Southern Winds

Finance Minister Levy is leaving his post by year end.  If so, he will have lasted just one year.

Almost a year ago, soon after his nomination, I wrote[1] that while he was highly qualified for the job and would “find some initial freedom of action… [which] could last a couple of years..,[his] remedies and policies.. are the exact opposite of what the PT wants and what President Rousseff has supported in the past. I also wrote that Brazil needed to make profound reforms which “are political in nature and go far beyond the competency of the Minister of Finance”.
 

My misgivings were proven valid even sooner than I expected.  Minister Levy didn’t receive the political backing from his president nor from the PT in congress.  As a result, he could only raise some taxes but couldn’t significantly cut public spending.  The last straw was the government refusal to hold the line at 0.7% for the 2016 primary budget surplus.

 

Nelson Barbosa, currently Planning Minister and a traditional proponent of active government intervention in the economy, will replace him.  He will get along better with President Rousseff but I don’t think that it will mean better decision-making.

Ravaged by corruption scandals, economic recession and depressed commodity prices, the future looks bleak for Brazil.  The political opposition is by and large clean (perhaps because it didn’t have access to the levers of power) but weak and lacking grassroots organization.

Further south, the winds are beginning to blow in another direction.  Mauricio Macri was elected president of Argentina and wasted no time in liberalizing the foreign exchange regime via a dirty float system.  He also cut taxes on the main grain exports which got him the exporters’ agreement to bring back, daily, some $400 million of grain export proceeds.  Finally, Finance Ministry’s and the Central Bank’s teams look very good.

I have no doubt that the Argentine recovery will be rocky at times: undoing several years of ill-advised policies takes time and is politically difficult; the opposition is well organized and deeply resentful of its loss; finally, the world economies are still weak.

But Macri has a number of factors in his favor, besides having adopted good policies and chosen good people:  Argentina is smaller than Brazil, with a population of 44 million vs. 206 million; its population is better educated and economically less unequal; last but not least, he was clear in his campaign as to what his policies would be and voters, in their majority, backed him.

In Venezuela, the heirs to Hugo Chavez have suffered a heavy defeat in the latest congressional elections.  Clearly, the population is unhappy with the abysmal performance of the economy.  External pressure is also mounting for the regime to respect human rights.  More than anywhere else in the region, low commodity prices are shaking political and economic foundations.

Elsewhere in South America, commodity prices are forcing government to revise their policies, although with distinct flavors.

 

The education, social and political reforms which the Bachelet government wanted to carry out have faced fiscal realities: the money is not there; the haste with which they were introduced met a pushback from both moderate politicians and a population facing other priorities.

In Colombia, where oil accounts for half of exports, the government is scrambling to raise tax revenues, ease oil and gas permitting, hold inflation in check with a more aggressive monetary policy and, at last, intervention in the foreign exchange market.  The wild card is the peace process with the FARC: the rebels are increasingly isolated as their foreign backers are short of funds (Venezuela) or considering a change in strategy (Cuba).

In conclusion, the implosion of the hard commodity markets has wrecked havoc in South America.  Populist policies have run out of money and change is forced upon these countries.  The choice is between liberalization, repression and chaos.

Argentina has chosen liberalization, Venezuela has chosen repression, Brazil is heading towards chaos.  Chile and Colombia are so far sticking to a middle of the road regime of open economies and politics.  If the prices for oil, copper and iron ore weaken further in 2016, the pressure will rise further on governments to “do something”.  The more unpopular they are, the harder it will be for them to heed to moderation and rationality.

Optimists will say that a cycle of populism in ending in South America, and that the example of Argentina will favorably influence its large neighbor to the north, Brazil; that Chileans and Colombians are unlikely to turn their backs on two decades of social and economic progress; that Chavismo has lost the legitimacy, credibility and financial means to rule as it wishes.

Pessimists will argue that economic and political liberalism is a foreign concept in South America and that voters not so much want that as an interventionist government largely financed by buoyant commodity prices.

