union, but also directly and involuntarily managed by Moscow.31
Despite the lack of an exiled government, by 1987 Estonian scholars and economists had begun to
formulate plans for an independent economy.32 Civil engagement also proliferated toward the late
1980s and three specific parties emerged: the Rahvarinne (Popular Front), who wanted gradual
26 Tagliabue, John. "Opening New Era, Poles Pick Leader." New York Times.(1989) 27 Applebaum, Anne. "Does Eastern Europe Still Exist?". LSE IDEAS.(2013) 28 Cook, Linda. Postcommunist Welfare States: reform politics in Russia and Eastern Europe. Ithaca: Cornell
University Press.(2007).p.16 29 Estonian Government. Soviet deportations from Estonia in 1940s. <www.estonia.eu> 30 Op.Cit. Hiden and Salmon.p.114 31 Pautola, Niina. "Fiscal Transition in the Baltics." Review of Economics in Transition.(1997).p.5 32 Lainela, Seija. "Private Sector Development and Liberalization in the Baltics." Review of Economics in
Transition.(1994).p.28
MSc International Political Economy – Alexander Havekost – September 2014
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change from Soviet institutions followed by a declaration of independence; the Eesti Kodanike
Komiteed (Estonian Citizens’ Committees or Restorationists), who demanded an immediate and
complete break with Soviet past to restore the pre-WWII republic; and the Interdvizheniye
(Intermovement), the pro-USSR party (ultimately banned in 1991) that was meant to counter the
nationalistic sense growing in the ESSR.33 Despite the Intermovement, pro-independence forces
were overwhelmingly successful in the 1991 independence vote with the Popular Front securing
victory and the nonelected Restorationists evolving into the first parliament, the Eesti Kongress
(Congress of Estonia), in 1990.34
Latvia
Another element of the Molotov-Ribbentrop Pact, Latvia was annexed by the USSR to become
the Latvian Soviet Socialist Republic (LASSR). Latvia shares many commonalities with Estonia,
having boasted similarly focused pre-independence political movements during the late 1980s.
The Latvijas Tautas fronte (Popular Front of Lativa) and the Pilsoņu komitejas (Citizens
Committees) had similar goals to their Estonian counterparts: the Front desired a more gradual
break from the USSR, integrating some of its institutions, and the Committees wanted an
immediate break from the Soviets.35 The USSR-loyal party, Interfront (International Front), was
also significant during Latvia’s burgeoning political scene; by the 1980s ethnic Latvians were “on
the verge of becoming a minority in their own republic.”36 In fact, it has been reported that of all
the non-Russian republics, only Kazakhstan underwent greater russification than Latvia.37 Despite
this, the International Front represented an insufficient counter-force to the dynamic shifts of
33 Budrytė, Dovilė. "From Ethnic Fear to Pragmatic Inclusiveness? Political Community Building in the Baltic
States (1988-2004)." Ethnic Studies.(2011).p.15 34 Ibid. 35 Ibid .p.17 36 Op.Cit. Hiden and Salmon.p.126 37 Ibid p.127
MSc International Political Economy – Alexander Havekost – September 2014
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societal views. Latvia’s Popular Front succeeded in 1991, with the Citizens Committees waning
in importance by this point; the Popular Front was able to gain control in parliament, the Supreme
Council, and in the executive branch of Latvia. The Soviet-loyal Latvian International Front,
similar to its Estonian Intermovement counterpart, was banned by 199238 in an attempt to further
distance the country from its communist past.
Lithuania
The most southern Baltic State, Lithuania was occupied by the USSR in 1940 after the agreement
of the Molotov-Ribbentrop Pact, becoming the Lithuanian Soviet Socialist Republic (LISSR). The
LISSR industrialized relatively quickly, and heavily, compared to the other Baltic States, but
“remained less advanced and did not experience so massive an influx of immigrants from outside
its borders.”39 Unencumbered by the heavy russification experienced in the ESSR and LASSR, the
LISSR was able to develop its domestic support base to form a unilateral challenge to Soviet
authority.40 The dominant party, Lietuvos Persitvarkymo Sąjūdis (Lithuanian Reform Movement),
was the major reform-minded party in the LISSR, countered by Yedinstvo (Unity) who were
created in 198841 to counter electoral pressures of nationalist party divisions. Attempts to lessen
the influence and intensity of the Reform Movement were in vain and thus Lithuania became the
first Soviet Republic to declare independence in 1990.42
38 Op.Cit. Budryte.p.17 39 Op.Cit. Hiden and Salmon.p.126 40 Ibid. p.127 41 Ibid. 42 "Lithuania: History."Global EDGE. Michigan State University.<http://globaledge.msu.edu/countries/lithuania>
MSc International Political Economy – Alexander Havekost – September 2014
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Commonalities
The economy of the USSR combined high employment protection with significant wage
compression, which translated into inefficiently allocated labor within rigid markets.43 Contrary to
capitalism, trade unions would often act as “transmission mechanisms” to “justify and implement
wage and social policy,” without a significant presence in wage determination.44 Lack of autonomy
was a common theme throughout the Baltic region; the European Community was required to
interact with the Soviet Council for Mutual Economic Assistance in order to organize any level of
trade relations in the Baltic States.45 The region was only able to regain some national footing,
however, when Gorbachev initiated his policy of glasnost and perestroika, meaning government
openness and economic and political reform, respectively.46
On an entirely different track than societal movements, strategic concerns were of great
significance, particularly when discussing the three Baltic States. As formerly independent
republics and as buffers between the USSR and the West, they were among the most militarized
regions in the entire Soviet Union. Moreover, the Baltic States served as a tactical “jump-off” point
for a theoretical westward incursion.47 Combine the military dynamic with the detail that the Baltic
republics were the only members of the League of Nations not to be restored to full sovereignty
after WWII48, and evidence further builds to explain the post-independence desire to ensure
sovereignty by decisively shifting towards the EU.
