Economic changes in Lithuania after re-establishment of independence in 1990: the case of a double transition
First draft, comments welcome
Constitutional changes introduced when Lithuania re-established independence in 1990 go beyond the reform of economic relations with the rest of the former Soviet Union. Political and constitutional changes have been paralleled by the changes of economic regime, i.e. transition from the centrally planned economy to the market economy. This type of systemic change implied radical reforms of property rights, transactions between economic agents and regulation of economic environment in addition to re-regulation of relations with the Soviet Union (and Russia). The centrally planned economy characterized by the waste of resources, huge disparities between demand and supply, social inequalities and popular discontent was replaced by the market economy. At the same time, economic relations with other parts of former Soviet Union which were based on the needs of centralized system run by the Communist party have been broken as country entered a global economic system.
These changes have been first resisted by the Soviet leadership which imposed economic blockade and isolation on Lithuania in 1990, but after the failed coup d’etat in August 1991 the Soviet Union was soon dissolved with Russia assuming its obligations (loans, military equipment, etc.). Lithuania’s relations with Russia have been based on newly negotiated international agreement signed in the end of July, 1991. From the legal point of view, by declaring the re-establishment of independence on March 11, 1990, Lithuania restored the statehood which was based on the interwar experience interrupted by Soviet occupation in 1940. In other words, legally it was not Lithuania breaking away from the Soviet Union in 1990, but it was the end of the Soviet rule in Lithuania which has been imposed from outside for fifty years. Economically, however, Lithuania had to restructure radically its economic relations with outside world since during the Soviet period its economy was an integral part of centrally planned system, significant part of which was oriented towards the needs of Soviet military industry. Lithuania’s economic relations have been limited to Soviet Union and after the restoration of independence it also reentered international economy and international organizations such as WTO and later the EU. There has been little domestic expertise of such type of systemic reform, so the transition has been based on external advice from the IMF, World Bank and other organizations as well as trial and error process. Market institutions such as the stock exchange, banking system and others had to be established from the scratch. Institutional change together with liberalization, privatization and stabilization processes constituted the main directions of reforms.
This article discusses in detail constitutional reforms which have been undertaken as Lithuania re-established its independence and reformed its economy. It focuses on the main elements of economic reforms, especially settling relations with the former Soviet Union and re-entering global economy. Although this transition to independent institutions and reorientation of trade and investment towards other economic partners has been undertaken relatively quickly it should be noted that in some areas like energy Lithuania together with other Baltic States still remains part of the former system which links it with Russia. This means that even being part of the EU for almost a decade Lithuania still maintains important links with Russia which often make it vulnerable to possible manipulation of economic links for political purposes. Russia remains one of the key trade partners for Lithuania and these economic links are from time to time manipulated by initiating excessively strict checks of goods from Lithuania in Russian customs or setting the price of natural gas higher than for most other EU countries. Unresolved bilateral issues include the compensation for the damages done by occupation which is claimed by Lithuania and which Russian leadership refuses to acknowledge. The systemic nature of changes which have been more radical than possible reforms which would have to be undertaken by Scotland if it votes to become independent from the UK as well as reluctance of regime in the center of the former Union to allow such transformation are the key characteristics which differentiate Lithuanian experience from the Scottish.
Keywords: transition reforms in Lithuania, external economic policies, disintegration, institutional reforms, reintegration into the global economy.
In March, 1990, after fifty years of Soviet Union occupation Lithuania re-established its independence. Political movement which started as a movement for reforms taking advantage of broader Perestroika reforms in the Soviet Union initiated in mid-1980s, changing geopolitical environment and the end of the Cold war soon transformed into complete overhaul of the Soviet repressive political system and central planning economy. The movement for independence supported by absolute majority of Lithuanian population resulted in the re-establishment of an independent country on the basis of the continuity of the state which existed during the interwar period from 1918 to 1940. Though history of Lithuania’s statehood goes back to Middle Ages, it was the memory of the independence of interwar period which served as a reference point in popular memory and as a legal basis for the re-establishment of a sovereign polity with its own institutions and public policies.
