Summary: KEY ISSUES The Baltic economies have performed well in the last two decades relative to other transition and emerging market economies, but they face some common challenges calling for national and regional policy responses. These challenges relate to their ability to sustain economic growth going forward, particularly as members (or prospective members) of the euro area. The Baltic economies have all experienced creditless recoveries following the global financial crisis, though with some underlying differences. In Estonia, real credit is no longer contracting. In Latvia and Lithuania, where credit expansion is yet to resume, measures aimed at reducing the private sector debt overhang—such as improvements in insolvency regimes—could spur credit demand, while reducing credit risk and thus encouraging supply. Over the medium term, the Baltic economies could explore initiatives to deepen capital markets and reduce dependence on bank credit. The Baltics aspire to move into high-skill, high value-added, exports in rapidly growing markets, but they are competing with other countries in search of the same markets. National policies to improve education and training would help, but collective efforts to improve infrastructure links to the rest of the European Union are also necessary to improve competitiveness. While labor markets have shown considerable resilience and flexibility, the Baltics appear to be at or near full structural employment but with still high unemployment rates (around 10 percent). This suggests scope for policies to reduce structural employment, including reductions in the labor tax wedge (particularly for lower-wage workers) and emphasis on education, training, and other active labor market policies that have shown cost-effectiveness in the Baltics or their Nordic neighbors.

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