43 Eamets, Raul, and Jaan Masso. "Labour Market Flexibility and Employment Protection Regulation in the Baltic
States.". Institute for the Study of Labor (IZA) Bonn.(2004).p.2 44 Huber, Peter, Herbert Brücker, et al. European Union. Regional and Labour Market Development in Candidate
Countries.(2002).p.21 45 Dinan, Desmond. Europe Recast. Hampshire: Palgrave Macmillan.(2004).p.272 46 Op.Cit. Hiden and Salmon.p.1 47 Op.Cit. Clemens.p.7 48 Op.Cit. Hiden and Salmon.p.125
MSc International Political Economy – Alexander Havekost – September 2014
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Resultant Politics and Society The Baltic region quickly found itself wholly independent for the first time since WWII. With
politically energized and hopeful populations, turnout at the first elections was impressively high
across all four republics.49 This section will describe the levels of political stability and subsequent
levels of democratic disenchantment, which determined the pace and capability of LML. In order
to assess the explanative power of selected transition and labor market theories in the subsequent
section, exploring these characteristics for each state in the Baltic region is vital.
Political stability
The four republics had a shorter history of central planning than most others who fell under USSR
control in the 1920s, allowing them to draw on pre-war knowledge and legislation where possible
for the creation of new laws.50 Nevertheless, a commonality in some of the region emerged:
“nationalists were better at gaining independence than managing a modern state.”51 Poland’s new
government struggled with balancing its “shock-therapy,” or high-intensity pace of economic
reform, whilst retaining support of the public. Moreover, Poland did not employ a politicized or
heavy-handed lustration toward the communist “old-guard,” most likely due to its more
“easygoing”52 experience with communism; continued influence by the old-guard caused
persistent conflict within the political ranks. Latvia was the last of the region to hold free
parliamentary elections. It reinstalled its 1922 constitution53 but was forced to reorganize many
governmental structures post-election, which progressed at a sluggish pace due to the ruling
49 Ervasti, Heikki. Nordic social attitudes in a European perspective. Cheltenham: Edward Elgar.(2008).p.114 50 World Bank. From Plan to Market. New York: Oxford University Press.(1996).p.99 51 Op.Cit. Clemens.p.61 52 Calhoun, Noel. Dilemmas of Justice in Eastern Europe’s Democratic Transitions. Basingstoke: Palgrave
Macmillan.(2004).p.95 53 Bozóki, András. "Democratization in Central Europe." Taiwan Journal of Democracy. 4.2 (2008).p.17
MSc International Political Economy – Alexander Havekost – September 2014
15
coalition’s minority in Parliament.54 Plagued by corruption and political scandals, this added
another level of difficulty for Latvian governance during transition. Lithuania differed from Latvia
and Poland, retaining greater ties to the communist style of governance. The 1992 parliamentary
elections led to former communists and some of the Lithuanian Democratic Party as the ruling
political force. A comparatively lesser break from the past left the public and the West with an
unclear sense of reform commitment for the future.55 Estonia was comparatively stable, with the
majority of seats in Estonian Parliament held by reform-committed right-wing parties who had
united with social democrats to form the governing coalition.56 Although the Soviet Communist
Party had been banned from Estonian politics, the Estonian Communist Party was permitted to
participate in post-independence governance and reform.57
Democratic Disenchantment
High turnouts for first elections quickly shifted to ennui and disappointment among voters. This
shift in allure was mostly due to the decline in living standards except for the nouveau riche.58
Secondary to this reason, one must account for the effort it took to attain independence. Once
achieved, the masses may have experienced activist fatigue, which only worsened with the poor
performance of the economy. Citizens quickly found themselves in a newfangled economic system
with an entirely new, private ownership-oriented, and profit-encouraging mindset. The promise of
independence quickly turned into a problematic reality, spurred by dysfunctional monetary and
payment arrangements.59 Russia was no longer the sole focus, causing trade to decline by 10-15%
54 Op.Cit. Lainela.p.28 55 Ibid. 56 Ibid. 57 Krupnick, Charles. "Expecting More from Democracy in Central and Eastern Europe." Whitehead Journal of
Diplomacy and International Relations.(2005).p.154 58 Op.Cit. Clemens.p.61 59 Op.Cit. Pautola.p.9
MSc International Political Economy – Alexander Havekost – September 2014
16
of GDP, inflation to spike, and shortages of raw materials to arise.60 Essential economic relations
with former Soviet states had to first disintegrate and be “rebuilt under market principles.”61
Looking inward, tax bases established under centrally-planned principles suddenly disappeared,
which required major cuts in public spending and reconstruction of underdeveloped fiscal
institutions.62 What once were centrally-determined principles, those of social welfare and
employment protection, devolved into a void, a void that inexperienced governments were ill-
prepared to fill.
Disillusioned with post-communist hardships, the region experienced a substantial weakening of
its civil society, indicative of citizen alienation.63 This was a marked change from the pre-
independence efforts, which had marshalled a significant portion of society to become politically
active. Attempts by each republic to revive the economy and public spirit would soon follow; the
Baltic States would initiate their exclusive Baltic Free Trade Agreement (BFTA) to improve output
and levels of inter-state cooperation64, which, with assistance from Nordic countries65, would
reignite the common public interest in becoming fully legitimate EU members. Poland, fortunately
at the peak of the EU “accession queue,”66 would soon join the Central European Free Trade
Agreement (CEFTA) to spur economic recovery and further its path toward EU membership.
60 Op.Cit. Pautola.p.9 61 Sorsa, Piritta. IMF. Regional Integration and Baltic Trade and Investment Performance.(1997).p.4 62 Op.Cit. World Bank.p.145 63 Op.Cit. Krupnick.p.152 64 Adam, Antonis, Theodora Kosma, and Jimmy McHugh. IMF. Trade-Liberalization Strategies: What Could
Southeastern Europe Learn from the CEFTA and BFTA?.(2003).p.3 65 Hilson, Mary. The Nordic Model: Scandinavia since 1945. London: Reaktion.(2008).p.143 66 Op.Cit. Dinan.p.276
MSc International Political Economy – Alexander Havekost – September 2014
17
With Regards to Labor Market Liberalization This paper will not adopt a chronological approach due to the coverage and magnitude of the
investigation. Instead, utilizing the framework of HINT and PDP, the analysis will aggregate the
aspects LML into four sections: Legislative Capacity, Trade Unions, and Civil Society; Wages;
Contracts and Mobility; and Welfare. These groupings highlight the successes of Estonia’s LML
relative to the accomplishments and shortcomings of Latvia, Lithuania, and Poland.
