LITHUANIAN QUARTERLY JOURNAL OF ARTS AND SCIENCES
Volume 41, No.1 - Spring 1995
Editor of this issue: Antanas Klimas, University of Rochester
Copyright © 1995 LITUANUS Foundation, Inc.
THE POLITICS OF MACROECONOMIC STABILIZATION IN THE BALTIC STATES1
Romas Tauras Viesulas
Harvard University Russian Research Center
One conclusion of recent theorizing on the nature of economic transitions in Eastern Europe might be that economists are better at telling policy-makers what to do than at explaining why policy-makers do what they do. Much of the New Political Economy in its theorizing, makes implicit assumptions about the realm of political decision making. Many articles on the politics of stabilization feature throwaway, often apologetic lines about the "political motives" that underlie the observed divergences of practice from prescription.2 The experience of developing countries in the eighties and of ongoing reforms in post-socialist states have made it clear that devising successful policies requires an understanding of the forces that govern policy-making. It is the aim of this paper to make explicit some of the assumptions made in this theoretical literature, with an eye to elucidating the relative success of the Baltic states, and among them, Latvia and Estonia, in macroeconomic stabilization. What is it that gets elites, political or technocratic, to commit to non-inflationary finance?
The Baltic republics have adopted their own currencies, made them convertible and, through tight monetary and fiscal policy, brought down their inflation rates to single-digit monthly rates in 1993. Similar success has eluded Russia, Belarus and the Ukraine. Following a near tripling of consumer prices as a result of the decontrol of most of them in January 1992, prices in Russia, for example, continued to rise at double-digit monthly rates, in the range of 15 to 25%, in most months thereafter. The other states have fared similarly, but in the latter months of 1993, Ukraine experienced monthly inflation exceeding 50%, the threshold of hyperinflation.3
Throughout Eastern Europe and the former USSR, the longer high inflation has prevailed and the more hesitant the change in the economic system, the larger the total fall in GDP has been, although certain allowances must be made for large external shocks in the case of Bulgaria, Estonia and Latvia.4 Romania stands out as a country with an initially limited output decline, but this decline has continued and become substantial. Meanwhile, Romania's level of inflation has remained at a steady 200% per annum. By the same token, an energetic stabilization and systemic change appear to contribute to an earlier turning point, as in Poland, the Czech republic, and Estonia, while Latvia, Slovenia and Hungary appear to be close to economic recovery. In Ukraine, Belarus and Russia, by contrast, the fall is just gaining pace.
Why are macroeconomic stabilization reforms that eventually benefit most of society adopted in, say, Estonia but resisted in the Ukraine? When these reforms are eventually adopted, what explains the delay?
Several proponents of the New Political Economy have proposed formal models to answer these questions of both political and economic behavior. Political agents and groups in these models are assumed to be rational and forward-looking, with expectations that are consistent with the properties of the underlying model. Thus, behavioral rules are derived from solving optimization problems with well-defined objective functions, and the political-economic outcome is derived as a Nash equilibrium in which each individual or group is doing the best it can given the actions of others. The challenge in these models is to explain how "inefficient" outcomes can be compatible with rational and non-myopic behavior at the individual level, without resorting to far-fetched or inscrutable assumptions about the political-economic environment.5
A key feature of policy reform is that the identity of many of the gainers from reform cannot be determined ex ante. Fernandez and Rodrik 6 show how this feature alone can explain some of the puzzles mentioned at the outset. In particular, they show that uncertainty about the identity of gainers and losers can block the adoption of an efficiency-enhancing reform. The presence of individual-specific un-certainty can distort aggregate preferences, so that many re-forms that would have been popular ex post are passed up ex ante.
This is particularly true of a transition scenario. In the context of comprehensive economic reform. Bates and Krueger 7 argue, it is difficult for particular groups to even calculate where their interests lie. Even economists who advocate changes in macroeconomic policies are unable to determine their precise impact on specific interests. They lack the models that would enable them to trace the micro-level impact of changes in macro-variables upon the economic fortunes of particular groups: workers in a given industry, firms using outmoded technologies, people living in different regions or of particular income groups, etc. It is therefore to be expected that persons subject to economic policy reforms would themselves remain uncertain as to how their interests would be affected by policy changes. In decisions made anticipating one-shot changes in economic policy, a big bang or leap to the market, models of the economy will obviously play a role in the formation of expectations and ideology plays a large role in shaping notions of economic interest as a result.
Ideological struggles can outweigh competition among organized interests as a determinant of policy change, and wide scope is thus left for rhetoric and persuasion, since in such situations, advocates of particular economic theories or ideological conceptions of how economics work can acquire influence.8 Extending these findings to the Baltic republics we find that neo-liberal theories have had a powerful impact upon the choices of governments in Latvia and Estonia, and to a lesser extent in Lithuania, where competing beliefs about the relationship between devaluation, inflation and the distribution of income affected the desirability of markets. Under conditions of uncertainty, and particularly where interest articulation mechanisms are in their formative stages, people's beliefs of where their economic interests lie may be created and organized by political activists; rather than shaping events, notions of self interest are instead themselves shaped and formed. In pursuing their economic interest, people act in response to ideology. Why, in particular instances, then, are they won over by what Chernomyrdin described as "free market romanticism"?
Elite Politics in the Post-Soviet World
Shleifer and Vishny, among others, assume that policy makers behave strategically, taking into account their own political and ideological objectives when making decisions about taxation, expenditure and money expansion.9 This approach departs significantly from the traditional view that considers policy actions as either completely exogenous or as being undertaken by a "benevolent dictator" who tries to maximize the present value of society's well-being. In fact, the most important implication of this strategic approach is that policy becomes an endogenous variable that depends on economic, political and institutional features of the country. Extending the conclusions of Bates and Krueger to post-Soviet cases, one might claim that economic policy reform emerges as a by-product of political struggles at the elite level. The key question thus becomes, what shapes the behavior of politicians? What determines the programs they will advocate in the political struggle?
