News Analysis: Reforms needed for Lithuania's economy to change course

Lithuania, once a model of strict fiscal discipline and robust economic growth, has been drifting recently towards a "lazy child" role in the EU family.

Several major international organizations, including the International Monetary Fund (IMF), the Organization of Economic Cooperation and Development (OECD) and European Commission (EC) itself, warned the Baltic country that rapid reforms are needed in order to strengthen Lithuania's economic growth and address demographic challenges.

"After a major recession, with one of the sharpest declines in real GDP across the EU in 2009, the Lithuanian economy showed a remarkable recover ... however, previous growth rates cannot be taken for granted," the EC said in a recent report.

It noted that on average, Lithuania's real GDP grew at 4.1 percent over the period 2011-2014. However, its GDP grew by 1.6 percent in 2015, the slowest pace the Lithuanian economy has advanced in five years.

LITHUANIA'S RESPONSE

Initially driven by rapid export growth, the recovery increasingly relied on domestic demand. Since 2013, private consumption has taken over as the main growth engine.

Noting Lithuania's achievements, nevertheless, EC rebuked Lithuania for slow reforms and clumsy response to earlier Commission recommendations.

According to the Commission, Lithuania made virtually no progress in 2015. Some progress was achieved only in easing tax burden, reforming pension and health care systems. There are still many economic and social problems which need to be addressed, the EC underlined.

Meanwhile, OECD urged to boost Lithuania's productivity in order to stay on a clear path towards an advanced economy, the one which is worth to join the "house of the best practices", as OECD is informally called.

"Productivity, productivity, productivity - this is what you need to boost because growth of labour productivity has been weak in Lithuania, therefore, you should catch up with leaders," Angel Gurria, OECD Secretary-General said in Vilnius earlier this month.

The OECD report on Lithuania found that labour productivity in the country grew by 5 percent on average in a period from 1995 to 2014. It marks one third below the OECD average and not enough if the Baltic country wants to declare its fully developed economy status.

Deficiencies of education system serve as one of the reasons for lack of productivity. The country's presidency acknowledges that Lithuania's higher education system is not sufficiently innovation-oriented.

"The proportion of pupils with insufficient basic skills is high, moreover, there are weaknesses in the quality of teaching in higher education and its ability to foster innovation," European Commission adds.

According to the EC, in certain sectors, skills shortages have been reported and are expected to become more acute in the future.

Another sizable challenge is Lithuania's negative demographic outlook. The working age population is shrinking rapidly and will soon threaten growth, major international organizations predict. The main drivers of the country's population decline are low fertility rates, overall poor health outcomes, and significant net emigration. Average net emigration in Lithuania during the last 5 years amounted to 22,000 people per year. A significant proportion of the emigrants were young and well-educated people.

"For a country with roughly 2.9 million people, this represents a sizable proportion of its population," the EC says.

RECURRENT OBSERVATIONS

After fresh warnings were released for Lithuania, Dalia Grybauskaite, Lithuania's president, repeatedly called the government to immediately address a bunch of problems, such as pension reform, fiscal discipline and stability, improvement in tax collection, liberalization of the labor market, reducing poverty and social exclusion.

"The observations on reforms (by the Commission) which face difficulties and are not carried out have been recurrent over the past several years; this is a very strong call to make more progress," the president noted.

The fact that Lithuania faces national elections in October this year might be one of explanations why the government is not willing to implement deep reforms. However, avoidance of structural changes is a longer-lasting feature in Lithuania, experts say. Some of them believe that the current coalition government with social democrats behind the wheel was too busy with its internal problems due to corruption-related scandals and political games, hence, it could not fully execute its direct duties.

According to Zygimantas Mauricas, head of research for the Baltic countries at Nordea bank, Lithuanian government only implemented some cosmetic reforms during its term, but this is not sufficient if the country wants to get out of "a closed circle of growing taxes, higher emigration and stagnating wage".

Nerijus Maciulis, Swedbank's chief economist in Vilnius, said he had a strong "déjà vu" feeling concerning the conclusions by the EC and remarks for Lithuania. According to him, all the problems have been repeatedly analyzed, structural reforms are on the "waiting mode" in agenda.

Most of reforms require complex and not popular decisions, Maciulis was quoted as saying by local website vz.lt earlier this month.

"Such reforms are usually implemented during crisis period rather than during period of modest growth; many of the reforms should have started right after Lithuania joined the EU (in 2004); we can only comfort ourselves that it is not too late yet," Maciulis said.

WAYS OUT

There are a few ways for Lithuania to get off the reforms laggards list.

Economy based on innovation, research and development is one of them. Going down this way, the country could also deter its young educated people from emigrating elsewhere and improve its demographic situation.

"Improving the labour market relevance of education remains important; the challenges are to streamline the funding and structure of the educational system, develop life-long learning and improve targeting and effectiveness of active labour market policies," the EC underlines.

Lithuania has already made important progress in the area of energy efficiency, nevertheless, further efforts are needed as energy consumption in households and industry is still too high, which increases costs for consumers and damages the country's economic competitiveness.

Labor reforms, designed to make labor market more flexible, are among those which would encourage businesses to create jobs in Lithuania and encourage investments, both domestic and foreign.

Despite numerous reproaches, Lithuania's economy growth is projected to be ahead of the EU and euro zone's average this year. The country's government forecasts GDP to advance by 2.5 percent this year and accelerate to 3.2 percent in 2017. European Commission expects Lithuania's economy to grow by 2.9 percent this year and 3.4 percent next year.

Lithuania's exports, an important contributor to the country's GDP growth, was hit hard by Russian import embargoes. However, the country's exporters managed to diversify their markets and their losses were not as big as projected. Endit