Legislative Capacity, Trade Unions, and Civil Society
Within the fledgling capitalist republics, democratic disenchantment was a common feature that
developed among the masses. Pautola notes that “one of the most fundamental issues connected
with fiscal transition…[was the] common distrust of government and politicians.”67 This was a
huge turnaround that drastically altered how the public would negotiate and influence public
policy; according to Clemens, “unlike the Popular Fronts of the 1980s, few NGOs cut across
societal divisions to represent the public at large.”68 To put this in perspective of labor, the
coverage of collective bargaining apparatuses in Estonia was low for the Baltic region, and more
so when compared to EU Member States69, signaling potential for labor market flexibility.
Nevertheless, apathy was not all-inclusive in the Baltic region. Although a vital critical juncture
for Estonian progression, LML in the other three states were either restrained by the desires of
legislators or constrained somehow by societal groups. This therefore restricted Latvia, Lithuania,
and Poland from achieving a comparable level of transition to Estonia.
67 Op,Cit. Pautola.p.7 68 Op.Cit. Clemens.p.83 69 Op.Cit. Eamets and Masso.p.17
MSc International Political Economy – Alexander Havekost – September 2014
18
From 1991-2001, no strikes or lockout-induced losses of working days occurred in Estonia.70 It is
a marvel to claim such a feat by any standards, but this was not necessarily due to ideal working
conditions. Simply put, this period in Estonian history had few active, domestically-focused
collective bodies. As a consequence to activist fatigue and dissatisfaction with capitalism, labor
retreated from the forefront of politics, leaving few who joined trade unions. Noncitizens also
found difficulty in organizing politically71, forcing them to act as less-effective outsiders through
street marches and popular gatherings. By 1995, few of the 750 Estonian NGOs included labor
concerns in their mandates, instead directing their focus internationally and on macro-level
national activities.72 Minimal social resistance permitted the newly appointed Prime Minister Mart
Laar to enact sweeping reforms of trade policy beginning in 1992, drastically reducing trade
barriers to the Estonian economy.73 Reform-minded legislators adopted and implemented the
liberal policies endorsed by Laar, signaling the importance of liberal economic ideas within
Estonia’s institutional framework. The quick transition to democracy left minimal time for civil
society to gain a foothold within the political framework, which left the door wide open to free-
market reform.
The rest of the region demonstrated similarly demoralizing statistics of voter apathy. For example,
confidence in Latvian political parties rose only from 5% to 10% between 1992-1997, and by 1996,
32% of Lithuanians believed voting unimportant.74 Nevertheless, the institutional framework in
the remaining states of the region were still not as conducive to overhauls in labor market reform.
Poland in particular had crafted its democratic system in which the executive was somewhat weak
70 Funk, Lothar, and Hagen Lesch."Industrial Relations in Central and Eastern Europe."Intereconomics.(2004).p.270 71 Op.Cit. Clemens.p.84 72 Ibid. 73 Ibid 74 Ibid.p.70
MSc International Political Economy – Alexander Havekost – September 2014
19
and more inhibited for unilateral action, which gave greater political leverage to interests whose
focus was on social welfare. As Cook notes, Poland had comparatively higher societal defenses
for entitlements and welfare75, the effects of which will be discussed in a subsequent section. With
regards to Polish labor markets during the early 1990s, the World Bank reported about the
historical persistence of institutional arrangements, discussing the heavily unionized labor markets
that had previously been part of the Polish government. These forces impeded the government’s
desires to privatize at a rapid pace.76 Such institutional legacies spurred new pacts to be put in
place during transition, like the 1990 legislation that required workers to be paid even during a
strike.77 Of the four Baltic republics, Poland endured the highest rate of strikes in 1991-1996,
peaking in 1992 with a 223-day strike.78 Most evident from the Polish case is the applicability of
HINT; institutional structures molded the dynamics of interaction to favor labor, more so than in
any other republic in the region.
Coming from a slightly different standpoint, Lithuania had neither the intensely reform-minded
politicians seen in Estonia nor a strongly unionized labor force. The least industrialized in the
region, Lithuania bucked the Baltic trend and instead employed the most gradual path of liberal
reform. There was a steady trade union revival throughout the 1990s, whose coverage peaked at
10-15% of the working population.79 This transition approach nevertheless still encountered
repeated large-scale privatization delays due to corruption and dishonesty. This issue was so
prevalent, it would plague Lithuanian politics throughout the 1990s up to the 2000 election.80
Latvia had corruption concerns disrupting its legislative capabilities as well, but its shock-therapy
75 Op.Cit. Cook.p.194 76 Op.Cit. World Bank.p.61 77 Ibid. p.89 78 Op.Cit. Funk and Lesch.p.269 79 Op.Cit. Clemens.p.85 80 Ibid. p.70
MSc International Political Economy – Alexander Havekost – September 2014
20
reform proved less turbulent. Industrial action was restricted in Latvia, with a requirement to notify
employers at least 14 days in advance.81 Risk of job loss in the transition was too significant a
concern for workers – few dared to try and organize against employers. Moreover, according to
Funk and Lesch, “most workers also recognize[d] the necessity of structural change in order to
strengthen the international competitiveness of domestic firms.”82 Until 2002, the Latvian labor
code stated that unions had to consent to employee dismissal before the action could take place.83
This practice would dissuade employers from expansion and would discourage foreign firms from
choosing Latvia for investment. In terms of NGO presence, Lithuania underwent a decline in
registrations during the mid-1990s. Latvia, on the other hand, reached over 4000 NGOs by 1998,
but awareness and prestige of their activities was largely absent.84
Wages
Wage liberalization is an essential component of LML, potentially including a lowering of taxes,
or perhaps permitting market forces and employers to determine wage and employment levels.