Political competition in the Baltic republics still bears the ideological stamp of the independence drive. In addition to giving the independence movements their tenor and intensity, historical attitudes to Sovietization and its legacy have also largely determined the dimensions of political competition. Political identities, and not interest configuration and representation, this paper will argue, are the primary structuring factor in post-Soviet Baltic politics. The political vision and economic theories of the new elites in the Baltic shaped the policy commitment of politicians and transformed debates about economic policy into debates about political ideology, centering on the identity of those in power.
Due in large part to the very high status given to cultural and spiritual concerns as safeguards of national identity under Soviet rule, the transition to democracy has evolved a political debate in which there is a predominant cultural/historical cleavage. Fifty years of Soviet rule created irreducible political identities among both the former nomenklatura and newly politicized elites. Representing antithetical policy clusters, religious nationalism and state-socialism have been seen as unequivocally in opposition. Finer differences of opinion over economic and social questions were collapsed into a unidimensional cleavage raised by the national independence movement.
Parties and Politicians in the New Political landscape10
As in other transitional states, party competition in the Baltics takes place at a remove from the social structures of mass politics which characterize the bases of party structures in the West. Since political alternatives have barely solidified into social coalitions or stable interests, this essay focuses on the interaction of political elites rather than between politicians and voters. Baltic parties compete not along social cleavages, but intra-elite divisions. In the Baltics irreducible political identities and non-negotiable demands have been the very currency of political debate, which has taken place not at the level of interest groups still in their formative stages, but among individual political actors. In the place of parties, behind a facade of multipartism, we find the interplay of key political personalities acting, at best, on behalf of ad hoc coalitions of narrow elite constituencies within parliament. This is all the more true of the Latvian and Estonian scenarios, where half of the population is excluded from the political process.
Nominally, the Baltic states have multiparty democratic systems expressing the common will and interests of their people. As yet, though, parties have operated ad hoc in imitation of Western systems, undisciplined, without political substantiation, and lacking the crucial representational link between parties and people. Party formation has occurred not in a society of cross-cutting cleavages but in the sociopolitical vacuum created by the collapse of central Communist authority. The party structure was thus imposed from the "top" on an unprimed electorate by parliamentary elites.11 Yet the elites themselves were not formed according to any strict partisan logic, as they were in Western Europe. The 1990 elections which inaugurated the first post-Soviet elites were votes of confidence in the ancien regime, on the question of independence. With the principal issue of elections the restoration of independence, individual political platforms served to limit the accountability of deputies to the electorate, unbound as they were by party discipline. This, in turn, encouraged personalized politics.12
Without effective channels for the representation of popular interests, party politics continues to take place abstracted form a society as yet insufficiently differentiated to make informed political and economic decisions. According to public opinion polls conducted in the region, "distinction between existing political parties functioned mostly on the basis of the images of their leaders. The ability of the public to associate different viewpoints and policy positions to the various parties has consequently been very weak."13
The New Political Elites and Dimensions of Political Competition14
Today's new political elites include both the players and pawns of yesterday's communist elite politics:
1. Communist Loyalists, largely Russians (and Poles),
2. Pragmatic managerial elite - a heterogenous cluster of old-line industrial and agricultural executives,
3. Reform-minded Party members, the core of which in Lithuania supported the breakaway LCP and some of which later joined the LDLP,
4. Non-Party professionals and intellectuals, farmers and workers,
5. Historically discriminated persons, former religious and political dissidents, detainees and exiles.
In addition to the "old" pre-transition actors, (groups 1, 2, and 3), the greater part of the new Baltic elites were made up of hitherto passive professionals and intellectuals, the backbone of Sąjūdis and the Popular Fronts (4), as well as a vociferous extremist fringe of former dissidents (5). Well-known writers, academic intellectuals, and non-conformist technocrats perceived themselves as their country's morally uncompromised "natural leader". Since the reestablishment of independence, the notion of "morally compromised" has been employed by the Right as a politically exclusionary device against "closet Communists".
It is accurate to describe Baltic politics as exhibiting a central axis of competition revolving around evaluations of the Soviet past. The process of Sovietization in the Baltics involved russification, industrialization and the imposition of a secular ideology on an agricultural societies which were ethnically homogeneous and, in the case of Lithuania, fervently Catholic.15 As a result, "communism" carries with it an array of issue associations ethnic, socio-economic, political and religious which have their counterpoint in the ideological and policy concerns of the new political class that had formerly been excluded from power.
One can therefore assume one "nation versus communism" dimension, an inherited cultural historical cleavage, while acknowledging that it consists of multiple orderings - depending on whether the criterion is socio-economic, constitutional, or religious. These orderings might be classified as follows:
free market/controlled market
Because of international exigencies, certain of these issue orderings have been in suspended animation, frozen by the question of national independence into a single cleavage dimension. As the imperatives of the independence movement waned, these finer criteria have emerged as separate dimensions, changing in salience as political circumstances change. The Baltics' role as the vanguard in secession from the USSR turned nation-building into a valence issue for elite competition.
All three of the Baltic republics exhibit the collapsed axis, though it manifests itself differently in each. In Latvia and Estonia, it identifies right action with neo-liberal prescription, because that is seen as non-Soviet, non-Russian.16 Lennart Meri, president of Estonia, summed up this attitude: "the kroon is not a piece of paper, the kroon is the flag of Estonian economic and political independence."17 Conversations with other Baits confirm his sentiment, much of which seems to stem from memories of the much idealized 1918-1940 interlude of independent statehood and free-market economics.18 Moreover, market reform becomes the only viable option, given the permeation of industry and other lobbies by Russian ex-nomenklatura, which had to be resisted. In effect, in Latvia and Estonia representatives of the "old thinking" (groups 1, 2, and 3 above) were excluded from power by disenfranchising the groups supporting those old elites. They were replaced by a younger, more technocratic elite, many of whom have received training in the West.
The radicalization of Sąjūdis helped to create an ideological rift between the new and old political elites that had collaborated to make the independence drive successful. Indeed, the declaration of independence would have been impossible without the LCP split from Moscow, the first such split from the Party, acting as a buffer between Sąjūdis and the CPSU. Personal predispositions centered on the ideological difference between so-called "patriots" and "communists" have dictated rival coalitions of shifting factions with limited ideological differentiation between themselves, but large ideological distance between rival coalition blocs. It is this ideological distance, in Giovanni Sartori's phrase,19 which precluded compromise in most parliamentary debates and discussions and lent incoherence to economic reform.
