The British and southern European governments have neither safeguarded public finances, nor stimulated economic growth. Perhaps they should look to an unlikely role model: the Baltic states. Estonia, Latvia and Lithuania were all hit harder than Britain during the global financial crisis of 2008-9, due to a complete liquidity freeze that sank their output by 15 to 24 per cent. But these countries were ruled by politicians who had lived through far worse (like the collapse of the Soviet Union), and knew how to resolve a crisis.
In a severe financial crisis, governments must act quickly to restore financial sustainability, confidence and economic growth. Each of the Baltic governments did so by cutting public expenditures by 6 per cent of GDP and raising tax revenues by about 3 per cent of GDP in a total budget adjustment of around 9 per cent of GDP. After two years of recession, all three countries returned to growth. In 2011 and 2012, they were the fastest growing economies in Europe.
The first advantage of a rapid crisis solution is political. Luxembourg’s long-serving Prime Minister Jean-Claude Juncker made the much-quoted statement, “We all know what to do, we just don’t know how to get re-elected after we’ve done it.”
But this is not true. Since 2009, the only governments in Europe that have been re-elected have been those of Finland, Estonia, Latvia, Sweden, Poland, and indeed Luxembourg. They have all pursued restrictive fiscal policies. Voters are prepared to suffer for a short time, but they do want to see light at the end of the tunnel.
A reform programme is usually better the faster it is constructed, because in developed economies the knowledge is ample, and the problems are political. A sudden crisis resolution can defeat ingrained vested interests. As President Barack Obama’s chief of staff Rahm Emanuel put it: “A crisis is a terrible thing to waste.”
Similarly, the nature of fiscal adjustment is better if carried out quickly. When public expenditures are slashed suddenly, the cuts tend to be concentrated to what is most superfluous. Sharp expenditure cuts drive beneficial structural reforms. In 2009, Latvia reduced its number of civil servants by one third, and it closed half the state agencies, which significantly reduced red tape.
Much has been made of Spain having more expensive access to public debt markets than the UK, even though Spain has a smaller public debt as a share of its GDP. One argument is that Britain benefits from having its own currency. But the simple truth is that we never know when investors will go on strike and stop buying bonds from a country. Latvia and Romania lost market access when their public debt was less than 20 per cent of GDP. Why play with fire? We should learn from the examples of the fiscally prudent Baltic states.
Anders Aslund is a senior fellow at the Peterson Institute for International Economics in Washington DC.