According to the model presented by Aghion and Blanchard, expected wage levels, among other
factors, will be positively correlated to job reallocation and negatively associated to the
unemployment rate.85 As part of the shock-therapy liberalization undergone in Estonia, previous
wage regulations were removed to allow for market-determined wages. The stark redirection in
state policy had positive ramifications, one of which being by 2000, Estonian wage differentials
between men and women were declining.86 Moreover, Estonia was the first to restructure their tax
81 Kohl, Heribert. "Where Do Trade Unions Stand in Eastern Europe Today? Stock-taking after EU Enlargement."
Internationale Politik und Gesellschaft.(2008).p.122 82 Op.Cit. Funk & Lesch.p.270 83 Op.Cit. Eamets and Masso.p.17 84 Op.Cit. Clemens.p.84 85 Aghion, Philippe, and Oliver Blanchard. "On the Speed of Transition in Central Europe." NBER. 9.(1994).p.8 86 Rõõm, Tairi , and Epp Kallaste. "Men and Women in the Estonian Labour Market: An Assessment of the Gender
Wage Gap.". Praxis Center for Policy Studies.(2004).p.1
MSc International Political Economy – Alexander Havekost – September 2014
21
system by switching to a flat personal income tax in 1994 to 26%87, setting a high future standard
for the Baltic States.88,89 This restructuring created a more attractive business climate and
incentivized FDI to funnel into Estonia, the results of which will be detailed shortly. Both Latvia
and Lithuania followed suit, adopting flat income tax rates of 25% in 1994 and 33% in 1995,
respectively.90 Wage determination in these two states was mixed; subject to governmental
guidelines, market forces determined wages as privatization increased throughout the 1990s, but
were not nearly as liberalized as Estonia. For example, Lithuania underwent a turbulent economic
transition and was forced to deal with briskly rising real wages during 1992, which required a
downward adjustment by almost 55% in 1993.91 The mid-1990s was a period of fiscal restraint
due to huge losses in government revenue through shrinking tax bases and industry privatization.
Poland, in contrast to the Baltic States, struggled with wage rigidities during reform attempts. Such
rigidities included pre-determined public sector pay scales, bloated union-negotiated wages, and
other occurrences that prevented labor supply from meeting demand at market levels. Particularly
as a consequence of the problematic initial Polish shock-therapy liberalization, wage determination
became strictly moderated by the 1993 government, under The Democratic Alliance. The Alliance
implemented higher levels of public sector pay, heightened public spending, and more moderated
social policy.92 This policy redirection was in stark contrast with the initialized reforms already
underway, but better conformed to the desires rippling through popular discourse. Most apparent
in Polish regulation was the apparatus in place for minimum wages. Whereas the levels in the
87 Saavedra, Pablo. "Flat Income Tax Reforms." Fiscal Policy and Economic Growth. World Bank.(2007).p.256 88 Lehmann, Martmut, and Alexander Muravyev. "How Important Are Labor Market Institutions for Labor Market
Performance in Transition Countries?.". Institute for the Study of Labor (IZA) Bonn.(2004).p.8 89 "The case for flat taxes." Economist.(2005) 90 Op.Cit. Saavedra.p.256 91 Op.Cit. Pautola.p.18 92 Op.Cit. Cook.p.199
MSc International Political Economy – Alexander Havekost – September 2014
22
Baltic States wavered and decreased throughout the 1990s, Polish minimum wages proved “sticky”
and did not decrease (relative to inflation) during the entire decade.93 Adjustments were made
during these years by the labor ministry, in consultation with unions, on a quarterly basis to ensure
fair levels were reaffirmed.94 Strict adherence to minimum wage policies were followed due to the
recurring levels of high Polish inflation. In 1990 Poland had an annual inflation rate of 555.7%,
which in the following years remained comparatively high but continued to decline, justifying
trade union expectations to recalculate minimum wages quarterly. The post-1990 rates exhibited
in Graph 1 illustrate the downward trend of average annual inflation in Poland, but its substantial
level over many years would serve to formalize labor-employer wage relations during a time of
institutional infancy.
Graph 195
Wage ceilings existed during the early 1990s, but were found to be rarely binding during the time
of price liberalization96; firm-level works councils and larger industry unions had significant wage
negotiating ability, preventing LML from becoming the kind of critical juncture in Poland as it
93 Op.Cit. Huber et al.p.22 94 Ibid. 95 Op.Cit. Bozóki.p.26 (data used for graph) 96 Op.Cit. World Bank.p.49
0
10
20
30
40
50
60
70
80
90
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Infl
ati
on
(%
)
Year
Average Annual Inflation Rates in Poland
MSc International Political Economy – Alexander Havekost – September 2014
23
was in Estonia. Poland had strength in industry, geographical size, size of labor force, and
proximity to the EU, however its struggle with LML prevented a utilization of these advantages.
Contracts and Mobility
Improving the physical and industry mobility of labor, as well as deregulating labor contracts, are
two key facets of LML. Mobility was improved through privatization, which was essential in
providing new and accessible labor opportunities. The pace at which these programs progressed
was vastly different throughout the Baltic region due to institutional norms and legislation. A 1996
World Bank report on transitions to market economies praised Estonia for its reforms thus far. In
line with the neoliberal ideology, Estonia was providing far greater opportunities for its labor force
by crafting and implementing “top-down privatization programs.”97 This contrasts the Polish
experience, where they were unable to reform in such a manner due to their comparative
decentralization of power and more effective employee unionization. Estonia was decisive in
industry transitions; previous constituencies often had absolute or relative specializations, and four
out of five constituencies were then diversified in their focus through 1990-1999, greatly
improving GDP per capita levels.98 Such improvements attracted entrepreneurship and production
by large domestic and international businesses, which would translate ultimately into greater
national facilities, such as infrastructure and telecommunications. Contractually-related, by 2000
the Organization for Economic Cooperation and Development (OECD) had rated Estonia with a
low 2.4 on their index of employment protection legislation, based on a 0-6 scale.99 Estonia’s
expenditure of less than 0.1% of GDP on “active labor market policies” was factored into this
97 Op.Cit. World Bank.p.65 98 Op.Cit Huber et al.p.56 99 Op.Cit. Ervasti.p.141
MSc International Political Economy – Alexander Havekost – September 2014
24
rating, which continued to reaffirm Estonian commitment to LML.100 Once again, institutional
circumstances, and particularly the legislators acting within these institutions, were vital in
attaining such levels of liberalization.
