Latvia has overheated; Lithuania and Estonia are perilously hot and show signs of overheating. These are the recent news and phrases, describing not the widely debated issue of climate change but, rather, these countries’ economies. Just as feverish brain, an overheating economy doesn’t sound good. What is the essence of this overheating and is Lithuania’s economy indeed too hot?
The metaphor of overheating economies has become popular due to the so-called business cycles, a process when a business or economic upturn is followed by a recession, then again by an upturn and so on. A number of theories have been constructed about this issue. Some of them associate business cycles with the cycles of sun’s activity and say that the situation must change every seven years; some simply write off all of it as an unpredictable phenomenon. But the answer was discovered already back in 1930s, and the Nobel Prize winner was awarded in 1970s. Business cycles stem from distortions of money supply as a result of government intervention – central banks, budget deficits and a reinforcement of all these factors through the so-called multiplier effect in commercial banks.
If the government spends money, it spends more than usual and builds an impression that not just money but economic goods increase as well. Thus, people are being misled and start to evaluate the situation improperly: they indulge in projects that are doomed to be unaccomplished because the amount of economic goods is smaller than it could have been judged from the amount of money available in the market at the start of the project. For example, a businessman starts to build a business centre for rent, but eventually it appears that he has to pay larger wages to the workers hired and that prices of building materials have gone up. So the project’s estimate grows bigger, which poses difficulties for finishing the job. Moreover, problems arise regarding the letting of the business centre as potential lessors are struck with the same troubles.
Today the amount of money in Lithuania has increased, and people consume more goods and services, more products are imported, more local goods are purchased and all this boosts businesses’ turnover and profits. This process has several causes: labour productivity and exports are on the rise (albeit not as rapidly as fancied), EU’s financial support keeps flowing into Lithuania, and a certain share of emigrants’ money is being spent here. Such an atmosphere heightens optimism regarding the future prospects, so people borrow more intensively (and they borrow money that comes from abroad). Equally the same, the government borrows, too. However, there is an essential difference between people’s and government borrowing. People will need to earn money to repay their debts, whereas the government will have to take money earned by people for paying back its debts.
Both of these things are associated with the so-called cooling of the economy. Government borrowing has boundaries. Not a single financial institution would lend money to a debt-laden, disreputable government or the one burdened with unreformed, ineffective public sectors, while debts will need to be repaid anyway. Consequently, an additional burden will fall on the taxpayers’ shoulders, and Lithuania will not be able to attract additional money from outside. For this reason, the first and underlying measure to revert artificial overheating of the Lithuanian economy today is to borrow strictly according to the government’s means. Today the state’s budget must be balanced with a plus, not a minus mark.
People who have taken loans will have to return them as well. All this would seem fine, if the conditions for creating welfare in the market did not depend on the same government. The thing is that the government is the source of most problems. In addition, the constantly cited emigration, from a systemic point of view, is more of an outcome than a cause. Restrictions of land use, inflexible employment regulation, the tax burden, ineffective public sectors and rampaging bureaucracy choke down business opportunities. And government borrowing, in its turn, not only diminishes financial resources available for the business, but also jeopardises that when the need for these recourses will be the biggest, the government will not only jump a reduction of taxes as it will need to pay debts but will also pump more money from the business sector.
It is impossible to say everything about economic upturns and downturns in a single commentary. It’s the basic problem of economic theory and the toughest practical task for economists. However, today one thing in Lithuania is clear – economic overheating in itself is not a threat. Quite the contrary. Lithuania’s economy needs to remain considerably warmer, compared to others, in order to catch up with at least the EU average. The problem is that the economy is being artificially overheated by the government through its borrowing and unjustified tax favours, plus that the government is incapable of directing economic policy towards making the country’s economic activity more competitive. In sum, there’s no fatalism regarding the overheating of the economy – we simply need to behave reasonably – we mustn’t pour oil on the flame, if we wish to sit beside it and get warm. This is valid for all people, but the greatest responsibility rests with the government.