The Transfer of Power: Elections of 1990,1992 and 1993
The new and old elites in Latvia and Estonia thus share far less common history than their counterparts in Lithuania ethnic Latvians and Estonians overwhelmingly comprise the new political elites, while the higher echelons of the former nomenklatura were predominantly "imported". By excluding the former communists as "Russian collaborators", the revolutions of 1990 in Estonia and Latvia seem to have been, therefore, a more complete overthrow of the ancien regime. Ethnic Estonian and Latvian politicians were able to monopolize the independence imperative in a way that was not possible in the more ethnically homogenous Lithuania. The result has been more cohesive elites, whose economic and political outlook has been bonded by their outright rejection of state-socialism, their ability to ostracize upper-level nomenklatura from the policy circuit and their enthusiastic embrace of Western neo-liberal ideology.
Sovietization in Latvia, for example, involved the importation of Russians and Soviet-born or Soviet-educated Russified Latvians to fill the leading posts in society. The latter group, known as latovichi, usually spoke no Latvian and, but for their names, were indistinguishable from Russians. Thus, embedded in the Leninist political system was an ethnic hierarchy, with Russians and Russified latovichi ruling over the indigenous Latvians, a hierarchy which was strengthened after a 1959 purge quelled an attempt to put a Latvian face on communist rule. It was followed by nearly thirty years of economic irrationality, extensive migration and Russification that many Latvians associate with the leader-ship of two latovichi, Arvids Pelse and Augusts Voss.20 Data on the nationality composition of the Latvian Communist Party, published only under Gorbachev, are telling: on 1 January 1989, well before the CPL crumbled, Latvians accounted for only 39.7% of party members and candidates.21 A portion of the Latvian total was accounted for by latovichi, thus rendering the number of home-grown Latvians even smaller. If earlier estimates of the nationality composition for previous years are accurate, the Communist Party of Latvia did not have a Latvian majority since the late 1940s, if ever.22
In the Estonian Central Committee and Politburo, too, native Estonians were in a distinct minority. Leadership cadres were drawn primarily form non-native Estonians, like first secretaries Johannes Kabin and Karl Vaino, and Russians, who favored centralization and showed little sympathy for ethnic interests.23 Thus, the pinnacle of power before perestroika remained outside the purview of native Estonians.24
The elections of 1992 and 1993 in Estonia and Latvia, respectively, changed that. Estonia, determined to rid itself of the vestiges of Soviet institutions and power structures, was the first of the Baltic states to hold parliamentary elections on 2Q September 1992. Whereas in Lithuania Sąjūdis had won an overwhelming majority in the Supreme Soviet elections of 1990, in Estonia candidates unequivocally in favor of independence affiliated to either the Popular Front of Estonia (PFE) or the Congress of Estonia or both won 49 seats as compared to the Free Estonia coalition of progressive Communists' 29 and the pro-Moscow Communists' 27.25 With the support of the free Estonia coalition, the PFE deputies persuaded the Estonian Supreme Soviet to move toward independence, and shortly after the restoration of independence Baltic lawmakers banned those parties that were loyal to Moscow. In the meantime, the transitional parliament resumed Estonia's naturalization legislation of 1938, which excluded most Russian speakers who arrived after the Soviet incorporation from acquiring automatic citizenship. As a result, the overwhelming majority of the Russian-speaking population could not participate in the June 1992 referendum on the constitution or the September 1992 parliamentary elections. In the "segregated" elections to the Riikikogu the candidates of the Pro Patria (Isamaa) coalition won 29 seats; the Secure home (Kindel Kodu) coalition 17; the PFE 15; the Moderates 12; the Estonian National Independence Party 10; the Independent Royalists and Estonian Citizen Coalition 8 each; and the Greens and Estonian Entrepreneurs' Party one apiece. The vote produced a legislature that was not only composed almost entirely of ethnic Estonians, but one in which former high-ranking Communists were a token minority. In reality, therefore, the political scene in Estonia is not as fragmented as it seems, since the Pro Patria, Moderate and ENIP deputies formed a coalition and jointly account for 53 of the 101 seats in the Riigikogu.26
In the March 1990 Supreme Soviet elections, all adult residents of Latvia could vote, including Soviet soldiers stationed in the republic. Matters were quite different on 5 June 1993, when Latvia held its first parliamentary election since regaining independence. Eligible to vote were all citizens, that is, citizens of the pre-war Latvian Republic, regardless of ethnic origin, and their descendents, including those living abroad. Because no laws on citizenship had been passed, however, most of the Russian-speaking community" some 700,000, or 34%, of adult residents could not vote.27 In effect, the Saeima, elected by the majority of voting residents in 1990, deprived a considerable part of its electors of political representation.
The outcome, as in Estonia, was a victory for new elites of the moderate Right. The leading coalition, comprised of 36 deputies of Latvia's Way and 12 from the Latvian Fanners' Union, did not command an absolute majority in the 100-seat Saeima, since the remaining six parties together account for 52 deputies: Latvia's National Independence Movement 15; Concord for Latvia 13; Equal Rights 7; For the Fatherland and Freedom coalition and the Christian Democrats 6 each; and the Democratic Center Party 5.28 Nevertheless, in July 1993 the Saeima endorsed the new government formed by Prime Minister Valdis Bikavs of Latvian Way, composed mainly of fellow Latvian Way deputies, resulting in a rather unified government.
Selection of the first republican presidents follows the same pattern. In Latvia the most popular politician at election time was Anatolijs Gorbunovs, the former chairman of the Latvian Supreme Soviet and erstwhile ideology secretary of the Latvian Communist Party. It can safely be assumed that he would now be Latvia's president if the voting had been carried out by the public rather than the parliament.29 Like Brazauskas, Gorbunovs is an astute politician with a remarkable sense of timing; never taking an extreme stand on issues, he is noted for having sought solutions that would be satisfactory to the public as a whole - not just Latvians but also Russians and other Slavs constituting nearly half of the population. Despite his personal popularity, Latvia's Way, the election coalition that sponsored him, did not nominate him for the presidency, choosing instead someone who had no association with the Soviet regime: Gunars Meierovics, the chairman of the principal organization of Latvian Exiles, the World Federation of Free Latvians. Guntis Ulmanis, the Farmer's Union candidate, won the vote. In Estonia, too, the presidency might have been won by the "republican" Supreme Soviet Chairman Arnold Ruutel if the head of state had been popularly elected; instead, Lennart Men, the candidate of the Pro Patria coalition which won the parliamentary elections, was elected.