The rest of the region fared differently than Estonia, although Lithuania privatized exceedingly
rapidly. With ethnic Lithuanians forming approximately 80% of the population, there was less
concern that other nationalities would acquire a disproportionate amount of new wealth from
privatization.101 In fact, by 1993 70% of all state companies were privatized; these levels occurred
so quickly that there were major concerns that purchases were made with illegal money through
larger, institutionalized corrupt practices.102 Lithuania reaped some benefits of greater
privatization and perhaps greater mobility of labor, but its slower reform in other aspects of LML
and general lack of industrialization hindered its progress. Latvia exhibited the slowest rate of
privatization of the Baltic States. Moreover, the Latvian institutional framework permitted
communist-era firms and their market-counterparts to often hold monopsony power over labor
throughout the transition.103 Labor mobility was severely restricted: officially workers needed a
stamp in their passports to designate where they would be allowed to live and work. These policies
were profoundly limiting for any kind of geographical or industry shift, with worker opportunities
only worsened by the publicly owned housing market104, which made it extraordinarily difficult to
obtain a change of residence.
100 Op.Cit. Lehmann and Muravyev.p.8 101 Op.Cit. Lainela.p.30 102 Ibid 103 Chase, Robert. "Labor Market Discrimination During Post-Communist Transition: A Monopsony Approach to
the Status of Latvia’s Russian Minority." Johns Hopkins University.(2000).p.7 104 Ibid.
MSc International Political Economy – Alexander Havekost – September 2014
25
Looking towards Poland, industrial asymmetry was a major concern during liberalization. The
USSR had selected the east of Poland for superior resource allocation to supply large areas of its
Soviet Republics, which often led to the formation of substantial industrial bases surrounded by
agriculture production. This type of manufacturing was well-suited to state-owned enterprises that
acted as cogs in the communal national machine, however the transition to a market economy
found these hubs laden with out-of-date infrastructure and inefficient labor practices.
Asymmetrically, western areas of Poland had proven to be better equipped to manage supplies
directed toward the West, even before 1990.105 This meant that inherited capital and labor practices
were better able to adapt to Western capitalism. This division in industry styles imposed a
structural rigidity that made the Polish labor market quite uneven throughout the 1990s. Standard
practices in the East produced the relatively static skills of the Eastern labor market, which made
it difficult to migrate to another industry or geographic location. By 2000, Poland had the highest
unemployment in the Baltic region106; the issue of unemployment would become a core in Polish
national concerns as it neared EU accession.
Welfare
The transition to capitalism rapidly shifted former bases of public sector finances for the entire
region. A part of LML, welfare can include unemployment benefit provision, pension provision,
and subsidies, all of which were determined differently in the region. Three distinct governmental
approaches arose, the most radical of which was demonstrated by Estonia. By 1996, Estonia had
formalized the requirement that unemployed workers, who were able-bodied, must perform at least
105 Duffy, Fiona, and Patrick Walsh. "Individual pay and outside options: evidence from the Polish labour force
survey.". Institute for the Study of Labor (IZA) Bonn.(2001).p.2 106 Op.Cit. Huber et al.p.22
MSc International Political Economy – Alexander Havekost – September 2014
26
80 hours of monthly public service in order to be eligible for unemployment benefits.107
Additionally, the unemployment benefits offered by 2003 were only 7% of the average Estonian
wage. This level was by far the lowest of the region, as can be seen in the Graph 2 on the below.
Graph 2108
As can be seen above, the rest of the Baltic region averaged closer to unemployment benefits at
20% of the average wage. This is one of many indicators that Estonia was region’s model liberal
transition country by 2004.
107 Op.Cit. World Bank.p.93 108 Cazes, Sandrine, and Alena Nesporova. "Combining flexibility and security for employment and decent work in
the western Balkans." South-East Europe Review.(2006).p.17 (data used for graph)
0 5 10 15 20 25
Estonia
Latvia
Lithuania
Poland
2003 Unemployment Benefits
(% of average wage)
MSc International Political Economy – Alexander Havekost – September 2014
27
Contrary to what might be expected, Estonia did not reserve the finances kept from frugal
unemployment benefits to promote policies that incentivized working. To give an example of such
policies, Latvia had enacted legislation to pay lower benefits to early retirees, whilst incentivizing
retirement postponement by raising benefits for those who waited and continued to contribute to
an employer or the national pension system.109 As is illustrated in Graph 3, Estonia did not use the
surplus of funds for labor market expenditures.
Graph 3110
As is demonstrated in Graph 3, the Baltic States refrained from the level of labor expenditure that
Poland employed. Prospects for EU membership solidified the historically institutionalized social
welfare dynamic in Poland of high health, labor, education, and social services spending.111 These
aspirations matched with civil society’s concerns of social provision and welfare state change,
which were often considered a form of compensation for the costs of liberalization during the early
1990s.112 Poland was able to ease its fiscal balance through subsidy reductions, although social
109 Op.Cit. World Bank.p.90 110 Op.Cit. Cazes and Nesporova.p.17 (data used for graph) 111 Op.Cit. World Bank.p.35 112 Op.Cit. Cook.p.200
0.00% 0.20% 0.40% 0.60% 0.80% 1.00% 1.20% 1.40%
Estonia
Latvia
Lithuania
Poland
2003 Labor Market Policy Expenditure
(% GDP)
MSc International Political Economy – Alexander Havekost – September 2014
28
transfers remained persistently high. This practice was similar to Estonia, who had abolished all
industry subsidies by 1997, including the often heavily-protected agricultural sector, except for
few subsidies in the energy sector.113 Nevertheless, the institutionalized, democratic representation
of concerned parties in Poland was pivotal in upholding expenditures. Bargaining capability,
whose importance is reaffirmed by HINT, is engrained in Polish history and persisted due to the
rise of neoliberal forces running counter to social welfare. Such counter-forces would gain
momentum due to the significant strains on the fiscal base of the government that quickly
developed, such as the 28% rise in Polish pensioners between 1989-1993, matched only by a 1.5%
increase in population during the same time period.114
Looking briefly towards Latvia and Lithuania, one of their roles in the USSR had been to
contribute significant transfers to the greater union. Once this obligation was removed with the fall
of the USSR, they were able to improve their fiscal balances; initial surpluses in national accounts
provided the opportunity to implement cash rationing and expenditure controls.115 Both countries
followed the Estonian policy agenda of limiting expenditure in subsidies and social transfers, albeit
to a lesser extent. Lithuania, for example, implemented cuts in pensions, public sector wages, and
unemployment benefits to reign in fiscal expenditures between 1992 and 1993.116 The slightly
greater presence of civil society and pursuance of less absolute reforms meant that the two
countries fell in the middle of the Baltic reform spectrum.