The case of Lithuania as well as other two Baltic States (Estonia and Latvia) is interesting as a case of a double transformation. For fifty years the country was incorporated into the Soviet Union with no sovereign powers to conduct its policies and ruled from the center of the Union by decrees of the Communist party. Its economy was also managed from the center by central planning institutions assigning production and distribution of resources on the basis of their calculations and plans. Therefore, re-establishment of independence implied political reforms to end repressive regime and creation of sovereign democratic institutions as well as the transition from the central planning economy to the market. Although the transition reforms took place in many Central European countries which have been part of the Soviet dominated block after the II World War, the change in the Baltic States has been most radical due to their previous incorporation into the Soviet Union.
This article provides analysis of economic and institutional reforms that formed the basis of what constituted the break-up of the former centrally planned economy and re-integration of Lithuania’s economy into the global system of economic relations and the institutions managing them. Re-regulation of relations with Russia was part of this process and has gone through several stages from open hostility of the Soviet elites to aspirations of independence of Lithuania and resulting economic blockade in 1990, even military actions in January 1991, to signature of the treaty between Lithuania and Russia as two sovereign countries, to the failed coup-d’etat in Moscow which allowed recently elected President of Russia B. Yeltsin to consolidate his powers, to dissolve officially the Soviet Union by the end of 1991 and embark on reforms in Russia.
Although there has been a lot of interest in transition reforms of 1990s and a lot has been written about their methodology, instruments, directions and results (see, for example, Lainela, Sutela, 1994, Balcerowicz, 1995, World Bank, 1996, OECD, 2000) much less attention has been given to the re-regulation of economic relations with the former center. This article focuses on the main steps which have been taken by Lithuania in restructuring its economy, re-establishing new institutions and settling relations with Russia which used to be its most important economic partner. It is argued that re-regulation of economic relations between Lithuania and the rest of the former Soviet union, especially Russia, has taken place as part of the political, institutional and economic reforms which have been driven by the desire to restore sovereignty of Lithuania and “return to Europe” as well as international community.
Since this has been a double transformation, re-establishment of sovereignty was accompanied by systemic economic and institutional reforms making re-regulation of external economic relations and establishment of domestic institutions a challenging task. It was learning by doing process often reinforced by references to the interwar policies and institutions, active use of foreign expertise and interrupted either by external factors (hostility of Soviet leadership and collapse of former trade relations) or domestic politics. Interestingly, it was through the use of international norms and institutions (especially the EU since accession in 2004) that Lithuania attempted to settle some of its relations with Russia and continues to respond to the instances of Russia’s authorities manipulating bilateral trade and energy links.
The article first presents the political context, the main legal steps which have been taken and the arguments which have been used during the process of re-establishment of independence, also the background information on Lithuania receiving diplomatic recognition by other countries. It then discusses key economic reforms and external policies which have been initiated by its first governments during early 1990s, their main elements and directions with a focus on re-regulation of economic relations with the former Soviet Union, also the main steps in trying to settle relations with the Soviet Union and Russia and the most controversial issue some of which still remain unresolved even after more than two decades since the treaty between Lithuania and Russia has been signed. It discusses the role of previous experience of independent institutions and policies during the interwar period as a reference point and the impact of integration into the EU as an important factor which frames Lithuania’s economic policies, especially external economic relations. It concludes with observations regarding the key trends in re-regulating Lithuania’s economic relations, its re-integration into the international economy and provides insights on possible lessons for other cases of re-regulating relations between newly (re)established sovereign entities.
