Krugman Baltic Bashing 2.0

It would seem that after a tweeter row with Estonian President, Krugman hasn’t had enough fun senselessly putting down Baltic States. In his new blog post, Krugman turns against Latvia in his anti-austerity tirades. While he initially criticized pro-austerity commentators for ‘lionizing’ Estonia as a standard bearer for successful austerity policies, he know seems to believe that Latvia was the lionized example for austerity. Leaving aside Krugman’s inability to decide which austerity policy orientated government is easiest to criticize let’s take a closer look at his accusations.

Krugman quotes Eurostat numbers for real GDP levels, showing that Latvia has had the deepest contraction of the Baltic States, Ireland and Iceland, also showing Latvia having the smallest recovery of pre-crisis level GDP. A few notes must be added to his demonstration. Firstly, both Ireland and Iceland received EU/IMF bailouts to stabilize GDP and also e currency’s value in Iceland’s case, none of the Baltic States received such external inflow of capital to buttress government spending.

Furthermore, both Latvia and Lithuania racked in relatively big budget deficits during the crisis in comparison to Estonia. Why attack the Baltics states least keen on austerity for their austerity policies, why stop talking about Estonia, the real standard bearer for fiscal hawkishness. Again leaving aside this Krugmanesque inconsistency let us look at Baltic States in Comparison to other Euro economies many of which signed on to the G20 pledge for stimulus spending during the crisis.

 Here, seasonably and daily adjusted quarterly per capita real GDP numbers from Eurostat (same source as P. Krugman) tell a different story. This chart shows that while the recession was deep in the Baltic States the recovery was strong, leading all Baltic Nations to have caught to their pre crisis levels (per capita of course) and to the EU as a whole. While Germany, arguably the strongest economy in Europe is above its pre crisis level, there should be no denying that the Ba;tic States chose to bite the bullet early but recover quickly. One wonders if so much can be said for the PIIGS. So without a European bailout Latvia and its Baltic colleagues don’t seem to be doing all that bad. As has been argued before Krugman fails to take into consideration decline population into his thinking when using national GDP numbers. A guess can also be ventured that depending on what time series he chooses to use (constant vs market prices) numbers may vary substantially when evaluating economic performance, no nuancing words from him on that subject.

In any case to better understand recovery dynamics between nations attention must be paid to the depth of contraction as well as the magnitude of recovery. The above chart shows the ratio of real per capita GDP recovery to real per capita GDP contraction. With an EU average a smudge over 1, one can see that the strength of the recovery has been stronger in the Baltic States than in most of Europe. Only the Norther nations of Germany, Austria, Finland, Luxembourg and a few others have been stronger.

So how to explain the difference between austerity in the south and in the Baltic region. The most obvious answer is that states that don’t rely heavily on Government spending during the good times stand to loose less from tight fiscal policy in the bad times. Ireland and Spain do of course buck that trend but the conjecture of their recessions were different in nature than in most of Europe. 

Again it must be repeated that much of the superficial weakness in the Baltic States must be attributed to Europe in general and the rest of the sluggish growth in the World. As export dependent nations they should not be expected to outgrow other regions when there is only week growth in consumption outside their borders. There is however much hope for the Baltic tigers future prospects. As export dependent nations who have refused to transition to internal consumption driven economies, they remain leveraged to an eventual uptick in World growth and are less dependent on foreign capital flows to pay for their growth.

Small open economies the World over should learn from the Baltic experiment that is unfolding and look forward to the next chapter that will surely put stubbornly uncompetitive economies to shame. Let’s hope Krugman can remember his own writings when that happens, so that the rest of us can enjoy his efforts at keeping a straight face when attempting to convince us he was right all along.

Shameful Estonia Bashing

So Krugman likes to put graphs on his blog every now and then to try and dispel the notion that he is a mortal commentator, and to remind us underlings that he is a Nobel Laureate. In this post Krugman shows that Real GDP in Estonia dropped by 20% since the peak. He challenges the assertion that Estonia is a model for austerity and unwittingly pisses off everybody in Estonia.

While it’s nice to say that real GDP has fallen by 20% there are a few sticky points one looks at when trying to parcel together a nuanced and representative view of a nations economic well being. First of all comparing Estonia to any other industrialized nation is very hard. As a small open economy based on trade, the country’s GDP is naturally leveraged to the rest of the World, hence when Estonia’s exports are off it’s fair to say it’s probably Europe’s fault. If the Eurozone decides to avert a World depression Estonia will bounce back strong, not like the squeamish recoveries the Italians, Spaniards and French are expecting.

Second we have to ask ourselves how relevant it is to look at a peak to trough GDP levels. In 2008 Estonia had to be at least 5% above potential GDP if not more, one can imagine that today Estonia is only a few %’s below, what’s the big fuss about then?

Now we also need to remember that with a population dropping by just under 1% a year, that adds about 1% a year of real GDP per Capita, which is a sensibly more important figure when analyzing peoples’ plight. Furthermore, when converted to Purchasing Power Parity  GDP per capita in Estonia doesn’t look the same at all. Here it would seem after 2 years of foreign generated crisis, aggregate consumption is only down by 10%, not too shabby.

In any case when a country of 1.3 Million people is faced with serious foreign headwinds, internal demand cannot be deep enough, even when backed by government, to successfully grow an economy. Austerity is the solution, without a culture of austerity Estonia would look like Cyprus right about now, on its knees and begging. But no, Estonia stands tall with its annualized 40% growth in industrial production in the months following the recession, hands not extended, but rather working hard.

Were the government to have decided to stimulate the economy with massive stimulus (which incidentally past austerity now affords them) the rebalancing of the economy from export secteurs to internal consumption would have crippled its growth profile in the medium term. As noted above Estonia current economic growth is leveraged to external demand, shifting that to internal demand would require spending on training, temporary adjustment spending and the like to great cost. Sure GDP would go up temporarily as half the population goes from manufacturing exports or exporting services to building variously unnecessary infrastructure. Then, when World GDP starts growing (hopefully one day) Estonia would not then be able to benefit from external demand. The opportunity cost of government stimulated internal demand can be huge in the long run in terms of lost exports.

To recap: Krugman is advocating de-leveraging the economy from exports by financially leveraging it to sovereign debt. Let’s ask the Greeks how that worked out for them shall we? Estonia has had it though over the last century or so, what with communism and all, why doesn’t Krugman go pick on somebody who deserves it for once.