Harvard economist advocates effective government regulation

  • 2006-07-12
  • By Joel Alas

Ketels advocates state intervention as a means of preventing an economic downturn.

TALLINN - A leading Harvard economist has suggested Baltic governments need to increase business regulations to prevent the region from slipping into economic turmoil. While most governments around the world seek to trim back red tape, Baltic countries need to increase "positive" business interference to maintain growth, the economist claims.

The recommendations were the result of an assessment of Baltic Sea competitiveness by Dr. Christian Ketels, a faculty member of Harvard Business School and senior research fellow at the Stockholm School of Economics.

Ketels warned that Baltic nations risked losing their competitive advantage if growth and wage increases were not more closely regulated. "The governments will need to transition from a 'zero interference' mode to a 'positive contribution' mode where they make investments and sets rules and regulations that enable companies to raise productivity while wages rise, without creating bureaucracy or inflexibility," Ketels said.

"That is a challenge 's it is easier to slim down public administrations than to build effective ones."
Ketels presented his findings at the recent 30th anniversary seminar of the Nordic Investment Bank in Helsinki. He told business and government leaders from across Scandanavia and the Baltics that the current economic strength of the region was on the verge of faltering.

"Current trends suggest that the region is close to reaching the top of a cycle and is slowly falling behind international peers," Ketels said.
The Baltics had enjoyed growth in recent years thanks to their high skill base, low wages and attractive tax environments. For several years in a row now the economies of Estonia, Latvia and Lithuania have registered the highest rate of growth in terms of gross domestic product, although the countries occupy the bottom of the ladder in the EU25 in terms of GDP per capita.

"This model has proven tremendously successful but will over time lose traction. Economic growth will increase wage pressure, lead to shortages of skilled labor, and can easily create social divisions between those that are well prepared to take advantage of these new opportuities, such as young, urban and well educated people, and those that can't," he said.
"There is a danger that the Baltics will become much less of a 'good deal' if wages continue to rise while economic opportunities for productivity growth become smaller. It is in the hands of the Baltics to devise economic policies that will avoid this scenario. Countries like Singapore and Ireland have shown that it is possible to move from competitiveness based on low wages to competitiveness based on productivity," he said.

The region needs to identify a "brand" and set a clear market position so businesses and investors can understand its unique strengths, he said.
"The Baltics will need a mix of old and new industries and idealy, business clusters. High productivity can only be reached if a region or country specializes in areas where it developes uniquely beneficial business environment conditions. Nobody knows today what the succesful clusters of the future will be."

Existing industries need to be supported and should not be discarded "even if today they seem low wage," Ketels added. New industries should be created to feed off the skills and technology of existing industries, or at the intersection of existing business clusters. The general business environment should be upgraded to encourage entrepreneurs to launch ideas.
The economist advocated that Baltic and Nordic countries make themselves more visible in Brussels and be more assertive in pushing their case for changes in European Union policies. But his strongest advice to Baltic businesses and governments was to pay close attention to their largest neighbor, Russia.

"This is clearly where the main economic potential for the future lies, but it is politically a huge challenge and can only to a small degree be controlled by the Baltics. The Russians clearly have their own political agenda and might be tempted to use economic relations to the Baltic countries as a political tool, as seen with energy, rather than developing mutually beneficial economic ties.
"The Finnish EU presidency might provide a small window to bring this on to the table. In any case, the Baltics need a plan on how to deal with this situation in different contingencies."

The Nordic Investment Bank seminar also heard from Finnish President Tarja Halonen, who agreed the region needed to invest to survive. "To be winners in the global competition in the future, we need to increase our investments in human resources, lifelong learning and in research and development," Halonen said.