Political context, legal steps, international recognition
Lithuania’s drive for independence should be seen in the context of previous history of statehood and resistance to Soviet occupation after the II World War. Reminiscences of interwar independence have remained strong in the popular memory throughout fifty years of Soviet occupation. They have been reinforced by the stories of postwar military resistance against Soviet occupation which lasted more than a decade, massive prosecutions and deportations of Lithuanians to Siberia by the Soviet regime. Therefore, when the window of opportunity opened with the start of Perestroika initiated in mid-1980s by M. Gorbachev and changes in geopolitical situation in Europe, the movement for independence started. The fact that about 80 percent of country’s population were Lithuanians – partly a result of less intensive Soviet industrialization than in other Baltic States, could have contributed to the rapid rise of independence movement. This also allowed later to grant the rights of citizenship to all inhabitants residing in Lithuania, which was not the case in other two Baltic States due to much larger Russian minorities in these countries (in 1989, Russian minorities in Estonia and Latvia made up respectively 35 and 42 percent, and only 12 percent in Lithuania with Polish minority constituting 7 percent of Lithuania’s population (OECD, 2000, p. 19)).
The Movement for Reform of Lithuania (Lietuvos Persitvarkymo Sąjūdis) was officially established in June 1988. It had a wide support among the population of a country which was expressed during numerous public meetings and actions such as “the Baltic Chain” of about two million people coming together and holding hands from Vilnius to Tallinn which took place in August 1989 to commemorate the 50th anniversary of Ribentrov-Molotov Pact between Stalinist Soviet Union and Nazi Germany. Such public actions have been actively coordinated with similar movements from Latvia and Estonia.
Initially the movement supported reforms aimed at increasing economic autonomy of Lithuania within the Soviet Union. In the program of the Movement for Reform, the section on economy comes after sections on society, human and citizen rights, culture, religion, nationality and others. It emphasized the sovereign right of Lithuanian people to manage their economy, the autonomy from the Soviet Union based on the contractual relations with other parts of the Union, sovereign monetary, fiscal and other policies, establishment of private property and competition. However, it did not detail how these principles should be implemented and mostly emphasized, that state economic entities (there were almost no private ones) should become regulated by Lithuanian institutions rather than Soviet Union. Although in its program, the Movement mentioned the possibility of federal arrangement with the Soviet Union, the notion of sovereignty which soon became associated with independence was the most important one.
In 1988, a group of economists many of whom later were elected to the Supreme Council of Lithuania or became ministers prepared a concept of Lithuanian economic autonomy. It outlined reforms linked to the property rights and introduction of market relations (at that time the term of “socialist market” was used and “cooperatives” together with state enterprises rather than private companies were seen as the main entities in the economy), sovereignty of Lithuanian state to decide domestic economic issues and use resources, reform of monetary and fiscal systems, introduction of national currency and national tax system (Šimėnas, 1996). Although it was planned that trade, tax receipts and other economic relations with the rest of the Soviet Union would be conducted on the basis of inter-state agreement, the assumption at the time was that Lithuania would still be part of the Soviet Union, there were also no provisions on Lithuania’s external relation with other parts of the world outside the Union. There were no quantitative estimates made on the effects of economic sovereignty, rather it was based on the underlying assumption that the system of centrally integrated Soviet economy was proven to be inefficient and the proposed measures were supposed to be welfare improving. Besides, sovereignty was desirable in principle.
The reforms were supposed to be phased in from spring 1989 and early 1990. By mid-1989 the Law on the basis of Lithuanian economic sovereignty was adopted. However, it did not foresee concrete further steps and the mechanism of implementation and therefore remained detached from practical policies. More importantly, central Soviet authorities rejected the whole concept of economic sovereignty. This decision weakened significantly the arguments of the proponents of Lithuania remaining in the Soviet Union and strengthened supporters of drive for complete independence (Šimėnas, 1996). The Movement for independence gained strength and the reluctance of the Soviet leadership to allow more autonomy for Lithuania has been used in the domestic debate as a prove that the moderate method of reform within the Soviet Union supported by the Lithuanian Communist Party has no prospect.