113 Op.Cit. Pautola.p.11 114 Sachs, Jeffrey, and Andrew Warner. "Achieving Rapid Growth in the Transition Economies of Central Europe.".
Harvard Institute for International Development.(1996).p.45 115 Op.Cit. Pautola.p.5 116 Ibid p.19
MSc International Political Economy – Alexander Havekost – September 2014
29
The “Run-Up” to EU Accession For the Baltic region, there was a magnetic attraction to EU accession. Membership was one of
the final hurdles to ensure no future retrogression into the former-Soviet sphere. Moreover, EU
membership held promise of profound growth potential through access to the economic and
political union. Evidence presented thus far in this paper of LML in the region undoubtedly
demonstrates not only the institutional legacies of the four countries, but also the relevance of
LML as the critical juncture for Estonia within the PDP framework. PDP’s analytic strength in
this capacity is that of explaining outcomes in situations when key actors attempt to alter, or
successfully achieve an alternation in the status quo. Several resultant outcomes of LML in the
Baltic region will be presented below in a grouping of domestic results, subsequent external
influences, and specifically notable outcomes that confirm the critical juncture claim on the eve
of EU accession.
Domestic
Proponents of neoliberal reform shared a common concern: uncertainty. Politicians new to
democracy lacked the foresight to see long-term policy implications, particularly in the Baltic
States, which hadn’t enjoyed institutionalized independence for over 50 years. Economists from
across the world were discordant in opinion over how quickly market-oriented reforms should
occur.117 Estonia implemented the rapid pace of shock-therapy reform and largely succeeded,
whereas Poland was rife with disenchantment following its shock-therapy attempt. As has been
noted previously, Lithuania adopted the most gradual reform of the Baltic States from the outset,
matching what Stiglitz claimed to be the ideal method of reform in 1999. Stiglitz was
unquestionably in favor of privatization and encompassing reform, and also remained consistent
117 Op.Cit. Clemens.p.107
MSc International Political Economy – Alexander Havekost – September 2014
30
with HINT, but suggested there were “institutional preconditions that include[d] a build-up of
social and political capital to enable necessary reforms.”118 The post-communist transition of the
Baltic region was unprecedented in complexity and scope.
Estonia was not without fault through the transition, with its politics affected by various scandals
and corruption. Several governments came to power throughout the 1990s, with Prime Minister
Laar returning to power in 2000 as part of a relatively weak coalition, reaffirming Estonia’s reform
commitment.119 Specifically looking at Laar’s 1994 Estonian flat tax reform, the fiscal
consequences were fortunately inconsequential: before the reform in 1993, government tax
revenues approximated 39% of GDP. By 2002, these revenues approximated 40% of GDP.120 The
tax reforms did not prove a detriment to Estonian fiscal balances, and as a by-product Estonia
obtained a significantly more attractive business climate. Shifting focus to the other two Baltic
States, Latvia and Lithuania also endured malpractice and criminality during their transition to
market economies.121 Attempts to form a financial sector and effective supervisory mechanisms
that could support new businesses required structural changes, which have different difficulties to
legislating social reform.
Poland was similarly plagued with political disorder throughout the 1990s. The lack of a lustration
law until 1999122 left a non-legalized break with pre-independence politics, creating several
political scandals. Throughout the decade, social expenditures waxed and waned according to
growth levels and political fortitude. Growth during 1994 and 1995 permitted higher social
118 Stiglitz, Joseph. "Whither Reform? Ten Years of the Transition." Annual Bank Conference on Development
Economics. World Bank. Washington DC.(1999).p.4 119 Op.Cit. Clemens.p.63 120Op.Cit. The Economist 121 Op.Cit. Leinela.p.40 122 Op.Cit.Calhoun.p.128
MSc International Political Economy – Alexander Havekost – September 2014
31
expenditures, however the years of 1996-1998 brought on re-clarifications on welfare eligibility.
Finally, the government spearheaded reforms on pensions, healthcare, and education in 1999 to
improve overall levels of national efficiency.123 Despite various reform measures in social
provision, which ran counter to the neoliberal ideals of government restraint, Poland still had low
levels of phone and computer access, lower rates of higher education, and lower life expectancy
than the three Baltic States.124
Poverty was a key concern in Poland through the solidification of regional disparities and industrial
asymmetries. These structural issues were a severe determinant to the economy, often precluding
a significant portion of the relatively high labor supply from obtaining employment from the 1990s
into the 2000s.125 Graphs 4 and 5, on the following page, illustrate this trend.
123 Piêtka, Katarzyna. "Labor Supply Effects of Social Security Transfers." in: Poverty Dynamics in Poland Selected
quantitative analyses. Warsaw: Center for Social and Economic Research, Warsaw.(2002).p.39 124 Op.Cit. Clemens.p.168 125 Golinowska, Stanislawa. "Poverty in Poland: Causes, Measures and Studies." in: Poverty Dynamics in Poland
Selected quantitative analyses. Warsaw: Center for Social and Economic Research, Warsaw.(2002).p.35
MSc International Political Economy – Alexander Havekost – September 2014
32
Graph 4126 Graph 5127
Evident from both graphs was the prevalence of unemployment in Poland, which by 2000 rose to
levels markedly higher than the rest of the Baltic region. As has been explored throughout this
paper, institutional configurations and industrial asymmetries were significant determinants of the
unemployment. A study in 2006 found a negative correlation between trade union density and
youth unemployment; the protection of core workers through these unions may prevent younger,
less experienced workers from joining the workforce.128 Poland followed a historical path of trade
union presence throughout its transition, which could explain the approximately 40% youth
unemployment by the time of EU accession.
