The IMF blog has compared recently the evolution of crisis in the Baltic, Central Europe, and East Asia (1997).

Notably, they remind us that crisis in the Baltics has proved by now by far worse than than it was in East Asia 10 yrs ago.

Also, real effective exchange rates of the Baltic currencies have appreciated while we keep insisting for “internal devaluation”…

best,
Marek

The IMF blog has compared recently the evolution of crisis in the Baltic, Central Europe, and East Asia (1997).

Notably, they remind us that crisis in the Baltics has proved by now by far worse than than it was in East Asia 10 yrs ago.

Also, real effective exchange rates of the Baltic currencies have appreciated while we keep insisting for “internal devaluation”…

best,
Marek

http://www.foreignpolicy.com/articles/2009/06/1...

“Portraying the Baltic states in their current mess requires more than words and numbers. Only an old-fashioned chart, with a sea monster, a whirlpool, or perhaps a skull and crossbones, would begin to do justice to the plight of what were until recently the shining success stories of the ex-communist world. Eating a meal in a deserted restaurant in one of the fine old capital cities of Tallinn, Riga, or Vilnius gives a sense of the collapse. So does the silence of the half-finished construction sites, the rock-bottom rates in the glitzy hotels that shot up during the boom years, and the fall of a Latvian government under the weight of the current troubles. The Baltic states today are prime candidates to be the new basket cases of Europe, with their double-digit economic declines, beleaguered governments, and shriveling state spending.”

All the latter has been done and it looks that will be continually done even without devaluation.

Now it looks that it all comes down to what is the point of devaluation and what is the balance between good and bad consequences it brings.

The problem with such a freeze is not that it's a freeze rather than, as Madis also implied, that it is a *uniform* freeze, it doesn't allow to pay more for, to borrow your own phrase, competent senior management – which is not necessarily the same people as entrepreneurs, mind you.

And it is the same point about the devaluation – it would be a uniform administrative measure that wouldn't allow any differentiation. I am not saying that it should be off the table when it comes to discussing different policy options, but I too would consider it only after it is very clear that the economy doesn't adjust “organically”, or that the adjustment is too slow for it to have an effect.

I really don't see where is the notion that of “doing nothing” (that's the proposed package of measures is supposedly better than) coming from. I am a shareholder, if currently not necessarily an entrepreneur, in a company that employs a lot of people; many of my friends and acquaintances run businesses both in Estonia and elsewhere – and I really don't see that these people are “doing nothing” and simply hiding their heads in the sand and hoping that sun will be out again next month.

But, with a possible minor exception concerning the devaluation, it seems to me that in 2009 Estonia most of this discussion belongs into the realm of social science fiction (i.e. “not gonna happen”) anyway – be it for better or worse.

Very briefly once again, the combination of salary freeze and modest deflation is, among other things, designed to make the financial development of Estonia more certain, within and without, and hence stop a further slide downwards and even re-enable investment; after all, the Kroon is grossly overvalued. Somewhat risky? Yes. More so than doing nothing? No.

I know that wanting to cut public sector salaries is a knee-jerk reaction to almost anything in Estonia, including bad weather, but under the current circumstances, when one needs a particularly competent (senior) civil service, that’s particularly misguided. My concern is rather to retain and improve high administrative capacity, because without it, the current crisis cannot be overcome. If the private sector is anyway self-regulating its salaries on an ideal basis (I am not sure why it would; that requires faith in certain automatisms the crisis has shown do not exist), then there should be no problem with a freeze either. Genuine entrepreneurs are not salaried anyway, and already the original definitions of entrepreneur entails that he is not just motivated by money, often not even primarily.

Once again, sure the housing program is somewhat expensive, but any alternative would be more so, and it is ‘unfair’ only to the extent that the people who will suffer most from deflation and salary freeze will not be completely congruent with those who have taken too high mortgages (and yes, I agree that they shouldn’t have, but it was the mood of the times and they clearly were encouraged, though certainly not by myself). I admit that I am a bit queasy about that, but much less so if I consider the alternatives.

Finally, the entire proposal is precisely designed to enable Estonia to stay solvent (even) in the mid-term. To try doing so only by cutting expenses right away is the worst of all scenarios, as it will lead to disastrous side effects right away and later on as well. As a possibility of the very last resort and on a temporal basis, if really done across the board excepting the ‘net of decency’, it’s however exactly what I propose in the last point.

Having said that, I really don't see what would be the point of trying to limit salaries or the growth of salaries in the private sector by some sort of a government decision (either by prohibitive taxation or otherwise). There is certainly reason to be concerned that the salaries of government employees are not flexible enough and will not be cut sufficiently even if necessary. Private companies at the same time will never pay their staff more than they can and excessive pay increases in such difficult times are simply out of the question. If there is a particularly smart entrepreneur that can find a niche to exploit in the current economy and is able to make good money, I don't see any reason why he should not be allowed to pay the employees as much as he feels necessary. As long as there is a crisis, the risk of generating whatever inflationary pressures by such pay increases is zero, as the growth in salaries in a relatively small number of companies is most likely more than offset by increasing unemployment and/or declining incomes for everyone else that has a job.