The re-establishment of independence became the main goal of the movement. The Lithuanian Communist Party lost its dominant position and after initial hesitation majority of its leadership decided to split from the Soviet Union Communist party and to support the goal of the movement. In February 1990, first free elections to the Supreme Council of the Lithuanian Socialist Republic took place with absolute majority of members elected being either candidates of the Movement for independence or supported by it. The election program which formed the platform for the Movement during the campaign for the February 1990 elections to the Supreme Council was quite explicit about the sovereignty of Lithuania and the need for the Soviet Union to recognize its independence and re-establish mutual economic relations on the basis of international agreements. On March 11, 1990, the Supreme Council adopted an Act declaring the re-establishment of the independence of Lithuania.
It should be noted, that the process leading to the re-establishment of independence has been based on the logic of continuity of the statehood of the interwar period. A number of arguments have been used at the time to show the continuity of Lithuanian state, including the existence of Lithuanian diplomatic missions in many foreign countries during those fifty years of Soviet occupation, the fact that most Western democracies have never recognized the incorporation of the Baltic States into the Soviet Union, the use of Lithuanian passports which have been issued before the II World War in many foreign countries, finally, the protection of property of Lithuanian State (premises of the embassies, deposits and gold kept in foreign banks) (Sinkevičius, 2012).
Therefore all the steps of the Supreme Council leading to the re-establishment of independence (i.e. changing the status of the Supreme Council, the title and official symbols of the state) have been carefully drafted in order to ensure the logic of continuity. The Constitution of the Lithuanian Soviet Socialist Republic was repealed and the Lithuanian Constitution of 1938 was briefly restored with certain amendments to take into account the differences of political and institutional set up in the prewar Lithuania and the situation in 1990. Soon afterwards the temporary Constitution was adopted which in 1992 was replaced by the new Constitution of Lithuanian Republic adopted by a popular referendum. From a legal point view, it was not Lithuania’s secession from the Soviet Union. Since it was annexed and incorporated into the Soviet Union illegally fifty years ago, it was not Lithuania exiting from the Union, but the Soviet regime leaving Lithuania.
Thus, while Lithuania initiated negotiations with the Soviet leadership on the terms of inter-state relationship, it tried at the same time to gain international support and diplomatic recognition. This was not an easy task as major Western powers have been concerned about the situation in the Soviet Union, the prospect of its reforms and broader geopolitical changes. It took almost a year to get first diplomatic recognition. Iceland was the first country to recognize Lithuania on 11 February 1991. Denmark was the second to follow, 17 days later. However, despite the strong support expressed by leaders of foreign states in private communications, recognition from the majority of countries came only after the collapse of the Soviet Union had become obvious – after the Moscow coup in August 1991.
As a succession of recognitions finally began, the next task was to establish Lithuania in the most important global and regional international organizations and become an accepted and equal member of the international community. Lithuania became a member of the OSCE already on 10 September 1991, of the United Nations on 17 September 1991, and the Council of Europe on 14 May 1993. Strong efforts were also directed to advancing regional cooperation among the three Baltic States. Political trilateral cooperation among Lithuania, Latvia and Estonia had already begun during the rise of the independence movements in all three countries in the late 1980s and continued after they had re-established independence, to a large extent by following the model of Nordic cooperation. In the field of economic relations the Baltic States pursued liberalization with several free trade agreements signed in the course of the 1990s. Importantly, from 1994, when the first free trade agreement in industrial products was signed, these measures were directly linked to Baltic States’ integration into the EU. Similarly, efforts to achieve membership in NATO impacted directly on trilateral cooperation in security and military affairs (Vilpišauskas, 2003).
Finally, the period of early 1990s was marked by an intense discussion of the foreign policy priorities of the country. Essentially, there were two options on the table: integration into Western institutions or neutrality. Any possibility of creating an alliance or participating in another form of multilateral cooperation with Russia and other former republics of the former Soviet Union was rejected without any further discussion on the basis of the referendum of 1991 and the constitution of 1992. The Constitutional Act of the Republic of Lithuania “On the Non-Alignment of the Republic of Lithuania to Post-Soviet Eastern Unions,” which is an integral part of the Constitution adopted in the referendum of 25 October 1992, states that Lithuania resolves “never to join in any form any new political, military, economic or other union or commonwealth of states formed on the basis of the former USSR” (Constitution of the Republic of Lithuania, 1992).