Let me be a guarded optimist.  I do believe that most people aspire to a better life for their families and themselves, greater freedom and pride in their country.  In Latin America, they will also have realized that much of the government bonanza of past years was due to external factors (China’s appetite), not bureaucratic excellence; they have also seen the true cost of government largesse.  For all the above, I think that a new cycle is starting, first in Argentina. 

2016 promises to be interesting.

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[1]  12/7/14 Brazil’s uncertain future post.

Igauçu Falls (Epilogue)

Last week, General Antonio Hamilton Martins Mouraõ, the real head of the Southern Military Command (CMS), was relieved of his charge and assigned to an administrative position in Brasilia.

This was in response and punishment for the general having publicly been critical of the President Rousseff; according to people who attended a conference held last September, the general would have said that, should the President leave office, it would not be a destabilizing event but would mean that “incompetence had been cast aside.”

The general got in even deeper trouble in October when he encouraged members of his Command to attend a ceremony to commemorate Colonel Carlos Alberto Brilhante Ustra who had just died.  The colonel had led the DOI-CODI, a controversial Army unit responsible for “internal security” during the military junta days.

There is no question that the general was out of turn and got what he deserved.  It is however noteworthy that he was so upfront in voicing his opinions.  Perhaps he felt that he was saying out loud what many of his peers were thinking.

At this point, I do not expect Brazil to become so dysfunctional that its armed forces would feel compelled to intervene.  Nevertheless, there are only two large and well organized social forces in Brazil: the Partido dos Trabalhadores (PT) and the Armed Forces.  The former is the ruling political party, it is in trouble and it knows that it is not the only alternative to chaos.

Iguaçu Falls (Part three) – An exercise in fiction

On September 29, General (4 stars) Oscar Rossi, couldn't shake off a bad headache.  The evening before, he and two dozens general officers had attended the retirement party for General Adriano Galvaõ dos Santos, the Army Chief.  The affair had lasted until the wee hours of the morning, wine and cachaça had flowed with abandon.  By the time Rossi’s plane landed in Porto Alegre, the rain had stopped and it was daylight.

The political and security climate only made his headache worse.  The economy was in recession, wracked by sky high interest rates, an imploding currency, a confidence crisis, general strikes, and a government in total disarray.  Crime and politically inspired violence had multiplied as police forces, which had been widely criticized for excessive violence, were basically holding back.

Sensing its vulnerability, the Rousseff government had clumsily issued a decree to transfer some of the general officers’ powers to the Minister of Defense.  This didn't go down well, and an unease had developed where it had not existed.

With its economy in free fall, the majority coalition in disarray, the opposition not ready for prime time and the public clamoring for order and better wages, the army was the one force not tainted by corruption or incompetence.

General Rossi was the Head of the Southern Military Command (CMS) which covered the states of Parana, Santa Catarina and Rio Grande do Sul.  Before the oil boom, this region had been at the heart of an industrial Brazil.  It also abutted with Argentina, the perennial regional challenger and occasional historical foe.  Heading the CMS was indeed quite a career achievement for an ambitious 47 year old soldier.

The dinner had not been without controversy and had bared some tension.  Oscar Dürenberger, the brash leader of the 12th Infantry Airborne Brigade, having raised his glass to toast Galvaõ, looked at him straight in the eyes, smiled thinly and asked:” Well General, how long before we have to clean up this mess?”

Silence had fallen over the assembly.  Galvaõ had not risen to the top Army job by baiting his minister or displaying excessive ambition.  He also remembered history.  He held Dürenberger’s stare, lowered his glass, crossed his hands on the dining table, and slowly answered his junior commander:
-“Oscar, there is an elected government in place, it is up to them to figure out what to do and take responsibility.  We are neither cowboys nor crazed revolutionaries!...Besides, if you read your recent Latin American history, you will see that the armed forces rarely grabbed power; more often than not they took over when a substantial proportion of the population pushed them to….and I don't see this happening here.”

When General Almeida from the Northeastern Military Command proposed another toast, to a man, everybody stood up and the discussion veered into another direction.  Yet Rossi was still analyzing Galvaõ’s words in his head, and a brief look across the table convinced him that he was not alone in doing so.