It seems clear that the main tactical aim of the ruling coalition in Latvia and Estonia regarding the citizenship problem is to resist an expansion of the franchise until the next elections in 1995. The ruling coalitions are inevitably losing popularity due to the continued economic downturn and what has been referred to as "shocking therapy", which cannot, it is claimed, achieve adequate results in the near future and is losing supporters.30 People who could be naturalized before the elections would probably support the Accord and Equal Rights factions within parliament, bringing an end to the fragile balance of opinion in the Saeima.
Unlike Latvia and Estonia, Lithuania was not afflicted by a large number of Russified Baits unrepentant Leninists like the late Boris Pugo, who Gorbachev would turn to in 1990 as he sought to crush the Baltic independence movements, and Colonel Viktor Alksnis, a leader of the hardline Soyuz faction in the Latvian Congress of Peoples Deputies, come to mind. Longevity in office allowed the Lithuanian party chief, Antanas Sniečkus (1940-1974) to build his own personal machine and to manipulate strong nationalist sentiments to his advantage. Sniečkus' successors were two cautious and unimaginative bureaucrats, Petras Griškevičius and Ringaudas Songaila, but it was his legacy that Brazauskas claimed as his inheritance after October 1988, when he was elected the Lithuanian Communist Party's first secretary, asserting that the Lithuanian Communists saved the language, education, cultural artifacts and churches from Sovietization. He was at the helm when the party broke with the CPSU.31
The nationalist-populist right-wing forces led by Vytautas Landsbergis, who had expected a complete reallocation of power and wealth among the ruling parties, are dissatisfied with their losing position and are pushing for a second revolution. New Latvian and Estonian elites, by contrast, have maneuovered around their opposition, the former nomenklatura. They have been able to create political and economic institutions that enable politicians to withstand the temptation to employ distributive political strategies and that give power over economic policy-making to technocrats, largely because of the manner in which power was transferred from the old to the new ruling class, who see themselves as "platonic guardians" of general welfare. As the former chairman of the Bank of Lithuania, Romualdas Visokavičius put it, "The governments of Estonia and Latvia trust and allow their central banks to do what they are meant to do. One aspect of banking developments particular to Lithuania is that the politics of the Bank of Lithuania were conducted in a very tendentious and irrational way from the very start; even in the printing of litas there were many pitfalls. History will yet be the judge in this matter."32
The Politics of Stabilization and Old Rent-Seeking Elites
The distance of respective elites from the corrosive influence of the nomenklatura thus helps to explain stabilization policy success. Aslund maintains that "the main reason for the strong inflationary pressure is extreme rent seeking by a narrow stratum of society, essentially the younger generation of the old ruling nomenklatura".33 Breaking with vested interests in support of the status quo is necessary to secure changes in policy. In its absence, one might even speak of the "highjacking" of reform in post-communist regimes.34
In a competitive political environment, each politician, even when convinced of the necessity of stabilization, may be unable to afford failing to endorse the cause of particular, nomenklatura interests. And this may not be merely a question of votes, as in Western multiparty polities, but because of personal contacts and the relational contracting, both political and economic, that they imply.35 In terms of neo-liberal arguments, macroeconomic stability requires government commitment that cannot be altered for short term political popularity; it requires invariant policy rules, and not ones subject to political discretion. When each incumbent champions spending projects and credits so as to retain office or maintain networks of contacts, a move that is individually rational, deficits mount and economic conditions worsen, with the political popularity of incumbents as a group declining. Politicians committed to distributive strategies can be seen as treating the nation's economic base as a common pool resource.36 The result is a "tragedy of the commons", with heightened political risk for the incumbent regime. Politicians avoid this dilemma by creating institutions that can commit them to strategies that are collectively rational or efficient - an "institutional fix for politics" 37 With greater or lesser degrees of success, the Baltic states have "tied their own hands" in this manner.
Latvia and Estonia
Einars Repse, president of the Bank of Latvia, defends a hard-nosed free market attitude: "There are several ways to cope with the inter-enterprise debt problem. The best of them is to make recipients responsible for collecting payments themselves, or suffer losses. In other words, the best thing to do is nothing... Certainly arrears should not be financed, and an artificial inter-enterprise arrears clearing should not be arranged for."38 Indeed, any state concern over arrears boosts inflation and delays structural adjustment, as state funding is being channelled in the form of subsidies to enterprises that can no longer find solvent demand for their output.39
Bank of Estonia president, Siim Kallas, is also consistently firm in this commitment: "Some industrial circles, often connected with the former Soviet nomenklatura, have tried to force the Bank of Estonia to issue more kroons without proper backing. This could enable them to continue as before the production of expensive and low quality goods that have no market. The Bank of Estonia will never yield to such pressure."40 Nor has it, or the government, yielded to calls by the Ministry of Justice to overturn the law on the Bank of Estonia, claiming that it should be subordinated to Estonia's economic policy, since the law "turns some functions of executive power over to the Bank of Estonia."41
The most radical set of steps in banking reform in Estonia, taken in November 1992, is an eloquent statement of this attitude as it relates to the banking sector. While the currency reform had solved key problems - allowing for an independent economic policy, insulating Estonia from the monetary crisis in the ruble zone - it had worsened the functioning of the payments system. The currency board principle prohibited the Bank of Estonia (BOE) from financing its commercial banks, except in the context of a well-defined banking crisis. This cut regular access to soft credits, concerted stabilization bringing latent bad debt problems to the surface. Until the currency reform, the BOE had been weak in backing its directives with sanctions, something which may have induced banks to expect any needed liquidity assistance or bailout. When the BOE finally flexed its muscle, the banks became severely illiquid, and the BOE announced a moratorium on Estonia's three largest commercial banks. The crucial role of the "currency board" shows the gains in credibility which precommitment to responsible policies can bring.42
Which raises the interesting question, of where the locus of policy-making is in the respective regimes. Estonian and Latvian governments have managed to shift it from the representative institutions to an autonomous and coherent financial technocratic teams at the central banks and finance ministries, isolating them from the distributive pressures of ethnic and interest group politics. Technocrats are empowered because politicians delegate. Lithuanian politicians have consistently resisted delegation. On the one hand, treating economic policy as a national issue, they insist on their own superior capabilities, or, on the other hand, subject it to political pressures from ex-nomenklatura lobbies.