As for the rest – I still don't see what could be the real advantages of devaluation over a fairly quick cut in nominal costs/incomes. One can argue that the first is just stronger medicine that achieves the same goal of improved competitiveness more quickly, but it also comes with some higher risks and can create more instability. I also agree with jamie's comment that it is not really obvious how much would the competitiveness of the Estonian economy be improved after a devaluation. But we need to cut costs simply to remain solvent over a medium term..

Point #3 is certainly interesting, but the main problem here is clearly the cost of such a housing program and I believe it might raise some serious questions about fairness depending on the relative size of the effective subsidy. But I agree that the government probably does at some point need to step in and provide some more help related to housing, if people start defaulting on their mortgages in large numbers.

On demographics, even if it were a personal issue, as you make very clear in your last comment, parental compensation is not an economic or financial priority but a policy one. This is not what my proposal is about; it’s about stopping the bleeding. The same goes for your views on Estonia having in the end to export itself out of the crisis – I basically agree with you there (and would even say that if there is a clear example for policy failure regarding the Estonian economy, this aspect is it), but it’s not my topic right now but rather the next step – although the investment you mention clearly hinges on previous devaluation and most of all on some certainty about the future. There is none now, as you say, and that is the problem; no relevant entrepreneurship without financing, even in new and sensible fields. (Low wages alone don’t help at all in the Estonian case; they are always lower somewhere else.) Again, my main point is that quite moderate devaluation (which I doubt would necessarily be not be welcomed by the institutions you mention, even if unilaterally declared) and – it needs both – salary freeze, in synergy, are possible and will indeed have the desired effect of stopping the slide downwards if implemented right now. As regards the housing issue, real estate price correction would in essence mean eviction for too many people, so in some sense delaying it is precisely what the respective measure tries to accomplish, and the State can do that – and for less money than the alternative would cost in the end. Here, however, I would agree with you that the how and when is of crucial importance, and that there should be as much market n this process as possible.

And finally, I think that it would precisely be following this plan what would bring Estonia closer to the Euro (although, as you say, as I very much agree with, and as we can see right now, membership in the Eurozone will not solve all, I would say not even most, problems of the Estonian economy – this is just wishful thinking). Sitting there and doing nothing for the incredibly long time of 19 months you suggest, and during which we do not know what might happen in the Eurozone, on the other hand, would surely get the country farther away from the Euro than ever.

With policies there is always the issue of necessity vs possibility and it is not easy to distinguish clever advice from wishful thinking, subject to political realities.

1. The main obstacle in devaluation seems to be not the limited secrecy or Baltic brotherhood but some agreements with ECB, IMF and possibly also some Swedish commercial banks. The whole set-up between those has to be a little bit different. Estonia, of course can do it their own stubborn way as we did in 1992 with Kroon, but times have changed. We are a member of EU.

The big question is – does devaluation help? Obviously there is pressure to the monetary setup but the main argument is related to price levels, in particular labor cost levels that devaluation would help to sort out. Does this increase export demand? My subjective impression from the exporting companies of Estonia is that the problem is not price levels. The problem is that there just is NO demand for the particular goods and services we are into. It is very probable that the outcome will be very similar with or wo devaluation. Investors are hesitated now (in fear of devaluation) and they will be (in fear of the aftermath).

So the question is not devaluation->prices down->export demand up but investment in + entrepreneurship->new goods and services->exports. Labor cost is still 3-5 times lower than developed countries.

2. Salary deflation and freezing. Point taken but it is several times more simple to do it without/before devaluation than after it. Increased and/or progressive income tax does not seem to be bad at all.

3. In the exact wording of p3 “government takes over all housing”, I don't think it will work. Government should come in say 6 months after the collection/collateral liquidation agents have not been able to do their jobs and renting out should be under market terms. Nothing should be automatic. Otherwise we shift real estate price correction to the unknown future.

Clearly a safety net should be provided, but with devaluation, I guess, the social cost lies in lower income quantiles with higher monetary volumes than the borrowing strata who tend to be more socially mobile (enter entrepreneurship, cross subsidize inside families or emigrate).

All in all, the question is, how wrong is the hypothesis that the salvation is Euro ASAP for which we have to starve another 19 months or so. Even in a heavily (hopefully not spirally) deflated economy but with Euro we are possibly better off than when being devalued, still with an untrusted currency, no or little export demand and foreign investments. I don't preach a religion here, I am just confused.

As to the anonymity, please accept my apologies. But lets distinguish anonymity from lack of identity and misuse of the fact of not being connected to a real life person.