Rossi looked at his watch.  It was a quarter past ten in the morning.  He was still worried, and the fact that he want alone feeling depressed was small consolation.  What would this new day bring?  A lot of change as it turned out.

2,000 miles to the North East, over the draught stricken sertaõ, a large cb cloud system had been gathering foe s verbal hours.  At 10.43 am, a huge thunderbolt hit the 500 kv transmission line and the substation at Sobradinho.  The latter burst into flame and a chain reaction ensued, with circuits tripping one after the other.  For whatever reason, the energy management software at Cia de Eletricidade do Estado da Bahia (Coelba) failed to activate.

Brazil depends on hydroelectricity to the tune of 64%.   But persistent draughts, high transmission losses and erratic government energy policies which discouraged new investments had left the system both unbalanced and inefficient.  Over the course of the previous four weeks, the Ministry of a Energy had discussed the possibility of putting some of its thermal power plants back on line.  Unfortunately, no decision had been made.

The national grid was now tremendous stress; mismatches between loads and generation caused the system to break down into uncontrolled islands, collapsing frequency or voltage.  By 10.55 am the Imperatriz node was taken out of service, and with it the critical North-South electric transmission axis.  The 8,400 MW Tucurui hydroelectric plant was now a useless monument of concrete lost in the Amazon.

Resplendent and majestic in the morning sun, the Itaipu dam was still one of the world greatest engineering and construction marvels. Its massive turbines had a combined 14,000 MW electric generation capacity and their energy was transmitted over a triple set of 750 kv power lines.

At 11.20 am, the northern half of Brazil, down to Brasilia, was in the dark.  The states of Acre and Roraima, already self sufficient and not integrated to the national grid, were spared.

The cascading blackouts kept moving south.  By 11.30 am, with the big economies of São Paulo, Rio de Janeiro, Minas Gerais at full demand for electric energy, the southern grid system went out not massive overload.  Not even the mighty Itaipu could make up for the loss of the Northern power system.  Following protocols, the Itaipu system tripped; 98% of the Brazilian population and 90% of the territory were now without power.

Outside, somewhere behind the officers mess, the Cummins standby generators kicked in.  Shortly thereafter, Rossi's phone rang.

Iguacu Falls, (Part Two) - an exercise in fiction

In Salvador, an early morning thunderstorm washed away torn paper posters, empty soda bottles, as well as an odd assortment of abandoned sneakers, broken wood sticks and debris of the violent confrontations from the previous day. Now and then, an armored police van could be seen speeding silently down empty avenues, lights flashing.

This scene was repeated, with minor variations, in many large cities.  But in the heart of Brazil’s manufacturing, the so called ABC Region outside the city of São Paulo, TV crews were beaming back scenes reminiscent of Apocalypse Now: an acrid haze from still burning tires floated in the streets; blackened wrecks of police cars and buses haphazardly dotted the urban landscape; rows of shops with broken windows and gaping doors added to the vision of destruction and irreality.

TV viewers were served non-stop images of violence from the day before, of interviews with victims and of seemingly deserted cities.  Shocked by the extent of the destruction, many businesses had not opened and, by and large, people had decided to stay home.

Despite the endless televised group discussions and opinionated pundits, viewers were still struggling to make sense of what they had seen: massive crowds surging between concrete city blocks like the sea at high tide, companies of red shirted militias, some on foot others riding motorcycles, giving chase to straggling demonstrators.  But two videos held viewers in their seats: one of a policeman, his clothes set on fire, slowly crumbling to the ground in a silent scream, the other of a police squad, beating two men senseless with their clubs, long after these had stopped moving.  Had the police put their lives on the line in defending the safety of the citizenry or had they behaved like thugs?

The government seemed just as shocked and dumbfounded as the public.  The presidential office had released no communique so far, while the Interior Ministry had condemned the violence and declared a state of emergency.

The main opposition party had been divided as to how to react.  But on September 23rd, the leaders of the PSDB came out with a unified message that President Dilma  Rousseff should resign or be impeached, recalling the words of former PMDB icon, Ulysses Guimaraes, back in 1992 when then President Collor was himself under threat of impeachment for corruption:” He thinks he still he is president, but he no longer is”.