In Lithuania, radical economic reform has taken second place to political infighting in the Seimas, and divisions between it, the Bank of Lithuania and the president. 43 Five different Prime Ministers since the redeclaration of independence, each with different economic reform plans, have undermined consistent fiscal and monetary policy. Aleksandras Abišala had taken firm steps to halt inflation, including freezing the salaries of state employees in accordance with a memorandum signed with the IMF in October. When the Lithuanian Democratic Labor Party (LDLP) came to power, however, it claimed that such a policy placed excessive burdens of the population and implied that it would persuade the IMF to tone down its demands. The new Prime Minister, Bronislovas Lubys, installed on 2 December, increased salaries and pensions from 1 January 1993 and made no effort to persuade the Bank of Lithuania to alter its policies, leading to massive increases of money in circulation.44 The campaign promises of the LDLP and initial salary hike laid the foundation for a widespread belief that the government could keep increasing salaries and pensions without negative repercussions. Lubys' successor, Adolfas Sleževičius, whose government was appointed 30 March 1993 further announced that state salaries would be increased by 40% on 1 May, though IMF pressure induced the government to back down.
It is not surprising, then, that in the first six months of 1993 inflation in Lithuania reached 119.2%.45 However, to pave the way for the introduction on June 25 of the litas, the Bank of Lithuania under the direction of Romualdas Visokavičius introduced very tight monetary policy; by August the rate of inflation had dropped to 0.9%. However, the Bank's success was short lived. In September inflation grew by 4.2%, in October by 7.3% an in November by 6.8%. Lithuania signed, an agreement with the IMF promising to reduce inflation in 1994 to 10%, though the Economics Ministry predicted a rate of 30%, while the Deutsche Bank forecast an annual rate of 125%. Moreover, instead of channeling IMF, World Bank and EBRD funds to the modernization of industry and infrastructure, the government used them largely to pay off debts to Russia.46
The resumption of high inflation coincided with a vote of no confidence in the chairman of the Bank of Lithuania passed 77-18 on 21 October, initiated by the LDLP, and backed by the budget and finance committee. Prosecutor General Artūras Paulauskas said that Visokavičius "has self-seeking motives, and arranged the deal with the premier, and later pressured the finance minister Eduardas Vilkelis into compliance".47 Although he was acquitted on charges of damaging state interests and abusing his post, the episode has more than merely economic overtones. "A year ago we, the leaders of the Bank of Lithuania, were opposed to an emission of money without backing," said Visokavičius, "while the 'scandal' and the fabricated charges concerning the 20 million litas credit was a pretext for our dismissal". Brazauskas took the opportunity provided by the irregularity to purge the bank, dismissing all five of the Bank's vice chairmen from their posts.48 The dismissals were criticized by the parliamentary opposition and former members of the bank's board, claiming that they were motivated by the ruling LDLP's desire to stack the board with people who support Brazauskas' "loose monetary policies". Visokavičius, too, is critical of the new board: "The previous board successfully introduced the national currency, stabilized it and brought down the inflation rate. I'm afraid the new board has been bowing to the demands of money-losing state industries by artificially propping them up with credits. The result will be the rapid devaluation of the national currency and a new round of inflation". Indeed, Visokavičius' successor, Kazys Ratkevičius, said that the central bank must set interest rates and develop a coherent state credit strategy which would loan primarily to subsidized industries.
The ruling LDLP rejoiced over the new appointment, hoping that it would end "the state within the state", referring to the Bank's earlier unruliness.49 Perhaps in part in an attempt to distance itself from accusations that it has too much influence over the policies of the central bank, the Lithuanian government on 1 April created an independent currency board pegging the litas to the dollar. Its effectiveness remains to be seen; the latest surge in inflation is due to the central bank's buying too much hard currency and exceeding the permissible amount of cash in circulation, according to Adalbert Knoebl, the head of the IMP'S Baltic department.50
Why would the dominant group of former communists choose short-run inflation? Opposition parties clamor that it is because it enables them to dish out favors to "good friends". A simultaneous political-economic transition may provide the LDLP and some of its constituents with the opportunity, in the process of institution building, to encode a short-run gain into a long-run advantage. This is not to say that these positions will not be overturned, or that such short run gain is not associated with an enormously high risk of economic reversal given that hyperinflation may lead to wholesale collapse, but that these are considerations which transitional game players are taking into account. In conditions of uncertainty, the possibility of consolidating one's gains in future outcomes becomes important. For many members of the LDLP and their supporters, this means preserving key elements of the status quo, while for Latvia and Estonia's technocratic elites, this involves the preservation of their credibility as die-hard reformers.
There is a danger that inflation-induced distortions in the Lithuanian economy will long remain after stabilization, with structural corruption becoming a permanent post-stabilization feature. The "singing revolutions" in all three republics left largely intact the economic and financial resources of the former Communist elite, creating a new Party hegemony, a commercial ascendancy guaranteed by former party wealth and spontaneous privatization. In Lithuania, political activity shifted from elections to a struggle within the elite for control over economic resources, a struggle which in Lithuania extends to the highest echelons of the state. What one commentator sees as the Hungarian trajectory, an "Italian Road", may be an apt characterization of the Lithuanian political scene: a fragmented party system with an extended, deeply embedded system of clientage.51 The major actors in the new polity are the top ruling elites and their allies: the politically dependent administration and the economically dependent owner-managers, in what might be described as new "iron triangles" of power.
