Journal of Baltic Studies (forthcoming)
Baltic States in World Markets: Does Katzenstein’s Framework Still Hold?
Vytautas Kuokštis, Institute of International Relations and Political Science, Vilnius University
Abstract
Small states, argued Peter Katzenstein a quarter of a century ago, are different. Faced with the fluctuations of world markets, they adopt democratic corporatism and domestic compensation, thus ensuring political legitimacy and successful economic adjustment. The Baltic countries are an interesting case study for this framework, because in many ways they are ‘smaller’ than the seven countries analysed by Katzenstein. Thisarticle finds that, on a broader level, Katzenstein’s framework is very helpful in highlighting the key developments in the Baltic countries. On the other hand, the specific causal mechanism that can be drawn from this framework running from smallness to democratic corporatism to political legitimacy as well as domestic compensation has not developed in the Baltics.
Key words: Katzenstein, small states, Baltic countries,democratic corporatism, legitimacy, domestic compensation
Introduction
Small States in World Markets (SSWM) by Peter Katzenstein (1985) is a major work. At the time of writing this article, SSWM yields 3493 citations on Google Scholar. Since its publication, SSWM has inspired many lines of research and equipped scholars with new ways of thinking about issues in comparative and international political economy. In particular, Katzenstein managed to draw attention to small countries which had been neglected by previous scholars (Ingebritsen 2010). In his review of contemporary study of political economy, Mark Blyth (2009, p. 194) names SSWM as one of the three founding texts of the field,along with Peter Gourevitch’s Politics in Hard times (1986) and Peter Hall’s Governing the Economy (1986).
Question is: how well does the theoretical framework of SSWM travel? Does it still apply a quarter of a century since its inception? In his own revisit of SSWM in 2003, Katzenstein recognized that while he had carefully delimited his investigation to seven early industrializers of the Western ‘core’ nations (Sweden, Norway, Denmark, the Netherlands, Belgium, Austria, Switzerland), his conclusions could be potentially fruitfully applied and tested in other contexts: ‘analysis could have pushed further by investigating, in addition, the strategies of other small states situated differently in the world economy’ (Katzenstein 2003, p. 13).
Subsequent literature generally confirms Katzenstein’s insights in different temporal and geographical settings. According to Eric Jones (2008, p. 8), ‘Katzenstein’s thesis about small states and world markets remains relatively unchallenged’. The Baltic countries make a compelling case for testing the arguments of Katzenstein’s framework. Firstly they are small - indeed, they are smaller than the seven ‘dwarfs’ of SSWM. Recently, their smallness and vulnerability was painfully exposed by a very severe economic crisis in 2008-2010. Secondly, the Baltic countries seem to pose a challenge for Katzenstein’s predictions – given that they are very small and vulnerable, it is puzzling whythey have not developed democratic corporatism and strong domestic compensation mechanisms. Thisarticle therefore sets out to answer the question: does (and in what ways) the Baltic empirical experience fit into Katzenstein’s framework?
The implications of Katzenstein’s book are quite diverse, which speaks ofthe contribution that SSWM has had to the scholarly community. At the same time, this gives rise to some confusion, as it is possible to derive different and sometimes even contradictory insights from Katzenstein’s work (or at least its interpretations). In this article, I provide two interpretations. One interpretation is a ‘narrow’ one that posits a specific causal connection that runs from smallness to corporatism and domestic compensation to legitimate and flexible economic adjustment. The other is a more general (‘broad’) interpretation providing guidelines for analysis and variables to look into rather than speaking about a specific causal chain. This ‘broad’ interpretation encourages scholars to seriously take into account history, ideas, and size; it also suggests political legitimacy as a precondition for the success of economic policy.