The idea of neutrality was expressed by the metaphor of becoming a bridge connecting two worlds – the East and the West. This idea did not have much support, as it was considered mainly as a cover-up for remaining in the sphere of influence of Russia. Moreover, the experience of neutrality during the interwar period was a further argument against such a geopolitical status. Thus, around 1993 the consensus of the political elite began to emerge that the best foreign policy strategy for Lithuania was to become a member of NATO and the EU. This consensus was followed by the agreement of the parties and then by the official letter of the President Algirdas Brazauskas to the NATO Secretary General in early 1994. A free trade agreement with the EU was signed in July 1994 and the Europe (Association) agreement in June 1995. The official application for EU membership was presented in December 1995. Membership in the EU and NATO, together with the establishment of good neighbourly relations, became the three cornerstones of Lithuania’s foreign policy.
The preparation for integration into NATO and the EU took place for about a decade until accession in 2004. Lithuania became a member of NATO on 1 April 2004, and a member of the EU on 1 May 2004. The strongest efforts of Lithuanian foreign policy during these ten years had been devoted to reaching these two goals as soon as possible. Bilateral relations with neighbouring countries were developed within the context of the integration process. As it will be discussed below, active use of international and European organizations has become an important method for Lithuania to increase its bargaining power vis-à-vis Russia and to regulate its relations with Russia. WTO rules or EU 3rd energy package norms are just two examples which Lithuania used to regulate its trade or energy relations with Russia.
Economic reforms and re-regulation of external relations
Soviet economy was based on central planning which, despite official praises and grand statements about outcompeting USA and other Western economies
, was increasingly missing the planning targets, distorting incentives, misallocating resources and resulting in low quality products or simply empty shelves in the shops. The central planning system was based on the needs of Soviet Union, especially, its military industry, and all its fifteen republics have been subsumed into the centrally regulated production networks. Masking behind declarations about equality and progress, the Communist Party nomenclature was accumulating resources and power while most people have been living in poverty. Although officially there was no unemployment, people were not allowed to start private enterprise, acquire property, save and invest. Prices were regulated and because most of them have been set artificially low
, there was too little supply.
Information asymmetries characteristic to central planning, incentives to plan less and lobby for more resources from the suppliers, finally, lack of competition all resulted in misallocation of resources, wide spread corruption based on informal connections, low quality and lack of basic consumer goods (Šimėnas, 1996). Although the Baltic States “were the best pupils of an admittedly very bad class” (Lainela, Sutela, 1994, p. 18), many people have been very critical of the Soviet economic system and remembered prewar times as the times of prosperity when the levels of living standards in the Baltics and Finland have been similar. Soviet economic system was ridiculed by population and was increasingly exposing its deficiencies compared to market economy. This contributed to the initiation of economic reforms in mid-1980s in the Soviet Union and became a subject discussed by independence activists in Lithuania.
The next day after the Supreme Council adopted the Act re-establishing the independence of Lithuania on March 11, 1990, it also adopted the declaration to the leader of Soviet Union H. E. M. Gorbachev suggesting to start negotiations between Lithuania and Soviet Union regarding the settlement of all issues linked to the re-establishment of independence. However, Moscow refused to recognize the independence of Lithuania and to accept the fact that Soviet laws ceased their power in Lithuania. Soviet authorities reacted by imposing economic blockade and cutting supplies to Lithuania, stopping payments for the production sold to Soviet Union, restricting communications and border crossing. The main goal of the blockade was to cause popular discontent and to pressure Lithuanian leaders to give up the idea of a sovereign state. At the time almost all external trade of Lithuania was with the Soviet Union block, Latvia and Estonia accounting for about 5 percent of it. All three Baltic countries have been completely dependent on the Soviet Union labor, resources and demand, many industrial plants, especially energy enterprises and producers of military equipment have been managed directly from Moscow.