A Vindication of Neo-Classical Economic Theory?
There is a discontinuity evident in the new and old elites of Latvia and Estonia, the "revolutions" inaugurated by the popular fronts more complete turnovers that of Sąjūdis. In all three republics, the national independence imperative and an orientation away from Russia trumped free-market economic prescriptions, which were seen as a panacea to the inherited ills of the command system. Only in Latvia and Estonia were truly reform-minded coalitions able to monopolize the imperative and sustain it as both the legitimating myth for austere economic measures and a way of avoiding the influence of nomenklatura structures at the highest levels of government.
In Lithuania, the holdover elite managed to survive in the post-Soviet political scenario, lending an ambivalence to economic and political reform, for all their vaunted liberalism. It was the ideological divide between the "morally compromised" ex-communists and the so-called "patriots" that comprised the Sąjūdis faction, that dictated the inauspicious configuration of political forces in the Supreme Council and, after 1992, the Seimas. Essentially political amateurs, the radicalized Sąjūdis contingent relied on "patriotism" to establish a political identity and discredit its more cohesive opponent. Its continual appeal to this national sentiment determined the tenor and content of political and economic debate, contributing to parliamentary impasse and institutional fiasco.
It is now widely recognized in transition literature that successful democratic consolidation in post-Soviet states relies on the successful institutionalization both of new interest mediation structures and on the effective restructuring of economic institutions. In securing the conditions of political accord necessary to advance such reforms, the ideologically polarized personal platforms that emerged to contest the holdover elite of the LDLP were a failure, while the LDLP itself remains hidebound by its nomenklatura constituency. Estonia's and Latvia's politics are ever more turbulent and contentious,52 and it may be that any pacific notion of their reform is illusory, relying as it does on the disenfranchisement of nearly half of their populations. Until recently, however, they have been considerably more cohesive in their economic stance.
The Baltic scenario is consistent with the assumptions that inform the neo-classical approach to reform, that it is an elite-imposed rather than a coalition building model. Reflecting on Latin American experiences of democratic consolidation after coups, electoral landslides and crises, one can posit that the establishment of an authority to impose a post-reform distribution. Neo-classical intuition sees weak governments and coalitions as dangerous, whereas if one group can establish a dominant position and consolidate power, uncertainty is reduced and the stabilization effectively forced through. The success of macro-economic stabilization programs depends on the decisive manner in which governments are prepared to implement resolutely the concept of the hard budget constraint. Monetary policy must be "ruthless".
Theory suggests that "ruthlessness" may result from political domination. The Alesina and Drazen framework53 views the adoption of reform not as a consensual affair, but as the consolidation of one group's power over others too weakened to resist any longer. They show how distributional struggles over the benefits of reform may lead to delay, in the presence of uncertainty regarding the magnitude of the cost borne by each group in the prestabilization phase. Two groups, capital and labor, are assumed in their framework, with each incurring a cost as the stabilization is delayed. The group that caves in first is assumed to bear the larger part of the post-stabilization tax burden. Each group then has the incentive to wait and see whether the other group will throw in the towel first. Stabilization takes place only when one of the groups figures that it stands to gain more from the assuming the cost of the stabilization than from waiting another instant to see if its rival will do so instead.
This view is consistent with evidence that labor and low-income groups in the Baltics, as elsewhere in Eastern Europe, have not fared well in the aftermath of the stabilization. It may also help to explain why macroeconomic stabilization was accompanied by rather radical micro-economic liberalizations. The resolution of the "war of attrition" over stabilization provides the "winners" with an opportunity to impose on a temporarily weakened society its broader agenda as well. In Latvia and Estonia, at least, this is what appears to have happened.
However, one may question the extent to which such a debilitating confrontation was ever engaged in. The Alesina-Drazen framework helps explain a common feature of stabilization crises: things have to get pretty bad before decisive action is taken to bring the budget into balance and stop inflation. Hence serious reforms are more likely to take place during periods of crises: an increase in the cost of waiting makes political agreement more likely.54 The Baltic scenario suggests that endogenous reform is possible, even if you do not find yourself in the crisis point. This point was approached but never reached in the Baltics, in large part due to the fact that the independence imperative tipped the scales in favor of economic insulation from the freefall of the Russian ruble in 1992. To the extent that the stabilization in Lithuania is incomplete or faltering, one might posit a war of attrition with different features, one which assumes the new and old elites and their respective constituencies as the groups engaged in the distributional struggle.
The point of the political-economic modeling we have studied is to endogenize policy. Of course such attempts at endogenization will always remain partial, as all models have to treat some institutional or political features parametrically. Moreover, political-economy issues raised by systemic reform are even more complicated than the issues raised by the economics of the second best, so it is natural that no single model can do more than illuminate a certain aspect of the problem.55 In doing so, this paper does not consider some important elements of the Baltic stabilizations:
quantities of gold reserves in accounts abroad accessible by the respective regimes; the external influence of Western
financial assistance; the relative benefits of smallness, there being less of a threat of wholesale collapse due to unemployment; all of which were clearly influential in the Baltic case. Moreover, the argument presented is at best schematic, culled as it is from the impressionistic evidence of interviews, political manifestos, and interpretations of events since 1990. A more rigorous analysis with greater empirical substantiation would be required to establish a relation between ideological commitments and policy outcomes that might be incorporated as a significant variable in political-economic modeling.
Most broadly, this paper supports the conclusions of empirical studies of economic reform in developing countries, that the inflation tax depends on the degree of political instability of the country in question, and that the use of inflationary financing is the deliberate result of policy actions undertaken by governments acting strategically.56 It is the specific contention of this paper that political ideologies formed on the basis of ethnicity and nationalism may have an unexpected influence in policy content and success in the Baltics, varying in their effects on the one hand with differences in the historical composition and role of the CPSU in the three republics, and with the extent to which these differences became the constraints on political and economic transformation after 1990.57
1 This article is based on published and unpublished Western and Baltic sources and interviews with party leaders,
parliamentary deputies and diplomats conducted in Vilnius and Kaunas between 12 July and 30 August 1991, 21 December
1991 and 7 January 1992, and 11 July and 5 August 1993, and in Washington, D.C. on 16 August 1994. I am grateful to
all who agreed to be interviewed.