The article surveys the current stock of literature on Baltic economic policy by framing it according to Katzenstein’s approach. It reveals that in certain ways the Baltic countries do not fit into Katzenstein’s framework (interpreted in a narrow way).While they are even smaller and thus more vulnerable than the seven countries of SSWM, of all the new EU member countries they have been the least inclined towards corporatism and domestic compensation policies. Furthermore, while Lithuania and Latvia show very low levels of political legitimacy measured by the level of trust in political institutions (which is compatible with the predictions of Katzenstein’s framework), Estonia, which in fact pursued the most consistent (neo)liberal policies, is characterized by relatively high levels of political trust, and thus serves as a deviant case for Katzenstein’s theory formulated in a ‘narrow’ way.
Nevertheless, the article concludes that the broader interpretation of SSWM illuminates the core themes of Baltic developments since regaining independence. Thisarticle argues that the broader interpretation helps to shed light on the emergence, continuity, and even on some aspects of the relative success of the Baltic politico-economic regimes (in particular Estonia’s better performance). Based on the analysis, it is concluded that SSWM continues to be of relevance to the study of politics and economics of small countries (and beyond).
The first section describes Katzenstein’s original contribution and its two interpretations. The second section discusses and measures Baltic ‘smallness’. In the third section, the ‘narrow’ and ‘broad’ interpretations of SSWM are tested in the Baltic empirical case.
The SSWM and its two interpretations
Katzentein wrote his book in order to solve an interesting puzzle about small Western European countries (1985, p. 9). On the one hand, political scientists emphasized their political stability generated by corporatism. On the other hand, economists focused on their economic flexibility and successful performance. In SSWM, Katzenstein aimed to resolve this conundrum by arguing that these two aspects were in fact related: ‘they are not contradictory but mutually contingent’ (p. 9). He noted how other states could potentially learn from their experience, as even ‘large industrial countries are beginning to experience an increasing economic openness and vulnerability’ (p. 9).
Katzenstein chose to investigate the political economies of seven small Western European countries. Although he did not explicitly state what ‘smallness’ meant, he largely discussed such aspects as population and size of the economy. Importantly, smallness was also related to and to some extent captured by economic openness. Overall, Katzenstein noted that ‘small countries are more open and vulnerable than large ones, economically, politically, and militarily’ (1985, p. 81). Smallness and openness generate vulnerability stemming from changes in international economic conditions. Small countries are more vulnerable to these changes because they need depend heavily on imports. Furthermore, they tend to specialize in certain sectors and are thus less well diversified. Finally, important parameters of economic performance, such as growth rates and inflation, are heavily influenced by outside forces.
Overall, according to Katzenstein, all countries must find ways to respond to global economic change. However, there are three basic responses. First, ‘liberal countries such as the United States rely on macroeconomic policies and market solutions’ combined with ‘limited, ad hoc protectionist policies’ (p. 23). Second, ‘statist countries such as Japan are endowed with the means and the institutions to pre-empt the costs of change through policies that pursue the structural transformation of their economies’ (p. 23). Small countries, however, do not have the means to adopt either of these two approaches. Instead, the elites in small European countries ‘live with change by compensating for it’ (p. 24). They have ‘a preference for a reactive and flexible policy of industrial adjustment (…) relying heavily on indirect policy instruments such as taxation rather than broad-gauged political efforts to transform the structures of their economies’ (p. 27).
What is this ‘domestic compensation’? It includes measures such as welfare spending to compensate the losers from economic changes and reduce the uncertainty stemming from market fluctuations. According to Katzenstein, ‘these policies are carried by the conviction that it is important to counter some of the harmful effects of international liberalization’ (1985, p. 47). This is what explains a faster growth of public economy in smaller states than in large ones in Europe (Katzenstein 1985, p. 54). Besides, these small countries ‘have tried to restrain their wages and, occasionally, prices through a government-coordinated incomes policy (as in the Netherlands and Denmark), or through a centralized system of collective bargaining (as in Sweden and Norway), or though some combination of the two (as in Austria)’ (Katzenstein 1985, p. 56). Wage restraint is used to ensure competitiveness and adjust to balance of payments problems.