This tense situation between Soviet Union and Lithuania not only contributed to chaotic breaking of economic relations but also to postponement of market reforms in Lithuania (Vilkas, 2008). Lithuanian leaders concerned about popular reaction to possible price increases after their liberalization, hesitated to start implementing economic reforms – liberalizing prices and economic transactions, privatizing, establishing private banking, allowing noncompetitive state owned enterprises to go bankrupt, introducing national currency and other reforms. Lithuanian government tried to regulate the economy by using administrative methods, compensating regulated price increases by raising wages, although gradual price liberalization and private business activities have started taking place. Market transactions appeared in parallel to state economic activities and softened the effects of economic blockade imposed by Soviet regime.
After several months of the deteriorating economic situation in Lithuania since the blockade was imposed, its leaders announced a one-hundred-day moratorium on the legal consequences arising from the Act of re-establishment of independence. The moratorium was terminated by the end of 1990 after the unsuccessful attempts of the Soviet leaders to convince the Lithuanian authorities to abandon their goal of restoring independence. The Soviet authorities tried to use force as well in efforts to prevent the re-establishment of an independent Lithuania and the dissolution of the Soviet Union. On 13 January 1991, they sent tanks to Vilnius, occupying the TV tower and killing 14 people during that night.
This move of the Soviet authorities, which was publicly also condemned by the leader of the Russian Federation Boris Yeltsin, did not succeed in reducing the popular support for Lithuania’s independence. The initiative of the leaders of Lithuania to involve the public by organizing a referendum on the re-establishment of the independence of Lithuania on 9 February 1991 – when a clear majority of those who participated voted for an independent and democratic Lithuania – was seen as an important step legitimizing the decision to seek international support. Popular support for independence was later reconfirmed in two other referendums – one organized the next year on the withdrawal of the Soviet army and compensation for damage from the occupation, and another one on the Constitution of Lithuania.
As it was noted, the hostility of Soviet authorities to the idea of re-established state of Lithuania and to negotiating new international agreement to settle economic relations and outstanding issues contributed to slowing down initiation of economic reforms in Lithuania. The first government, which worked in 1990, was dominated by former Communist party members and was rather slow to implement reforms which have been adopted by the Supreme Council, mostly due to high political and legal uncertainty associated with the position of Soviet authorities not to recognize sovereign decisions of Lithuanian institutions. Although legal basis for re-registering enterprises in Lithuania rather than Soviet Union was adopted in mid-1990, many directors of state owned enterprises remained loyal to Soviet authorities and their removal was complicated by the presence of Soviet military in the country. The branches of the Soviet Union banks also continued to operate under centralized rules ignoring Lithuanian law and the policy of the central Bank of Lithuania. Lithuanian authorities in 1990-1991 urged people to keep their savings in the banks trying to avoid bank runs and the shortage of cash for financing most basic functions of the state. The main concern of the first government was to ensure the functioning of the institutions and supplies of most important products for consumers under conditions of economic blockade. It resigned after the decision to finally allow price increases in early 1991.
The reforms have been started only in 1991 under the second and third governments which have been dominated by reform oriented ministers. From early 1991, Lithuania had formed its own national budget separate from the Soviet Union. There have been favourable initial conditions to limit fiscal deficit and borrowing as Soviet Union loans and assets were later assumed by Russia. From late 1991, all the banks which used to be subsidiaries of the Soviet Union banking system in Lithuania became the property of Lithuania with all their assets and funds. However, Soviet authorities retained significant funds in its banking system which belonged to Lithuanian citizens. In 1997 Lithuanian authorities decided to compensate losses of Lithuanian citizens who had savings in the Soviet banks and lost them during the process of economic reforms – a process which lasted until 2011 during which about 3,6 billion litas have been used for compensations paid to over a million of people, mostly by using receipts from privatization. In 2007, after joining the EU some leaders of Lithuanian independence movement – namely member of the European Parliament at the time Vytautas Landsbergis – tried to get European Commission involved into the claims of Lithuania presented to Russia to compensate these losses resulting from taking over savings of Lithuanian citizens. However, as it will be discussed below, the issue of compensations for the overall impact of Soviet occupation is one of the most difficult issues on which Lithuania and Russia have very diverging positions.
