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This article argues that substantial differences in political legitimacy can help explain why Estonia dealt with the recent economic crisis more successfully than Lithuania. In 2009, when the crisis hit hardest, Lithuania saw its budget deficit expand substantially, while Estonia managed to keep the deficit under 3% of GDP and consequently was invited to join the Eurozone, to which it acceded in 2011. The experience of these countries presents an interesting puzzle, as the divergent fiscal performance cannot be attributed to purely economic factors. Both countries have a similar economic structure, and both were similarly affected by the crisis. Furthermore, both pursued similar expenditure and tax policies during the crisis. Based on quantitative and qualitative evidence, it is argued that higher tax compliance and subsequently higher tax revenues can explain the difference. In turn, this compliance gap can be attributed to different levels of trust in political institutions in Estonia and Lithuania. Adapted from the source document.

The article addresses the question of why the Baltic countries chose internal devaluation over external devaluation in response to the economic crisis of 2008-2010. After describing the situation in the Baltics and the two main choices, the paper argues that economic explanations are insufficient in accounting for the choice. Several political explanations for the choice are laid out based on external pressure arguments, society-oriented perspective and institutional perspective. The paper finds that the external pressure hypothesis is unable to account for the Baltic decision, which rather reflected a very strong domestic consensus on the importance of safeguarding fixed exchange rates. This consensus in turn was based on both widespread support by the general society and concentrated producer groups. Nevertheless, society-oriented perspective cannot fully explain the Baltic choice either -- economic policies pursued during the crisis can only be fully understood when analyzing specific historical conditions under which the fixed exchange rate institutional system and its supporting elements were created. Over time, self-enforcing effects of the system became apparent both in the ideational sphere (principled beliefs about nationhood as well as particular causal beliefs) and in the material one, largely through the credit channel (indebtedness in euros). The current crisis also witnessed tendencies largely reinforcing the institutional equilibrium that supports the fixed exchange rate system. Adapted from the source document.

Adapted from the source document.

The paper seeks to explain the differences as to how successfully the three Baltic countries managed the economic crisis between 2008 and the first half of 2010. More specifically, it analyzes investors' confidence, Estonia being the most successful country in this regard, Latvia the least (the only country that applied for aid from the International Monetary Fund), while Lithuania staying in between. The paper aims to take into account the differences (and similarities) between the Baltic countries as well as emphasize the importance of political-institutional factors in explaining investors' confidence. The importance of investors' confidence as is discussed and different ways of measuring it are reviewed. Moreover, the relevance of political-institutional factors in explaining investors' confidence is established from the theoretical point of view. Based on existing literature, a number of explanatory factors are distinguished, namely electoral processes, non-electoral pressures on government, government stability as well as the quality of informal institutions. The paper argues that Latvia was indeed in a significantly worse situation in terms of economic pre-crisis vulnerabilities than Lithuania and Estonia, both of which had certain, albeit different, economic advantages. The main difference between Lithuania and Estonia emerges comparing political-institutional, rather than purely economic, factors: Estonia was better placed in terms of electoral cycles, the extent of non-electoral pressures, and -- most importantly -- better institutions (governance quality, corruption level, trust in political institutions). Both Latvia and Lithuania found themselves in a significantly worse situation regarding political-institutional factors. Adapted from the source document.