In turn, the policies of domestic compensation allow for securing political legitimacy: ‘through their policies, political leaders in the small European states have maintained the legitimacy of the political arrangements governing their societies (…) Political leaders retain a tight hold on mass participation, and electoral changes have been very small’ (Katzenstein 1985, p. 28). In his follow-up article writing about the small Western European industrialized countries, Katzenstein (2003, p. 19) notes that ‘since for decades their policies offered generous social protection against international dislocations, confidence levels are high and stable’. Katzenstein (1985, p. 28) acknowledges that legitimacy is a ‘broad construct’ and difficult to measure. When writing about legitimacy, he refers to such aspects as trust in politicians and political institutions, high levels of participation, small electoral changes and lack of protests (Katzenstein 1985, p. 28).
Both domestic compensation policies and political legitimacy arecreated via the institutions of ‘democratic corporatism’. Katzenstein distinguishes the ‘democratic corporatism’ characteristic of small industrialized Western European states from authoritarian corporatism (e.g. in fascist Italy) or ‘state capitalism’ (e.g. in Japan). Democratic corporatism has the following characteristics (Katzenstein, 1985, p. 32): ‘an ideology of social partnership expressed at the national level; a relatively centralized and concentrated system of interest groups; and voluntary and informal coordination of conflicting objectives through continuous political bargaining between interest groups, state bureaucracies, and political parties’. Corporatist institutions ensure greater political stability and consensual, rather than confrontational, policies. Eric Jones (2008, p. 9) stated this in the following way: ‘small states are more consensual because they are more vulnerable to world market forces (and because they are aware of that vulnerability)’.
All of these preconditions also ensure a successful adjustment to changing economic conditions. Political legitimacy and consensual politics reduce tension within society and form a basis for the search forflexible solutions and policy learning. Furthermore, coordinated wage bargaining helps to avoid deteriorating competitiveness and associated macroeconomic problems.
Narrow interpretation
One possible way of reading SSWM is extracting a specific causal chain running from smallness to vulnerability to corporatism and domestic compensation to political legitimacy and finally to successful economic performance. Smallness (vulnerability) increases the chances for (or leads to, if stated deterministically) democratic corporatism and domestic compensation policies. Domestic compensation refers to the size of the public sector, and especially welfare spending. In Hardiman’s words, ‘the “compensation hypothesis” holds that increasing trade exposure gives rise to pressures for an expansion in public spending, especially on welfare items’ (Hardiman, Murphy & Burke 2008, p. 599). Of course, Katzenstein has not been the only authorto lay out this argument. Other authors provided theoretical and empirical support for the assertion that increased economic openness leads to public sector growth (e.g. Rodrik 1998).
It is interesting that in his follow-up article, Katzenstein (2003, p. 22) makes a specific prediction about the future development of Eastern European capitalist systems, including those in the Baltic countries. After noticing what he saw as corporatist trends, he outlineshis expectations:
The emerging social market economies are unlikely to resemble statist or neoliberal variants of capitalism. It is more likely that they will have greater resemblance with the institutions of the German variant of capitalism, among the large industrial states the closest cousin of the democratic corporatism of the small European states.
Focusing on the second part of the causal argument, democratic corporatism and domestic compensation create condition for political legitimacy. This, in turn, helps to secure successful economic performance. The prediction is that countries (at least small ones) which have democratic corporatist institutions as well as strong domestic compensation will be more successful economically and, even more importantly, politically, and as a result more trust in political institutions. One should note here that this assertion also implies a counterfactual: in the absence of democratic corporatist arrangements and domestic compensation policies, wide economic fluctuations would preclude the build-up of political legitimacy and trust or erode its existing stock. Overall, the expectation is that small open countries lacking legitimacy due to lack of democratic corporatism and domestic compensation will be less economically and politically successful.