The process of taking over the control of Lithuanian border was also difficult and characterized by high uncertainty during the first year and a half after re-establishment of independence. Although the law on Lithuanian customs was adopted in October of 1990, its borders were controlled by the Soviet customs until the coup d’etat in August 1991. Only in late 1991 on the basis of the treaty with Russia Lithuanian authorities started taking over the control of Lithuanian borders and the activities of the customs.
During one and a half years Lithuanian economy was separated from the Soviet (and later Russian) economy by terminating administrative links between organizations, abolishing the system of centralized provisions of resources, liberalizing prices of most products and services (except energy and some others), creating conditions for competition, introducing temporary currency (coupons) in late 1992 which became the sole legal tender but circulated in parallel to rouble for some time, starting privatizing companies and assets. Although after failed cout d’etat in Moscow many state owned enterprise directors loyal to Soviet regime have been removed, some reforms were still resisted by former nomenclature in state and municipal institutions and therefore have been distorted during the process of implementation (Šimėnas, 1996).
Especially privatization and land reform suffered from implementation problems, creating conditions for manipulation of insider information, corruption and criminal activities. Restitution of rights to the property owned before the Soviet occupation, though based on the goal of restoring justice, due to many amendments to its implementation eventually led to a wide spread disappointment of population and also restricted significantly effective use of productive resources. Restrictions to foreign investors to participate in the process of privatization and greenfield investments which have been maintained until around 1995 also reduced the speed of restructuring and inflows of productive capital. Although Lithuanian authorities cooperated with the international institutions such as World Bank and IMF, which Lithuania joined in 1992, influence first by Soviet pressure and later by domestic politics distorted implementation of the transition to market economy. From 1990 to 1994 Lithuanian real GDP declined by around 70 percent (Šimėnas, 1996). High political and legal uncertainty which complicated reform process and economic recovery could be illustrated by the fact that in three years from 1990 to 1993 the governor of the Lithuanian Central Bank has been changed three times. The initial years of transition reforms have been characterized by reluctance to reform public sector institutions and redirect public expenditure to the priority areas, too little attention has been given to the creation and strengthening of the basic economic institutions such as property rights and effective functioning of the judicial system, enforcement of law, transparent environment for competition.
This chaotic process of reforms and growing prices (with inflation reaching 1180 percent in 1992) contributed to the return of former Communist party nomenclature – renamed as Lithuanian Democratic Labour Party – to the majority in the Parliament in early elections organized in October 1992. According to some analysts, the fact that in Lithuania “the goals of economic transition have never been as clearly defined as in Estonia” may have affected the results of these elections (Lainela, Sutela, 1994, p. 13). On October 25th, 1992, a new Constitution was adopted establishing the political system of Lithuania, the rights and freedoms of citizens, country’s political, legal and economic institutions, including private property, environment for competition and other provisions typical to constitutions of liberal democracies and market economies. The same month the title of the Supreme Council was changed into Seimas – a name of the Parliament which has been used in Lithuania during the interwar period. Although the Constitution created an appropriate framework for economic reforms, the implementation of its provisions in practice has been slow and eclectic. Compared to Estonia, where newly established institutions have been led by young reformers having no links with former Soviet ruling nomenclature, partly because of the significant share of Russian among the latter, in Lithuania this change of high level decision makers has been slow and partly accounts for the eclectic implementation of reforms and slow process of restructuring. Privatization, enforcing of competition rules, especially for large companies managed by former nomenclature, and establishing transparent private banking system was also slower in Lithuania compared to Estonia.