Attuned as ever to where power was shifting, and conscious of its own weakened position as a result of the indictment of several of its most prominent members, the PMDB issued a communique calling for “ the voice of the people to be heard, and for politicians to respect it”.

Fearing an imminent vote of impeachment, the PT and its allies called for “an immediate popular show of support in favor of democracy and against the rabid forces of oppression”.

Soon, thousands of armed milicias petistas and sympathizers took to the streets in Brasilia, encircling the seat of government, the Planalto , as well as the Brazilian Nacional Congress, ostensibly to protect both.  When Vagner Freitas and a handful of CUT followers stormed the news set of TV Brasilia to denounce a presumed coup, the temperature rose by several degrees.

In Goianias, São Paulo, Rio, Salvador, and elsewhere, supporters of the government in place occupied or blocked access to strategic centers of power or industry.  Having been widely criticized for the use of excessive force, federal and local police forces stood by.

The 23rd came and went.  On the 24th, public employees unions called for a general strike.  They were soon followed by those of Petrobras, Banco do Brazil, as well as those of the likes of CSN, Usiminas, GM, Ford and Fiat.

On the 25th, air traffic controllers joined the movement.  The country had ground to a halt.  The PT had effectively broken into several factions, the more extreme being the more vocal, the PMDB was not sure whether to make effective its dominance of the governing coalition, and the opposition was, as usual, divided and not ready to govern.

Brazil slowly drifted into chaos, as basic services were no longer provided, private industry was on strike, the supply chains of commerce were no longer functioning, and the streets were no longer safe.  Change needed to come, and it did on the 26th.

Iguacu Falls, (Part One) – an exercise in fiction

It had been a hot summer, in more ways than one.  China had made the biggest headlines; its vital economic signs, as could be inferred from its periodic statistical releases, were worse than most pundits had expected; in private, many wondered whether 2015 GDP growth could be flat or even negative rather than settling around the +6.9% or so trumpeted in public..

The dizzying gyrations of the Shanghai stock market, the increasingly erratic government interventions, and finally industrial catastrophes like the explosion at the Tianjin port frayed nerves around the world.

A still slow growing U.S., a convalescent Europe and a teetering China were wrecking havoc for many commodity dependent countries.  Low oil prices had hit Colombia hard, but Brazil had fared worse.

The country of the future and likely to remain so, as skeptics had dubbed it, Brazil had hugely benefitted from the commodity boom which started in 2003.  Indeed, it had been able to finance a generous social program and ambitious oil and gas related investments without difficulties and without needing to correct glaring structural economic weaknesses.

The discovery of huge offshore oil and gas reserves had triggered a renationalization of sort at Petrobras, had encouraged the federal government to intervene more than ever into various sectors of the economy, and as was to be discovered later, had given birth to institutionalized corruption on a scale never seen before.

The Great Recession of 2008, the profound change in investor sentiment and the uncovering of the Petrobras corruption scandal gave birth to the biggest crisis that Brazil had experienced in three decades.  Petrobras, weighed down by huge debts contracted to carry out the government’s pre-sal ambitions, came close to debt restructuring; the international financial markets effectively closed to Brazilian borrowers; the abrupt economic slowdown cut federal tax revenues while public spending was only slightly reined in, leaving the country with a flat to negative budget primary balance.

But most of all, the petrolao scandal tore apart the political system, leaving Brazil with either a weak presidential or parliamentary regime, depending whom you talked to.

During her reelection campaign, President Rousseff and the Workers Party (PT), had scoffed at the necessity of budgetary cuts; likewise, by delaying cash outlays and having Congress amend the budgetary Law, the government had avoided more immediate trouble.

Now, President Rousseff had to backtrack on her promises, which proved difficult as her own party strenuously opposed spending cuts and the population was ill prepared to accept them anyway.

Against this ominous background of incipient economic, institutional and financial crisis, the government blindingly stuck to its authoritarian ways in nominating a new president of the House.  This backfired badly, and its political ally, the PMDB, managed to elect one of its own, Eduardo Cunha, to the job.  With PMDB member Renan Calheiros already holding the presidency of the Senate, the government had dealt itself an incapacitating blow.

