The Fall and Rise and Fall Again of the Baltic States

It took the collapse of the Latvian government in February, amid fevered speculation about devaluation and political unrest, to bring the Baltic states’ problems to the world's attention. Signs of trouble had been visible much earlier, however. For those who knew the countries well, the sense of hubris in the years of the post-2004 boom was almost stifling. Growth in Latvia, for example, was an unsustainable, debt-fueled 11.9 percent in 2006 and 10.2 percent in 2007. Current account deficits—a good sign of how far beyond its means a country is living—soared too, reaching nearly 25 percent of gdp. That made all three countries completely dependent on outsiders’ willingness to keep lending them money. As upsets elsewhere in Europe from Iceland to Ireland have proved, the trouble with this model is that borrowing money is easy when you don’t need it, but difficult when you do. In past years, the inflows inflated the bubble. Now, national survival depends on the willingness of Swedish taxpayers to guarantee banks that so unwisely overextended themselves.

The boom years in the Baltics—as in so many other fast-growing emerging markets—turned out to have been wasted. Instead of firmly applying the brakes, running large budget surpluses, tightening control of the banking system, and taking urgent action to preserve competitiveness, politicians harvested the proceeds and ignored the risks, thinking that the growth was the result of their own good decisions. Calls for caution were brushed aside. Rather, the impulse was, as Latvian tycoon-turned-politician Ainars Slesers put it, to "put the pedal on the metal."

The detrimental effects of this mentality were clear. A tight labor market sent standards in service industries plunging. At the region’s premier security thinkfest, the Lennart Meri Conference in Estonia in 2007, startled delegates turned up for breakfast on Sunday morning at Tallinn’s Radisson hotel to find that nothing was on offer. The staff simply hadn’t turned up; the manager shrugged, "Who wants to work on a Sunday morning?" Foreign tourism operators began complaining. Once a bargain destination for those seeking a quick break, the Baltic states became pricey before they became good.

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