Broad interpretation
However there is another way of interpreting SSWM. In contrast to the ‘narrow’ version, the ‘broader’ interpretation refers not to specific causal connections outlined above, but rather to a more general way of approaching the study of political economy in particular and politics in general. What I mean by ‘broad’ interpretation in this article is the position to take into account size (smallness) as a variable, analyse ideas and history, as well as recognize the importance of political legitimacy in affecting economic performance. Note that only the first item focuses on differentiating small states from larger ones. History, ideas and political legitimacy are important regardless of state size.
To begin with, one of the main lessons of SSWM is that size is important and should be treated as a variable rather than a constant. In ‘Small States and Small States Revisited’, Katzenstein (2003) briefly explains his motivation for writing SSWM. SSWM was a follow-up on an earlier research project – Between Power and Plenty (Katzenstein 1977) – and an attempt to address some of the latter’s drawbacks. One of the chief ones was inattention to size as an explanatory variable. Smallness and vulnerability – Katzenstein maintains – have important and far-reaching consequences for the development and functioning of small countries’ politico-economic regimes. Of course, the ‘narrow’ interpretation also focuses on the effects of smallness, but it formulates a specific prediction on its role. By contrast, the ‘broad’ version simply states that size is significant, but the way it affects any country’s political economy and politics is contingent.
The second implication of SSWM is the significance of history. Specifically, ‘in the small European states (…) a tradition of accomodative politics dating back beyond the nineteenth century facilitated the political reorientation that took place in the 1930s and 1940s’ (Katzenstein 1985, p. 35). In SSWM, Katzenstein claims that history is important, which means that there are powerful continuities to a given country’s economic and political strategies as well as the related policy choices. He explains the emergence of and differences in democratic corporatism historically. In other words, choices are not simply made in an abstract vacuum, but rather are conditioned by historical context. In explaining the emergence and continuities of the corporatist systems in small Western nations, Katzenstein turns to their experience of vulnerability in the first half of the twentieth century. One of the conditions for the formation of democratic corporatism, Katzenstein argues, was weak political right. Notice that this argument is in some contradiction with the first causal link of the ‘narrow’ interpretation, because vulnerability alone is no longer enough to produce corporatism – rather, democratic corporatism is a product of two necessary but insufficient conditions: (perception of) vulnerability and weak political right. In fact, adopting a historically informed perspective it’s possible to argue that this corrected version of the causal chain is still flawed in the sense that while vulnerability and weak right produced corporatism in the specific temporal and spatial context (industrialized small western countries), it might not occur in other contexts. In other words, causal processes are context-specific and should be treated as such. Third, SSWM highlighted the significance of ideas. In his revisit of SSWM, Katzenstein (2003, p. 11) writes this:
What really mattered politically was the perception of vulnerability, economic and otherwise. Perceived vulnerability generated an ideology of social partnership that had acted like a glue for the corporatist politics of the small European states. This was the first and most important explanatory variable in Small States.
Katzenstein continues noting that this point was largely missed in the reception and reviews that followed SSWM’s publication. He argues that the field of political economy was not yet ready to include ideas as an important and researchable variable into the analysis of political and economic reality. Consequently, Mark Blyth (1997, p. 201) sees the seeds of constructivist political economy in Katzenstein’s work:
This is why Small States is more than a synthesis of coalitional and institutional approaches. It also opened the door to moving beyond them, to put ideas and social constructions front and center in political economy explanations rather than treat them as a residual category to mop up variance unexplained by these other approaches.
Finally, Katzenstein’s work attests to the importance of political legitimacy. As Herman Schwartz (2010, p. 365) points out, it is exactly the issue of political legitimacy, and not economic efficiency, that is at the core of SSWM: ‘Small States in World Markets is about political efficacy and legitimation rather than scoring who is ahead in the economic sweepstakes. Its case for democratic corporatism rests on norms, particularly stability, rather than on narrow measures of economic efficiency’. In Katzenstein’s words, ‘economic performance, then, is not a yardstick by which we can directly measure the successes and failures of the small European states’ (Katzenstein 1985, p. 28). Still, even if economic performance was not the key issue in SSWM, one can draw the implication that political legitimacy does matter for economic performance.