The PMDB quickly made it known that it no longer was a junior partner of the PT, and Eduardo Cunha made it known that the Legislative Branch had responsibilities and powers equal to the Executive’s.  Bewildered, frustrated, the PT dragged its feet when called upon to vote for painful measures, leaving President Rousseff in a weakened position to negotiate the support of the PMDB.  The politics of Brazil became very complicated, with a weakened Executive, a powerful Legislative with no mandate to govern, and a divided, ineffective, opposition.

Yet matters were getting much worse.  Continuing revelations by the investigating magistrates, leaks and plea bargaining by a slew of suspects further destabilized the various branches of government.   The presidents of both the House and the Senate were formally investigated for corruption, along with a number of senators, congressmen and former governors from the parties that had formed the governing coalition, namely the PT, PP and PMDB.

Fighting for his political life, Eduardo Cunha opened his own House inquiry into suspected malversations at the National Bank of Economic and Social Development  (BNDES), as a means of pressuring the government into letting him off the hook.  The Executive and the Legislative were now at loggers head, despite being led by the same political coalition.

As September came, further revelations of mishandling of funds surfaced: billions lent by BNDES to Cuba, Venezuela and others in support of the same engineering and construction companies that were already suspected of corruption, and with similar results: overbilling and (credit) losses in the billions.  Worse, former President Lula, the highest profile politician in Brazil and  the PT leader, was formally indicted of influence peddling.

His response was immediate and virulent: on September 17, in Sao Bernardo do Campo, flanked by thousands of PT and United Workers’ Central (CUT) members waving red flags and giant portraits of him, former President Lula denounced the hidden agenda of the opposition, ridiculed PSDB leader Aecio Neves’ “pathetic attempt to clear his way to the next presidential elections”, and threatened that any attempt to put him under preventive custody would be “opposed by the Brazilian people”.

Standing to his right, Wagner Freitas, president of the CUT, remained impassive. Yet all of the members of the press in attendance remembered his fiery declarations, a month before, when talks of impeaching President Rousseff were growing:

-“ what is coming to Brazil today is intolerance…. We are the defenders of a national project to bring better conditions to all, and this means, right now, getting down in the street, and digging in, weapon in hand, in case they want to overthrow President Rousseff.  Any attempt against democracy, the lady [Dilma Rousseff] or President Lula, we will be the army that will confront those bourgeois in the street.”

Like the mythical straw that broke the camel’s back, the indictment of President Lula, after the long string of revelations at Petrobras, Eletrobras and most recently at the Federal Railway System, struck a raw nerve in the population.

Brazilians were already suffering from high inflation, negative growth and accelerating layoffs most visibly in the automotive, oil and gas and related sectors. Yet while they were facing hard times, midlevel managers and politicians admitted to having stolen tens of millions of dollars.

There were no institutions to believe in anymore.  Even the Judicial Branch, which had gamely exposed the misdeeds, was resented for ruining the national mood, and the common man still doubted very much that the miscreants would spend significant time in jail anyway.

A huge wave of popular anger and despair spread throughout the country.  Just like in March, calls for a nation-wide day of protest rose spontaneously.  On September 20th, a huge protest march was to assemble in Brasilia to “throw the bums out”, and a massive sit-in was to start in front of the Planalto until the President resigned.  Another demonstration would gather in front of President Lula’s residence any many more would spring up around the country.

Meanwhile, both the PT and the CUT decided to organize counter-demonstrations against what they viewed as politically orchestrated efforts to unseat the President.  Some on the fringes of these organizations were eager to “retake the streets” and viewed the Venezuelan, motorcycle mounted, milicias bolivarianas, as a worthy model; after all, these had succeeded in dispersing and discouraging popular demonstrations.  There had been casualties among the population but no militia has been prosecuted.

The PSDB was ambivalent about the marches.  Neves and his associates viewed them as genuinely popular, and a wave to surf on politically, especially since their party didn't have the kind of structure and manpower the PT had.  But they also realized that this limited manpower wouldn't allow them to control mass demonstrations should they get out of control.  If that happened, the PSDB would be held responsible.

