Small States Under Pressure

Hilmar Þór Hilmarsson

It is not always easy to be a small state in a global world. Many small states seek shelter, some by building alliances with larger states, others by joining international organizations such as the European Union. A shelter can be political, military as well as economic.

The Nordic and the Baltic States have all sought some, albeit, different levels of European integration (see figure 1). Iceland and Norway are the least integrated with access to the single EU market via EFTA-membership and the EEA-agreement. Sweden and Denmark are EU member states without adopting the euro Finland and the Baltics states have the highest level of integration with both EU and Euro Area membership. For those countries euro adoption is perhaps as much for security, as for economic prosperity. All four euro countries in the Nordic Baltic group have borders with Russia. Ironically, unstable Russia has become a force both to expand and keep the Euro Area together.

Figure 1: Different levels of Nordic Baltic European Integration

For the Baltics Euro Area membership has become even more important with the uncertain US commitment to NATO. Some American politicians have made absurd statements about the Baltic States. Newt Gingrich, former speaker of the House of Representatives, told CBS that “Estonia is in the suburbs of St Petersburg […] I’m not sure I would risk nuclear war over some place that is the suburb of St Petersburg.” Statements like that from an influential US politician must be especially shocking for Estonians and all the Baltics, but also for all EU member states as well as for European NATO member states. During the election year 2016 President Trump said, according to the Washington Post: “Pulling back from Europe would save this country millions of dollars annually. The cost of stationing NATO troops in Europe is enormous. And these are clearly funds that can be put to better use.”

The Baltic states sought economic shelter in the EU during the 2008 crisis. But the cost was high with austerity and fixed exchange rate policy, a condition for euro adoption. Staying within the Euro Area is not easy. Tight fiscal discipline and a fixed exchange rate have not exactly proven to be a growth formula for transition countries wishing to catch up. But this formula seems perfect for stable stagnation. And the Euro Area crisis continues with incomplete fiscal and banking union. But the Baltics know that powers like Germany and France could not possibly tolerate an attack from Russia on the Euro Area. They would be forced to respond. So, the Euro provides external security for the Baltics, but the austerity policies fuel internal divisions and outward migration.

Big Brother

Some small states have also sought alliances with larger more powerful states. During the Cold War Iceland sought security shelter in the US with a bilateral defense agreement and NATO membership. When the crisis hit in October 2008 US defense forces had already left. The Prime Minister appeared on TV with a statement ending “May God bless Iceland.” Not very comforting to its citizens during a week when 85 percent of its banks went bankrupt. Iceland was without allies. No one in Washington or Brussels or London wanted to pick up the phone to receive a call from Iceland during those days of great need and uncertainty. Iceland had no economic shelter. But in retrospect this was a blessing. Loans to rescue those banks would have become a burden for the future. Fortunately for Icelanders, the government failed to rescue those banks and was forced out of office by the public. Democracy found a way forward.

Iceland and the Baltics post-crisis exhibit a big difference in economic performance. GDP growth in Iceland in 2016 was over 7 percent, unemployment 3 percent and inflation just below 2 percent. Of course, things can change quickly, but one can´t help thinking that the fiscal stimulus and flexible exchange rate policy there paid off. And Iceland has access to the single EU market as Norway does and has good relations with the EU without formal membership.

And one can hardly mention European integration or disintegration today without Brexit. The old Empire is sailing away from Brussels into an uncharted territory. Who knows where it will end? Will the Scots consider jumping off the ship? EFTA/EEA arrangement Norwegian/Icelandic-style might be unacceptable for a major country like Great Britain, but perhaps not for an independent Scotland wanting to maintain access to the single market. The Nordic Baltics are sometimes referred to as NB8. Will NBS9 including Scotland materialize? I don’t want to underestimate Great Britain, a country that has faced international challenges before. But the task ahead is daunting. The pathways are unknown. The Tories seem clueless.

Shelters can be a blessing and a curse for small states. For the Baltics, the shelter provided by the European Union in 2008 came at a high cost with fixed exchange rate policy and austerity programs. Foreign banking systems were saved. Iceland enjoyed no such shelter. Its currency depreciated sharply and the government ran large stimulus deficits well beyond the formulae prescribed in Brussels. Its local banks collapsed but its economic recovery was resounding.