Graphs 4 and 5 also illustrate the Estonian trend of comparatively low unemployment, although
youth unemployment reached similar levels seen also in Latvia and Lithuania. Following the PDP
126 "Unemployment Rates in Estonia, Latvia, Lithuania, and Poland." Indexmundi - Data from World Bank ‘World
Development Indicators’. www.indexmundi.com 127 Ibid. “Youth Unemployment Rates in Estonia, Latvia, Lithuania, and Poland; Ages 15-24”. 128 Op.Cit. Cazes and Nesporova.p.20
0
2
4
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1992 1994 1996 1998 2000 2002 2004
Un
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plo
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Unemployment Rates in the
Baltic Region
Estonia Latvia Lithuania Poland
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1995 1997 1999 2001 2003
Yo
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Ages 15-24
(% of total labor force)
Estonia Lativa Lithuania Poland
MSc International Political Economy – Alexander Havekost – September 2014
33
concept directed by Estonian LML, the country offered external interests more than deregulated
wages, but also a highly educated and well-trained workforce of skilled professionals. Aspirations
of EU accession, fear of job loss, and exceedingly limited unemployment benefits incentivized
workers to perform with diligence. Latvia was able to follow a similar path: by 1998, 66% of
workers were in the private sector and strikes were rare.129 The most government intervention was
exhibited by Lithuania, whose expansionist fiscal policies tended to push wages upwards at rates
higher than GDP growth.130 These consequences, understood in the PDP context, were due to the
gradual reform employed by Lithuania. Nevertheless, by 1998 Lithuania had revised its general
outlook by providing firms with incentives to improve human capital.131 Nearing the 2004 EU
accession, the Baltic States were able to offer foreign investors cheap and skilled labor, with
potential for relocation throughout Europe and Russia.132
International Interaction
While the Baltic region was under USSR control, external actors had already begun to realize their
economic and political potential. As the region developed further, EU accession aspirations drove
greater international interaction. Poland had immediate attention from the EU due to its proximity
to Europe and sizeable population. Across the region the EU would also form individual trade
agreements (Europe Agreements), whose purpose was to provide closer political and economic
ties; schedules for tariff reform; and technical, legal, and financial assistance.133 The Europe
Agreements served in an advisory role, as well as presenting the tantalizingly close carrot of EU
membership. National governments would then provide the stick to drive reform and meet
129 Op.Cit. Clemens.p.172 130 Ibid 131 Ibid 132 Ibid. p.170 133 Op.Cit. Adam, Kosma, and McHugh.p.5
MSc International Political Economy – Alexander Havekost – September 2014
34
accession conditions. Unique to the Baltic States, the BFTA was formed as a truly free-trade
agreement without so-called “loophole clauses” that would have given rise to disputes. Liberal
reforms and the ability to openly engage competitive pressures, as would be experienced in the EU
Common Market, sent positive indications to the EU and other foreign investors.134 Below is
Graph 6, depicting comparative FDI inflows to the Baltic Region.
Graph 6135
Graph 6 is highly illustrative of the business climates that developed as a result of the region’s
transition to liberal market economies. Initial focus is on 1998, when Estonia rapidly received a
surge in FDI flows. Following Russian oil crisis that damaged the Baltic economies, flows from
Scandinavia rapidly increased to take leading roles in Baltic investment.136 With Poland as the
134 Kazlauskiene, N., and W.H. Meyers. "The Baltic Free Trade Agreement in Agriculture: Early Results of the
Experiment."MOCT-MOST. 9.(1999).p.292 135 Op.Cit. Indexmundi. “Net FDI Inflows in Estonia, Latvia, Lithuania, and Poland.” 136 "Foreign Investments in Latvia." Baltic Export. Lithuania. <ww.balticexport.com>.
0
5
10
15
20
25
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Ne
t FD
I In
flo
ws
Year
Net FDI Inflows
(% of GDP)
Estonia Lativa Lithuania Poland
MSc International Political Economy – Alexander Havekost – September 2014
35
primary focus of the EU for a significant period during the 1990s, the Nordic countries shifted
substantial human and physical resources into Baltic State projects. As the northernmost of the
Baltic States, Estonia shared close “lingual, historical, and geographic ties with high-tech and high-
wage Finland.”137 The ties with the region served to accelerate the positive reforms within Estonia,
funding high-technology improvements and promoting job creation. Although slightly beyond the
scope of this paper, one can clearly see in Graph 6 the rapid investment post-accession; Estonia
had been primed to take advantage of full market access. The Nordic countries felt far fewer ties
with Poland despite significant emigrant communities, primarily due to the restricted privatization
programs and conflicting politics138, making the business climate less attractive than Estonia’s.
Despite the relatively modest investments from Nordic countries, Poland was able to be the first
of the region to join the World Trade Organization (WTO) in 1995.139 This accomplishment was
hugely beneficial for Poland, who had struggled with LML and more general resistance to liberal
reforms. WTO membership obligations not only formally protected Polish trade, but ensured at an
early stage of transition that liberal regimes would remain. Poland had significant sectoral interests
who held great privilege in policy-formation, which WTO obligations mediated from any form of
trade regime protection or backsliding.140 Latvia and Estonia were able to complete the accession
process to the WTO in 1999, with Lithuania joining by 2001.141 WTO membership for the Baltic
States gave an early form of security before that which was gained by EU accession. Moreover,
entrance to the global regime served to condition the three countries further in Western-led
economic practices. The Baltic region utilized external interactions throughout transition to
137 Baldwin, Richard, and Charles Wyplosz. The Economics of European Integration. 4th ed. Berkshire: McGroaw-
Hill Education.(2012).p.200 138 Op.Cit. World Bank.p.77 139 Ibid. p.147 140 Ibid. p.147 141 Op.Cit. Kazlauskiene and Meyers.p.292
MSc International Political Economy – Alexander Havekost – September 2014
36
expedite the implementation of best practices in their own economy, whilst situating themselves
better on the global stage for further inclusion in the West.
Hard work pays off
The evidence of LML as a critical juncture within the PDP framework illuminates how transition
progressed within the Baltic region. According to a 2003 Economist Intelligence Unit report,
Estonia had the most robust business environment in Central and Eastern Europe.142 The labor
market factors leading Estonia to this success have been discussed throughout this paper, and
whose quantification will be illustrated in terms of GDP per capita in Graph 7 below.
Graph 7143
As is demonstrated in Graph 7, Estonia’s LML prevailed by utilizing its centralized government
to sustain the increasing rates of GDP per capita. Poland may have been the first country in the
142 "Baltic States: Country outlook." EIU ViewsWire.(2003): ProQuest Business Collection. 143 Op.Cit. Indexmundi.“GDP per capita in Estonia, Latvia, Lithuania, and Poland”.