In the end, Neves publicly supported the forthcoming demonstrations and marches but advised PSDB members to attend individually and not in representation of the party.

September 20th was hot, especially in Brasilia when temperatures rose to 98F at midday.  According to police estimates, over 8 million people descended in the streets nationwide.  Some 50,000 police personnel were deployed to contain any violence.  Unfortunately, by the end of the day, confrontations between opposing movements had degenerated into deadly violence.  Accounts vary as to who started, but in the end, the excesses of a few thousands triggered massive and often uncontrolled popular reactions.  Police attempts at mob control often became desperate efforts to save their own lives, and live ammunition was used.

In all, there were 120 deaths and some 2,000 casualties that day.  Brasilia declared a national state of emergency and a 9pm curfew.  September 21st came, and with it, a new future.

Summer reading list

Enjoying the sun at the beach?  Waiting to board your delayed flight?  Just soaking up a late afternoon, refreshed by a light breeze?  Here is a short reading list:

Non fiction

The Smartest Kids in the World: And how They Got That Way, by Amanda Ripley.  Best book on education; how three countries improved their educational system and how the US could learn from their experience.

The Euro Trap: On Bursting Bubbles, Budgets, and Beliefs, by Hans-Werner Sinn.  A prominent German economist looks at the history of the Euro, what went wrong and what could make it right.  Very well researched yet easy to read.

Beyond Words: What Animals Feel and Think, by Carl Safina.  Do animals feel, communicate, and even think?  A leading scientist in his field addresses questions we all have asked ourselves.  Fascinating.

The Accidental President, by Fernando Henrique Cardoso.  The autobiography of the most successful Brazilian president in decades.  Modest, humorous yet very informative.  Perhaps the best introduction to Brazil, its political history and challenges.

Fiction

The Laughing Policeman, by Maj Sjöwall and Per Wahlöö.  Best procedural crime novel by the famed 1970s husband and wife team.  Sweden has changed since then, but the story hasn’t aged.  The Fire Engine That Disappeared and Roseanna are very good too.

Black Run: A Novel, by Antonio Manzini.  For those who are tired of neurasthenic Scandinavian detectives.  Deputy Police Chief Rocco Schiavone, originally from Rome and now transferred to Aosta, is very different.  Original and funny.

Epistolario de Un Joven Pobre, by Klim (aka Lucas Caballero Calderon).  For years, Klim delighted readers with his column in El Espectador in Colombia.  Switzerland was never funnier.  Peerless, in a league of his own.  Read Memorias de un Amnésico too, as both volumes are very thin.

Sexe, drogue et natation: Un nageur brise l’omerta, by Amaury Leveaux.  A short autobiography by one of the best French swimmers.  Sincere even when not always truthful, interesting and entertaining.  For swimming fanatics.

 

“Why can’t Greece be more like us?”

Why can't a woman be more like a man?
Men are so honest, so thoroughly square;
Eternally noble, historically fair;
Who, when you win, will always give your back a pat.
Why can't a woman be like that?...

Henry:
Well, why can't a woman be like us?[1]

So the first steps in the third bail out of Greece were taken last weekend.  The terms of this new deal are hard and grating on the Greeks, but the perspective of lending up to €90 billion to a country which has caused private creditors to lose €105 billion in 2012, and which will likely need tens of billions of debt forgiveness from eurozone members should also be grating on European taxpayers.

Above all, there is little trust that, this time around, Greece will change its economic model to fit in the eurozone, relying instead on the reluctance of other members to pull the plug. The Greeks already went through a lot of pain, yet they have nothing to show for it.  PM Tsipras declared that he didn’t believe in the reforms which were demanded of Greece. 

Chancellor Merkel could be forgiven if asked, “Why can’t Greece be more like us?”

Contrary to most commentaries, the main problem of Greece is not the excessive burden of its public debt but its lack of economic competitiveness.  As explained in a previous post, its debts mature over 30 years, interest rate thereon is very low and payment thereof is partly deferred; that is not much of a burden.  Besides, Greece has had a primary budget deficit, that is a deficit before taking into account the payment of interest on its debts.