2 See, in particular, the articles discussed in D. Rodrik, "The Positive Politics of Policy Reform," American Economic Review 83, no. 2, 1993, pp. 356-61. Also M. Bruno, "Stabilization and Reform in Eastern Europe: A Preliminary Evaluation," in 0. Blanchard, K.A. Froot and J.D. Sachs (eds.). The Transition in Eastern Europe, Vol. 1, Chicago: University of Chicago Press.; and J.D. Sachs, Poland's Jump to the Market Economy. Cambridge: MIT Press.
3 G.E. Schroeder, "Two Years After the Collapse of the USSR: Economic Transformation," Post-Soviet Affairs, 9, 4,1993, p. 298.
4 A. Aslund, "Lessons of the First Four Years of Systemic Change in Eastern Europe." Journal of Comparative Economics 19, 1994, p. 33.
5 D.Rodrik, Ibid., p. 357.
6 R. Fernandez and D. Rodrik, "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty." American Economic Review, 81 December 1991, pp. 1146-55.
7 R.H. Bates and A.O. Krueger (eds.). Political and Economic Interactions in Economic Policy Reform. Cambridge: Blackwell, 1993.
8 Bates and Krueger, Ibid., p 456.
9 A. Shleifer and R.W. Vishny, "Politicians and Firms," Institute for Policy Reform Working Paper, January 1994.
10 The discussion which follows represents an extrapolation from the 1990 "founding elections" of a cleavage dimension relevant for party competition. See R. Viesulas, "Prospects for Multiparty Democracy in Lithuania," Lituanus Vol. 38, No. 2,1993.
11 In this, political development may be likened to C. Offe's concept of "political capitalism", whereby changes, the goal of which is to promote social, political and economic activeness, are implemented from "above" by elites expecting a passive acceptance of reform by the masses, rather than active engagement. C. Offe, "Capitalism by Democratic Design?" Social Research, Vol. 38, Winter 1991, pp. 865-92.
12 "Where no structured party system exists, the prevalent determination of voting behaviour is some kind of attachment to a notable - and thus we may speak, in short, of personality voting." G. Sartori, Parties and Party Systems: A Framework for Analysis. Cambridge: Cambridge University Press, 1976, p. 126.
13 J. Kivirahk, R. Rosimannus, and I. Pajumaa, "The Premises for Democracy: A Study of Political Values in Post-Independent Estonia," Journal of Baltic Studies, Vol. 24, No. 2, Summer 1992, pp. 135-137. R. Ališauskienė et al maintain that in Lithuania, "the concept of left/right political self-identification was related more to political views than economic or social attitudes. It was closely related to the evaluation of politicians who were seen as representing a particular viewpoint." R. Ališauskienė R. Bajarūnienė and B. Sersniova, "Policy Mood and Socio-Political Attitudes in Lithuania," Ibid., pp. 149-160.
14 The discussion which follows draws on the analysis of political competition in G. Sani and G. Sartori, "Polarization, Fragmentation and Competition in Western Democracies.", in Western European Party Systems: Continuity and Change, H. Daalder and P. Mair (eds.), Beverly Hills: Sage, 1984.
15 For an account of the links between religious and political dissent in Lithuania see H. Johnston, "Religion and Nationalist Subculture in the Baltics," Journal of Baltic Studies, vol. 23, no. 2, Summer 1992, pp. 133-148.
16 Asked whether economic reform was elite led or the result of interest groups bringing pressure to bear on politicians, Martin Lacis, first secretary at the Latvian Embassy in Washington, D.C. said that "Our political orientation towards the European Community sets the agenda. Colonial trade relations, which could be considered relations only conditionally, have made a 50% turn to the West. If Latvia is to be independent economically, it is important that its economic policy reflect that Western orientation." Personal interview, 22 August 1994.
17 "Estonia Has More Gold Than Europe," address to the Bank of Estonia Conference on the Reintroduction of the Estonian Kroon, 18 June 1993.
18 In fact, all three republics have exhibited what A. Przeworski has called the "Eastern European Syllogism." The major premise is "If it were not for Communism, we would have been like the West," the minor premise being "Now Communism is gone." The conclusion asserts that Eastern Europe should and will now embrace a Western-style economy. See A. Przeworski, Democracy and the Market: Political and Economic Reforms in Eastern Europe and Latin America. Cambridge: Cambridge University Press, 1991.
19 G. Sartori, op cit.
20 R. J. Misiūnas and R. Taagepera, The Baltic States: Years of Dependence, 1940-1990. Berkeley: University of California Press, 1991, p. 83
21 Padomju Latvijas Komunists, no. 6, June 1989, quoted in N. Muiznieks, "Latvia: Origins, Evolution and Triumph,", in I. Bremmer and R. Tarras (eds.). Nations and Politics in the Soviet Successor States. Cambridge: Cambridge University Press, 1993.
22 See estimates for various years published in Misiūnas and Taagepera, op. cit., pp. 281-284.
23 T. U Raun, Estonia and the Estonians. Stanford: Hoover Institution Press, 1987, pp. 190-193.
24 T.U. Raun and R. Taagepera, "Estonia in September 1988: Stalinists, Centrists and Restorationists," in Journal of Baltic Studies, vol. 20, no. 3,1989, pp. 227-278.
25 See Riina Kionka, "Free-Market Coalition Assumes Power in Estonia," in RFE/RL Research Report, no. 46, 20 November 1992, pp. 76-80.
27 Human rights and Democratization in Latvia. Commission on Security and Cooperation in Europe, Washington, D.C., 1993, p. 11.
28 D. Bungs, "Latvia: Transition to Independence Completed," RFE/RL Research Report, vol. 3, no. 1, January 1994, pp. 96-98.
29 Although the 1938 constitutions which were rescinded by the Soviets in 1940 formed the blueprint for the Provisional Fundamental Laws in the republics after independence was restored, for expediency the new arrangement kept Soviet-style institutions intact. The legislative and executive bodies of the SSR's -in the new democratic vocabulary called Parliaments and Cabinets, with their respective chairmen referred to as Presidents and Prime Ministers - were retained. Methods for the selection of chairman in each body, i.e. by Supreme Council ratification, were similarly retained.
