Europe > Latvia, Republic of
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This paper examines competitiveness and productivity in the Baltics. Focusing on recent developments, it asks why Russia’s war in Ukraine led to a prolonged recession and strong decline in competitiveness in Estonia, while Latvia and Lithuania shielded their economies more effectively. The paper starts by documenting a deterioration in export performance across the region. Using a constant share decomposition, it finds that, unlike in Latvia and Lithuania, Estonia’s declining export share has been mainly linked to a reduction in the ‘intensive margin’—a sign of weakening external competitiveness and declining relative productivity. Multivariate filtering techniques and estimates of the real effective exchange rates based on historical productivity trends, consistent with Balassa-Samuelson, confirm that differences in long-term total factor productivity growth have affected external competitiveness. While Estonia’s post-GFC slowdown in productivity growth and real exchange rate appreciation have eroded its competitive edge, Latvia and Lithuania have shown greater resilience, aided by more balanced real effective exchange rates and, for Lithuania, stronger corporate balance sheets. A micro-econometric analysis further reveals that resource misallocation, particularly in the services sector, has been a key driver of declining productivity in the region. These findings underscore the need for targeted reforms to improve allocative efficiency, boost productivity, and restore competitiveness in the Baltic region.
Europe has experienced a barrage of large shocks in recent years that resulted in diverging trends in productivity growth, with significant productivity gaps across industries. Our analysis reveals that TFP growth is driven largely by the extent to which countries are involved in scientific and technological innovation as the leader country or benefiting from knowledge spillovers. The technological gap is a highly significant factor with a substantial economic magnitude in determining TFP growth as countries move towards the technological frontier by adopting new innovations and technologies. Narrowing innovation and technology gaps are key to advancing productivity growth on a sustainable basis. These findings have important policy implications, including policy measures and structural reforms to promote innovation and facilitate the diffusion of new and existing technologies.