Baltic states on course for hard landing
Robert Anderson | Saturday, 7 June 2008
Last year Elcoteq, the Finnish electronics contract manufacturer, increased its Estonian salaries by 15 per cent but still had to bring in Hungarian workers to staff its Tallinn plant. This year Elcoteq is putting 300 of its 2,200 workers on compulsory leave because wage costs have made the production of mobile phone components uncompetitive at the plant.
Declining industries such as textiles are suffering even more from wage inflation. In Narva on the Russian border, Swedish-owned Kremholm - which less than five years ago employed 4,500 people - will cut its workforce again to 1,100 in July as it outsources production of ready-made fabrics to Asia because of rising costs.
"Raising productivity by 10 per cent to 15 per cent a year is possible," says Matti Haarajoki, general manager. "But with wage increases of 20 per cent or more you are facing problems, no doubt about it."
These cutbacks could not have come at a worse time for Estonia. The boom that followed accession to the European Union (EU) in 2004 is now over and from being the fastest growing economies in the EU the Baltic states are set to become the slowest.
Estonian gross domestic product (GDP) shrank by 1.9 per cent in the first three months of this year compared with the previous quarter, while Lithuanian economic growth slowed to 6.9 per cent and Latvian growth more than halved year on year to 3.6 per cent.
Double-digit GDP growth over the past few years has triggered rapid increases in wages, inflation and property prices.
Today economic growth is slowing sharply because inflation is eroding spending power and falling property prices are depressing consumer confidence and plunging the real estate sector into crisis.
More economists are forecasting that at least Estonia and Latvia will soon be in recession, the only questions remaining being how long and how bad the "hard landing" will be.
A severe recession and property crash would lead to pressure for a devaluation of the Baltic states' fixed exchange rates but even a temporary downturn will be painful.
In Estonia, the richest state, GDP per capita is still only two-thirds of the average EU level and rural areas throughout the region remain impoverished.
The economic woes are already weighing on the Baltic states' weak coalition governments, making it difficult for them to focus on counter-measures.
The downturn has exposed the serious problems the region's much applauded transformation from communism has left in its wake. Much of the huge credit inflow from Scandinavian banks has been spent on real estate and imported consumer items rather than being used for investments in export industries and research and development.
The boom this fuelled has pushed Estonian wages to Czech and Hungarian levels - accentuated by migration to western Europe - though productivity lags behind. Wages may still be one-fifth of German levels, but so is workers' productivity.
Nevertheless, the economic slowdown may yet have a silver lining. It should reduce the region's alarming current account deficits - as imports fall while exports remain robust - and once inflation is brought under control, all three states should be well positioned to adopt the euro early in the next decade.
At the micro level, companies are now focusing more on exports and are trying to move up the value chain.
Krenholm aims to produce more own brand and premium private label garments, while Elcoteq is switching from mobile phone components to more complex communication network products.
Companies believe that the end of the boom will enable them to close the gap between wage rises and productivity gains. This should also help ensure that the economic slowdown is not too prolonged.
"It will clear the air and put things on a more normal level," says Heikki M
Declining industries such as textiles are suffering even more from wage inflation. In Narva on the Russian border, Swedish-owned Kremholm - which less than five years ago employed 4,500 people - will cut its workforce again to 1,100 in July as it outsources production of ready-made fabrics to Asia because of rising costs.
"Raising productivity by 10 per cent to 15 per cent a year is possible," says Matti Haarajoki, general manager. "But with wage increases of 20 per cent or more you are facing problems, no doubt about it."
These cutbacks could not have come at a worse time for Estonia. The boom that followed accession to the European Union (EU) in 2004 is now over and from being the fastest growing economies in the EU the Baltic states are set to become the slowest.
Estonian gross domestic product (GDP) shrank by 1.9 per cent in the first three months of this year compared with the previous quarter, while Lithuanian economic growth slowed to 6.9 per cent and Latvian growth more than halved year on year to 3.6 per cent.
Double-digit GDP growth over the past few years has triggered rapid increases in wages, inflation and property prices.
Today economic growth is slowing sharply because inflation is eroding spending power and falling property prices are depressing consumer confidence and plunging the real estate sector into crisis.
More economists are forecasting that at least Estonia and Latvia will soon be in recession, the only questions remaining being how long and how bad the "hard landing" will be.
A severe recession and property crash would lead to pressure for a devaluation of the Baltic states' fixed exchange rates but even a temporary downturn will be painful.
In Estonia, the richest state, GDP per capita is still only two-thirds of the average EU level and rural areas throughout the region remain impoverished.
The economic woes are already weighing on the Baltic states' weak coalition governments, making it difficult for them to focus on counter-measures.
The downturn has exposed the serious problems the region's much applauded transformation from communism has left in its wake. Much of the huge credit inflow from Scandinavian banks has been spent on real estate and imported consumer items rather than being used for investments in export industries and research and development.
The boom this fuelled has pushed Estonian wages to Czech and Hungarian levels - accentuated by migration to western Europe - though productivity lags behind. Wages may still be one-fifth of German levels, but so is workers' productivity.
Nevertheless, the economic slowdown may yet have a silver lining. It should reduce the region's alarming current account deficits - as imports fall while exports remain robust - and once inflation is brought under control, all three states should be well positioned to adopt the euro early in the next decade.
At the micro level, companies are now focusing more on exports and are trying to move up the value chain.
Krenholm aims to produce more own brand and premium private label garments, while Elcoteq is switching from mobile phone components to more complex communication network products.
Companies believe that the end of the boom will enable them to close the gap between wage rises and productivity gains. This should also help ensure that the economic slowdown is not too prolonged.
"It will clear the air and put things on a more normal level," says Heikki M