30 A. Ruchkovsky and B. Tsilevich, "The Citizenship Issue in Latvia," Draft for the Latvian Union of Non-Citizens' report to Helsinki Watch, 8 January 1994.
31 On the CPL split, see A.E. Senn, "Brazauskas and the Communist Party of Lithuania," Problems of Communism, March-April 1990, pp. 23-40.
32 All quotes by R. Visokavičius presented in this paper are from a personal interview, 15 August 1994.
33 A. Aslund, op cit., p. 26.
34 V. Samonis, "Highjacking' Change in the Post-Communist World? Lessons From Lithuania," Lituanus, vol. 40, no. 3, pp. 5-10
35 See, for example, J.M. Litwack, "Legality and Market Reform in Soviet-Type Economies," Journal of Economic Perspectives, vol. 5, no. 4,1991, pp. 532-76.
36 On common pool problems as they concern the generation of property rights see G.D. Libecap, Contracting for Property Rights. New York: Cambridge University Press, 1989.
37 The argument presented here is consistent with A. Posen's view that central banks will take strong anti-inflationary action only when there is a coalition of interests capable of protecting it. A.S. Posen, "Why Central Bank Independence Does Not Cause Low Inflation: There Is No Institutional Fix for Politics," The Amex Review, 1992.
38 From a statement to World Bank Conference in Paris, 19 May 1994.
39 B.W. Ickes and R. Ryterman, "Roadblock to Economic Reform: Interenterprise Debt and the Transition to Markets," Post-Soviet Affairs, vol. 9, no. 3,1993, pp. 331-361.
40 From "Estonia: Monetary Reform, Hard Style," interview in The Baltic Review, Vol. 1, No. 3,1993, p.41.
41 A. Staprans, "Taking the Politics Out of Monetary Policy," in The Baltic Observer, 3-7 February 1994, p. 9.
42 A. Hanson, "Reforming the Banking System in Estonia," paper prepared for the LSE/IEWS conference on "Banking Reform in FSU and Eastern Europe: Lessons from Central Europe", Budapest, 14-15 January 1994.
43 A recent episode in this struggle was the nationwide referendum staged on-27 August 1994, on the "Draft Constitutional Law on Illicit Privatization, Depreciated Savings and Stocks, and Breach of Law Enforcement." Opposition lawmakers, led by Landsbergis argued that the plan, a thinly disguised attempt to discredit the ex-communist government, would benefit destitute Lithuanians. They were adamant that the results of the referendum become law, despite warnings from both IMF and World Bank officials that the draft law, by which all savings deposits held before February 1991 would be indexed one-hundredfold, would pose serious risks to macroeconomic stability, impede the growth of the private sector and involve a widespread re-nationalization of assets. In a curious twist, the LDLP government allocated 44.5 million lits (approximately $llm) from a World Bank loan to cover the expenses of holding the referendum, pronounced invalid for low turnout. See V. Vodeau, " World Bank and IMF Warn Lithuania of Economic Instability," in The Baltic Observer, 4-10 August 1994, p. 11.
44 S. Girnius, "The Lithuanian Economy in 1992," RFE/RL Research Report, vol. 2, no. 16,16 April 1993, pp. 44-48.
46 A. Kokk, "Economic Policy of the Baltics,." The Baltic Review, no. 3 1993, pp. 46-48.
47 A. Simėnas, "Bankininkystės Krizė Tęsiasi," Lietuvos Rytas, 29 October 1993, p. 1.
48 E. Staddard, "Lithuanian President Axes Half of Central Bank Board," The Baltic Observer, 26 Nov.-2 Dec. 1993, p. 4.
49 A. Okas, "Seimas Pritaria Naujam Banko Prezidentui," Lietuvos Rytas, 25 November 1993, p. 2.
50 Quoted in A. Staprans, "Taking the Politics Out of Monetary Policy," op cit.
51 A. Agh, "From Nomenklatura to Clientura: The Emergence of New Political Elites in East Central Europe," Labour Focus on Eastern Europe, no. 47,1994, pp. 58-77.
52 Disagreements over finer points of policy become ever more salient political consolidation and the removal of Russian troops from Latvia and Estonia makes nationalist solidarity among politicians ever less important. See, for example, A. Arklina, "Estonian Government Survives General Crisis," The Baltic Observer, 26 May-1 June 1994, p. 1, for an account of personal feuds within the ruling Isamaa coalition. The recent fall of the Latvian government was the result of disagreements over economic policy between the protectionist Farmer's Union deputies- and the free-traders of Latvia's Way who formed the ruling centrist-right coalition. See J. Karlen, "Latvia's Government Steps Down," Ibid., 21-27 July 1994, p.1.
53 A. Alesina and A. Drazen, "Why are Stabilizations Delayed?" American Economic Review 85, No. 81,1991, pp. 1170-88.
54 A. Drazen and V. Grilli, "The Benefit of Crisis for Economic Reforms," National Bureau of Economic Research, Working Paper, 1990.
55 D. Rodrik, "The Positive Politics of Policy Reform," op cit., p. 360.
56 See, for example, A. Cukierman, S. Edwards and G. Tabellini, "Seignorage and Political Instability," American Economic Review 82, No. 3, 1992, pp. 537-55. Also S. Edwards, "The Political Economy of Inflation and Stabilization in Developing Countries," Economic Development and Cultural Change, vol. 42, No. 2,1994, pp. 235-66.
57 The notion that distant events or patterns of behavior can influence the formation of political values long beyond the time that they occurred is a central tenet of "political culture" theories of democratization. For the classic statement of such an approach see G.A. Almond and S. Verba, The Civic Culture. Princeton: Princeton University Press, 1963. This thesis also supports the concept of "path dependence", that "the differing paths of extrication from state socialism that shape the possibilities of transformation in the subsequent stage." See D. Stark, "Path Dependence and Privatization Strategies in East Central Europe," Easte European Politics and Societies. Vol. 6, No. 1,1992, pp. 17-54. East European Politics