Small States and Financial Fragility

1
Small States and Financial Fragility

• Rainer Kattel
• Institute of Public Administration
• Tallinn University of Technology, Estonia

2
Concepts

• Small states are weak links in diverse
  international linkages
• Financial fragility
• Minsky/Kregel companies and countries can have
  following financing positions hedge,
  speculative, Ponzi
• Techno-economic paradigms from mass production
  to modularity

3
Financial fragility, origins

• Financial fragility has essentially one origin
  and two additional factors enforcing/alleviating
  it
• Origins all business models are speculative
  financing positions
• Minsky permanent stability is impossible as
  successful business models (innovations) engender
  systemic lowering of margins of safety

4
two factors

• First, businesses innovate in the hope to become
  hedge financing position (securitization, product
  eg iphone, business model eg skype, marketing to
  sell mortgages, assembly production)
• Second, public policies and regulations (exchange
  rates, labour laws, banking regulations) intend
  to finance sustainable growth (undervalued
  exchange rate, low inflation, flexible labour
  markets)
• Financial stability or fragility results from the
  interplay of these both factors and international
  context and countrys level of development they
  determine how and in what companies innovate

5
How can small countries avoid fragility?

• Small states are by definition prone to fragility
  as cushions of safety low
• Two ideal typical strategies
• Type A is Nordic economy in post WWII
• Type B is Baltic economy in 1990s-2000s

6
Type A

• Resource based exports, diversification into
  industry (scale economies in mass production)
• Exchange rate / capital controls devaluations /
  wage negotiations
• welfare state, active labour market, regional
  labour markets, NMT
• hedging long-term development and innovation in
  increasing returns industries with strong
  linkages to local economy, getting the paradigm
  right

7
Type B

• Macro-economic stability, currency peg and FDI
• Modularity in production (outsourcing, lack of
  increasing returnslearning), regional uneven
  integration
• Weak labour and social partners
• Inputs for exports and private borrowing in
  foreign currency, huge current account deficits
• Hedging short-term consumption and real-estate
  booms
• Crisis inevitable because Type B is a Ponzi scheme

8
Conclusion

• Type A fit perfectly TEP
• Type B fully misunderstood TEP
• Lessons for small states
• flexibility to respond to speculative positions
  regulations, procurement to create lead markets
  industry associations to socialize risks of
  development projects regional trade etc
  agreements, technical know-how creation
  macrofiscal policy help to socialize long-term
  RD risks