The Fall and Rise and Fall Again of the Baltic States

Instead, the Baltic states are pushing through an "internal devaluation," cutting wages and pruning bureaucracy in the hope that these measures will boost their exports and attract renewed foreign investment. The sole cushion is money from the European Union and other international lenders. It could work. The three Baltic economies have already shown that they can turn on a dime. They did this in 1991 under far harder conditions and again in 1998, after the Russian financial crisis. Still, these austerity measures require extraordinary patience and a high tolerance for pain among voters who will see their living standards plunge for the next two years. It also requires Swedish and other foreign banks to stay the course on their bad loans, even as they will lose money hand over fist.

The big hope is that the crisis will prompt the reforms that Baltic politicians so smugly skipped during the boom years. It is a scandal, for example, that higher education in all three countries is so second-rate. At least one of their universities should have turned itself into a strong competitor for students and faculty frustrated with the lumbering state-run universities of old Europe. Health, transportation, local government, and criminal justice still retain striking levels of Soviet-style producer power, corruption, and inefficiency. Progress on these fronts would not just reassure voters that the state was doing its job properly—it would also encourage external lenders, such as the European Union, to help keep the Baltic states afloat. If none of this happens, though, the water level will just keep going up.

The Baltic states' current fate epitomizes the wider story in Eastern Europe, of half-baked reforms pursued with more enthusiasm than judgment. Looking back on the 20 years since the Berlin Wall fell, it is clear that the economic difficulties facing the former captive nations were overestimated. Solidarity leader Lech Walesa once said that turning a capitalist economy into a communist one was as easy as turning an aquarium into fish soup. The difficulty was reversing the process. In fact, creating a thriving capitalist system on the ruins of a planned economy has proved the easier part. The difficulty has been in building strong institutions with the political supervision necessary for them to stay healthy.

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