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
1990 1992 1994 1996 1998 2000 2002 2004
GD
P p
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ita
(1
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0 $
)
Year
GDP per Capita
(Constant 1990 $ PPP)
Estonia Lativa Lithuania Poland
MSc International Political Economy – Alexander Havekost – September 2014
37
Baltic region to re-obtain 1989 levels of production, which it achieved in 1995144, but its
institutional focus on industrial policy and social inclusiveness came as part of its more
“embedded neoliberalism,” which could not match the consensually-desired and ideal market
economy that Estonia boasted.145 Despite the socially-focused policies implemented in Poland, a
2004 study of 26 European countries found Poland to have the lowest trust in its national
parliament, politicians, political parties, and legal system. Internally conflicting politics and
erratic policies during transition put Poland on a path of low trust, which ultimately fell below
countries such as Ukraine and Hungary, both of which were notorious for political corruption.146
Returning to FDI inflows, Krupnick reaffirmed HINT and PDP’s relevance for Estonia:
neoliberal policies pursued by each Estonian government were hugely beneficial for prosperity
and economic harmonization with the EU.147 Although the Baltic States had reformed at
different paces, full GDP recovery was reached in all by 1998148 and Estonia emerged as the
clear forerunner for reform commitment.149 Clemens likened the success of the Baltic States to
the “Asian Tiger” of Taiwan: working with limited natural resources and every-wary of their
former subjugator.150 GDP per capita rose in Estonia due to their ability to utilize highly-skilled
and low-cost labor.151 These skills were constantly modernizing, with Estonia also ranked as one
144 Upchurch, Martin. "Persistent economic divergence and institutional dysfunction in post-communist economies:
an alternative synthesis."Competition and Change.16.2.(2012) 145 Baboš, Pavol. "Varieties of capitalism in central and eastern Europe: measuring the co-ordination index of a
national economy." Journal for Labour and Social Affairs in Eastern Europe.(2010).p.450 146 Op.Cit. Ervasti.p.141 147 Op.Cit. Krupnick.p.155 148 Op.Cit. Upchurch 2012.p.5 149 Op.Cit. Lainela.p.34 150 Op.Cit. Clemens.p.2 151 Op.Cit. Sorsa.p.6
MSc International Political Economy – Alexander Havekost – September 2014
38
of Europe’s most computerized societies; by 1998 more than 10% of Estonia’s population used
computers, which matched similar levels in France and Germany.152
A final indicator of Estonia’s success was that as the country neared EU accession its economic
policies were found to be too liberal and had to be reduced before entry to the EU. Moreover,
Estonian tariffs were so low that by 2000, in order to be admitted into the EU, Estonia would
have to raise tariffs on over 10,000 items against non-EU countries.153 It was evident that EU
accession undermined the highly liberal Estonian labor and trade policies employed in the 1990s.
Estonia was by far the model transition country of the region, exhibiting comparatively low
growth rates of industrial production, strict fiscal policies, and low levels of social welfare,
which had to be revamped to better fit EU standards of trade and social protection.154
152 Op.Cit. Clemens.p.109 153 Ibid. p.170 154 Op.Cit. Baboš.p.448
MSc International Political Economy – Alexander Havekost – September 2014
39
Conclusion “Actors who seek to move in new directions find that their choices are constrained by the
existing set of institutional resources. Institutions limit the field of action, preclude some
directions, and constrain certain courses.”155 This quote from Stark and Bruszt succinctly
identifies the key explanatory capacity of HINT and PDP in the case of Estonian LML. Pre-
independence frameworks preconditioned the governance capabilities of the Baltic region; these
frameworks went far deeper than formal governmental institutions to include cultural and social
norms. Following the collapse of the USSR and the introduction of market capitalism,
institutional legacies had varying effects on reform attempts. Dependent on governmental reform
commitment, civil society presence in policy formation, and democratic disenchantment, the
critical juncture of LML was either a breakthrough moment for continued reform, or as a marker
signaling internal conflict.
Estonia was willing and able to capitalize on the free-market ideals that permeated through its
political arena, and with the general withdrawal of popular counter-forces, was able to put itself
on a path of reform towards an ideal neoliberal economy. The other three countries of the Baltic
region inherited an expectation of social provision and more generous state coordination from
their socialist past, whilst also striving to obtain the benefits of democracy and independence.
The early 1990s was a period of necessary fiscal constraint for the entire region due to legislative
reform and shifting tax revenue bases, causing many of these expectations not to come to
fruition. Resistance to liberalization, particularly in Poland, hindered the effectiveness and
sustainability of Polish shock-therapy reforms at the outset of its independence. With few laws
restricting strikes and significant inclusion of unions in wage negotiations, the whole society
155 Op.Cit. Stark and Bruszt.p.83
MSc International Political Economy – Alexander Havekost – September 2014
40
came to embody same mindset – that of social entitlement. Struggles with disillusionment went
on to plague Polish attempts to move towards a neoliberal economy, leading to several instances
of social policy “flip-flopping.” Reform was often pushed forward by the desire for and eventual
entrance to the WTO and future prospects for EU accession. For Poland, Latvia, and Lithuania,
guidance in developing Western-approved governmental and political institutions156 provided an
avenue to somewhat steer the path of development, helping to offset the urge to slide into
becoming an economically non-competitive nation.
The critical juncture of LML was absolutely vital for Estonian success. Historical desires for
Westward-looking reform and active policies of liberalization such as wage deregulation and
privatization paved the road to success for this small Baltic State. It transcended shortcomings of
resources, geographic size, and population to become a high-tech country with a highly skilled
labor force. Nordic FDI inflows surged as EU accession neared, unemployment rates were
comparatively low for the region, and there were tight fiscal policies that minimized
expenditures for unemployment benefits, pensions, and other social transfers. The coordinated
efforts of Estonian governments over the 15 years of transition created a reputation for
commitment to market economics and rule of law, which only furthered its success – a virtuous
cycle was established. It was so successful that the EU required Estonia to temper its neoliberal
policies to better match EU trade and social welfare policies before it joined to the union.
156 Lane, David and Martin Myant. Varieties of capitalism in post-communist countries. Basingstoke. Palgrave
Macmillan.(2007).p.35
MSc International Political Economy – Alexander Havekost – September 2014
41
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