The government formed by the new majority continued privatization process, although modifying its rules and facilitating the purchase of state owned enterprises by their management. It liberalized external trade relations and created conditions for the restructuring of the economy and growth of economic relations with the EU, especially Germany and other geographically close countries. Probably the most important was the monetary reform and the introduction of new national currency litas (as it was also called during the interwar period in early 20th century) in 1993 which in 1994 was pegged to the US dollar on the basis of the currency board (and in 2002 re-pegged to euro). In popular memory, “strong litas” has been remembered as one of the key successes of interwar Lithuanian economic policies and an important symbol of national sovereignty. Introduction of the national currency and the currency board, which prevented politically motivated emissions of money, stabilized macroeconomic environment. It should be noted that although Lithuania was the first among three Baltic States to re-establish independence, it was the last one to implement monetary reform and introduce national currency. Although there have been strong reasons to leave the rouble zone – establishing sovereignty of economic policies, rapid depreciation of rouble and high inflation, etc., domestic politics slowed down the process of introducing national currency which during its first year until adoption of the currency board was also accompanied by loose monetary policy. Still, assessed in the broader context, the Baltic currency reforms “have been a veritable success contributing to some of the lowest inflation rates among post-communist countries” (Lainela, Sutela, 1994, p. 9).
It has been argued, that “central planning system in itself has been the most important nontariff barrier to trade, therefore abolishing it was the first important step towards opening of the economy” (Kaminski, 1999, p. 5) Thus, economic reforms creating conditions for the market economy and political agreement with Russia made it possible in several years to establish sovereign economic policies and to start normalizing trade and investment environment. By the end of 1992 Lithuanian economy was already separated from the former Soviet Union and functioned as a sovereign state, while in 1993-1995 the process of re-integration into the world economy and the EU accelerated. It is has been widely accepted that “foreign trade has been the most important factor for economic recovery”, especially for such small and open transition economies like the Baltic States (OECD, 2000, p. 36).
Lithuania signed free trade agreements with the other Baltic States and Nordic countries, which soon were followed by the free trade agreement with the EU. These free trade agreements have been important not only in facilitating restructuring and trade, but also stabilized economic environment and made it more difficult to revert to protectionist policies later when domestic interest groups (i.e. farmers, some industrialists) became better organized and lobbied for protection. Institutionalizing economic relations with the Western countries and organizations such as the EU has been one of the main instruments to reduce dependency on the former Soviet economy and to restore conditions for economic growth. However, like in the case of monetary policy reforms, Lithuania has been the slowest to remove administrative barriers (quotas and licencing requirements) to external trade among the Baltic States which has been done only in mid-1993. Estonia has been the most consistent and advanced in terms of opening its economy to outside competition with a complete removal of import duties and establishing free trade regime with the outside world in 1992 (the policy which had to be modified as it joined the EU and adopted its customs code in 2004 which implied re-introduction of some import protection instruments). Lithuania was the last among three Baltic States to join the WTO in 2001 after six years of negotiations, mostly because of domestic lobbies concerned about more intense competition.
Gradually share of trade with the EU reached a quarter of Lithuania’s external trade by 1994, several years later it made up about half of Lithuania’s foreign trade turnover and increased further to two thirds after the financial crisis in Russia in 1998 which further pushed Lithuanian companies to reorient their business links to the EU market. EU countries also became dominant sources of foreign direct investments into Lithuania, especially from the Nordic countries, Germany and Poland. However, even after the accession into the EU in 2004, Russia remained an important market for Lithuanian companies and the source of supplies, especially energy resources. Until now Lithuania is also still part of the former Soviet electricity system linking three Baltic States, Russia and Belarus. In 2010, after the complete closure of the Ignalina nuclear power plan about 80 percent of all electricity consumed in Lithuania originated from Russia, the latter is still the only source of supply of natural gas which is sold by charging prices higher than to most other EU member states. As it is discussed below, the use of these economic links by Russia’s regime for the political purposes has been one of the main challenges to economic relationship between Lithuania and Russia.