This time around, the euro safety net has grown so tenuous that either Greece accepts to make big changes now, or it is forced to leave.  Even then, absent changes, it would experience a painful drop in living standards.

The needed changes are huge, the government is ideologically opposed to them, the Greek population is no more enthusiastic, and time is short.  Yet Greece could find examples of small countries within the eurozone which successfully reformed their economies, and did so with far less outside financial assistance and in a relatively short period of time. 

I am talking of the Baltic States: Estonia, Latvia and Lithuania.  Having won their independence from the USSR, these countries switched from a centrally planned soviet economic system to one open to the rest of the world.

What is remarkable however is that the bulk of the reforms took only five years (1992-1997)!

The essential policies that allowed the “Baltic Miracle”, with some variation in emphasis and timing, can be summarized as follows:

·        Anchoring the currencies either via a peg[2] (Latvia, Lithuania) or a currency board[3] (Estonia), to control inflation;

·        Reforming and simplifying the tax system with a combination of lower - sometimes single flat - income tax rates for individuals and corporations[4] and of VAT taxes.  This, combined with prudent public spending helped bring budget balance close to equilibrium[5];

·        Liberalizing prices and markets, and in the case of Estonia, opening up its economy to imports by eliminating tariffs and quotas[6];

·        Privatizating state enterprises to reduce the overwhelming size of inefficient public sectors, make the transition to free markets difficult to reverse, and bring fresh capital into the economy.  In Estonia, privatization was carried out via international tenders to choose a core/majority investor for a given company and then via the voucher system to attract minority shareholders.  Lithuania used the voucher system.  On average, over the 1993-1997 period, annual government revenues from privatizations averaged of 3.4% of GDP.

·        Reforming the pension systems, between 2001 and 2004 with a combination of (1) a solidarity scheme based on Social Security contributions, (2) mandatory personal funded retirement accounts, and (3) discretionary personal retirements accounts.

Critics will point out that the Baltic States’ economies shrunk more that the rest of Europe’s in 2009.  They did.  Clearly they had allowed bubbles to grow, and they were constrained by their strict monetary systems[7].  But that doesn’t take anything away from the remarkable and successful efforts undertaken in the 1990s, before some complacency crept in.

Furthermore, one should note that the Baltics also responded positively to the 2009 crisis by pushing forward deeper reforms in their pension systems and keeping a lid on their budgets. 

By 2014, Estonia, Latvia and Lithuania’s budget balances were +0.6%, -1.4% and -0.7% respectively.  This compares favorably with France (-4%), Greece (-3.5%), Italy (-3%), Portugal (-4.5%) and Spain (-5.8%) for example[8].

Today, the Baltics enjoy faster economic growth, far lower debt levels and healthier employment than Greece.

In conclusion, small democratic countries can and indeed have made profound reforms in their economies, with great success.  The key ingredients were:

1.     Facing an even greater danger (Russia for the Baltics, implosion for Greece?),

2.     Having the support of their population,
3.     Ensuring that their governments and technocrats believed in free-markets,
4.     Applying shock therapy and speed.

Greece has #1.  It lacks #2 and #3, but it is its choice whether to change or not.  Smaller, worse off European countries did.  And in Athens, economic advisers from  Tallinn will be more welcome than those from Frankfurt.

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[1]   My Fair Lady – An Hymn to Him.

[2]  Latvia pegged its currency to the SDR while Lithuania pegged his to the US dollar.

[3]  Here the anchor was the German Deutsche Mark.

[4]  In 2000 the Estonian system was modified to tax corporations only on their distributed profits (as Chile did in the 1980s).  Lithuania adopted an income tax abatement on reinvested corporate profits.

[5]  Except for the period 2010-2012 where the deficit grew to around 9%.  However the same policies greatly helped bring the budget deficits to around zero in 2014.

[6]  In subsequent years, Estonia negotiated bilateral agreements and joined the EU which watered down this policy a bit.

[7]  Estonia joined the eurozone in 2011, Latvia in 2014 and Lithuania in 2015.

[8]  Source: Eurostat.