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This talk explores the political economy of Latvia's economic development, focusing on the twin roles of the natural resource curse and ethnic fragmentation. It examines the impact of accession to the EU, the challenges of resource-rich economies, and the implications of ethnic divisions.
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The Political Economy of Latvia’s Economic Development: The Twin Roles of the Natural Resource Curse and Ethnic Fragmentation Vyacheslav Dombrovsky May 24, 2011
Plan of the talk Latvia 20 years ago and today The political economy of development Application #1: Accession to the EU Application #2: The natural resource curse Application #3: Ethnic fragmentation
Latvia 20 years ago 1990-1993: Latvia’s GDP fell by half 1992: inflation 958 % per annum 1990-2004: about one government per year on average
Latvia Today A market economy A parliamentary republic based on political competition Member of NATO Member of the European Union Member of the World Trade Organization
What’s really interesting: Latvia vs Estonia Very similar starting positions (except Finland?) Divergence in GDP growth that is already substantial and growing Estonia has more industry (28.7% of GDP), than Latvia (20.6%) Estonia’s Summary Innovation Index is above European average, Latvia’s is first from the bottom Estonia is less corrupt (26th place in the world), than Latvia (59th), based on Transparency International Estonia is home to Kazaa, Skype, SMS parking, internet voting, etc. Estonia handled the crisis differently, and now has the euro
The questions and the theoretical framework What explains Latvia’s performance vs. ex-Soviet republics? Latvia vs. Estonia? These are the big questions of development, we need to invoke some theories. One is the institutional view: rule of law is what matters, but there is a commitment problem; societies create institutions as a cobwebs of checks and balances to ensure protection of property rights. Another is the theory of active, meddling state that must tackle a variety of country-specific market failures (e.g. Rodrik, 2006).
Application #1: Latvia vs fSU Latvia implemented the standard ‘Washington Consensus’ + full transposition of the European institutional matrix (aquis communaire) That doubtlessly hurt many domestic (special) interests Where did the ‘political will’ come from? My guess is that the ‘Russian card’ has been crucial (as in Georgia more recently?)
App #2: The Natural Resource Curse The rule of law is crucial to the economic development In nascent polities, however, economic power means political power, and vice versa – i.e. limited access orders (North, Wallis, Weingast, 2006) Substantial literature has established Natural resources tend to be negatively correlated with economic growth (e.g. Sala-i-Martin, 1997) The quality of institutions is decisive whether natural resources are a blessing or a curse (e.g. Cabrales and Hauk, 2011) Discovery of natural resources tend to make states less democratic (e.g. Tsui, 2011)
NATURAL RESOURCE OWNERSHIP POLITICAL POWER
NATURAL RESOURCE OWNERSHIP POLITICAL POWER EXCESS PROFITS Switzerland, etc.
NATURAL RESOURCE OWNERSHIP POLITICAL POWER Enhancing returns EXCESS PROFITS FIRM 1 FIRM 2 Investments Switzerland, etc. … FIRM N
NATURAL RESOURCE OWNERSHIP POLITICAL POWER Enhancing returns EXCESS PROFITS FIRM 1 FIRM 2 Investments Switzerland, etc. … FIRM N RULE OF THE LAW
NATURAL RESOURCE OWNERSHIP POLITICAL POWER Enhancing returns EXCESS PROFITS FIRM 1 FIRM 2 Investments Switzerland, etc. … FIRM N RULE OF THE LAW PRIVATE SECTOR DEVELOPMENT FOREIGN DIRECT INVESTMENT ECONOMIC GROWTH
Latvia’s Natural Resource Curse is… A combination of geographic position and incompatibility of railroad tracks between fSU and Europe – the port of Ventspils In 1990s, Mr. Lembergs (then mayor of Ventspils), with some enterprise directors, ‘privatized’ the port largely to themselves He then took control of some media (e.g. NRA) A political party (e.g. Union of Greens and Farmers) And sought to use his influence to gain ownership of other assets (e.g. Latvian Shipping Company)
Estonia seems to have no ‘oligarchs’ Somehow, there are no clearly identifiable ‘oligarchs’ in Estonia No clearly politically controlled media or political parties One theory is that the absence of oligarchs is due to the choice of privatization methods, i.e. selling to foreigners This may have contributed to better protection of property rights
App #2: Ethnic divisions Also seems to be a blessing for some countries (U.S.?), and a curse for others (e.g. Africa) Both Latvia and Estonia have large ethnic Russian-speaking minorities However, ethnic voting seems to be much stronger in Estonia, rather than in Latvia To date, a ‘Russian’ party has never been admitted to a ruling coalition in Latvia
Decision making in groups MORE DEMOCRATIC Dictatorship Simple majority Unanimity 1 (N/2)+1 N MORE EFFICIENT
Ethnic fragmentation: implications One implication is that the decision rule, effectively, is somewhere between qualified majority and unanimity. Unanimous decision making in the parliament (liberum veto) likely crippled Poland’s development in 17th-18th centuries. Ethnic fragmentation may make it difficult to create good governance, i.e. Rodrik’s ‘meddling’ state
Ethnic fragmentation: implications Another implication is that ethnic fragmentation may have helped oligarchs to exercise influence, thus, undermining the rule of law. For oligarchs, political influence implies substantial campaign finance investment to woo ‘impressionable’ voters. The return on investment depends on the chances to get into the ruling coalition. Ethnic fragmentation increased the chances of oligarchs’ pocket parties having the ‘golden share’.
