Rich State, Poor State — how Ongoing Reforms Pave the way to a Country’s Success

Countries succeed when they have leaders capable of explaining and providing the political context for tough and ongoing reforms. Bursts of reform-minded leadership are seldom enough, as development requires continuous restructuring and innovation over generations.

20 November 2023 ·   12 min read

Rich State, Poor State — how Ongoing Reforms Pave the way to a Country’s Success

The history of the city of Narva on the eastern edge of Estonia helps to explain the “Baltic Tiger’s” economic performance since regaining its independence from Russia in 1991.

Narva became part of Estonia after the Treaty of Tartu in 1920 which concluded the War of Independence. This freedom lasted only until the German invasion of 1941. Between February and March 1944, the Baroque city was virtually destroyed by a combination of the retreating German troops and Soviet bombardment.

About a quarter of Estonians fled the country or died during the Second World War. Under the subsequent Soviet occupation, a policy of collectivisation saw mass deportations and Russification, which led to the percentage of Estonians declining from 97% of the population in 1945 to two-thirds by 1989. Much of the country was militarised and closed to public access, with living standards falling far behind those of Finland whose capital, Helsinki, is just 80km away across the Gulf of Finland.

Mikhail Gorbachev’s perestroika (restructuring) in the Soviet Union retriggered Estonia’s independence process, known as the Laulev revolutsioon (Singing Revolution). Following free elections in November 1988, the Parliament issued a Sovereignty Declaration, giving notice of its intent.

On 23 August 1989, 2 million Estonians, Latvians and Lithuanians participated in a mass demonstration, forming the “Baltic Way” human chain across their territory. Then, after a referendum in March 1991, Estonia took advantage of Boris Yeltsin’s rise to power in the Soviet Union, declaring the restoration of independence on 20 August 1991. Four weeks later, on 17 September 1991, Estonia was admitted into the UN, and the last units of the Russian army left the country in 1994.

In Narva, on the border with Russia, the influx of Russian-speaking workers from across the eponymous river made Estonians the minority during the Soviet years, when the remnants of the city’s famed Baroque architecture were levelled to make way for Soviet-style apartment blocks. Various monuments to Soviet military victories still adorn the area, the irony of those who replaced three years of Nazi occupation with a half-century of their own apparently lost.

Today, more than 90% of Navra’s population is Russian-speaking, and one-third have Russian nationality. When Estonia regained its independence, some local leaders wanted autonomy through a breakaway Transnarovan SSR republic, a shade of contemporary Ukraine.

This has, to date, been settled in favour of staying, perhaps more so now than ever with the ongoing war in Ukraine.

“We used to brand ourselves as the bridge between Russia and Europe,” says Katri Raik, the mayor of Narva, “but now we say we are the beginning of Europe. The slogan is ‘Europe starts here’.”

But it has not been easy, “given we have mostly Russian speakers, who have a Russian identity, part of which is Putin. Now people speak not of being Estonian Russians, but Europeans.”

Economic growth

Inclusion is of course easier when your economy is expanding.

After 30 years of independence, Estonia has averaged more than 4% economic growth (nearly double SA’s average figure), peaking at over 13% in 1997. Constant growth has a compounding effect: per capita wealth leapt from around $3,500 at the end of the Soviet era to $35,000 today.

The reasons are, at least on paper, clear.

Estonia has the lowest ratio of government debt-to-GDP among EU member states and possesses a balanced budget and free trade regime. Its Programme for International Student Assessment scores (Pisa, which examines students in reading, mathematics and science, and what they can do with this knowledge) are among the highest in developed countries, and it is seen as the champion of e-government worldwide.

This has not been a process of recovery, but fundamentally one of a revolution in economic affairs. Under the Soviet Union, Estonia’s economy was extractive in its orientation, focused on producing what “someone else wanted”.

“The Russians did not develop the place,” notes Eerik Kross, a member of Parliament and former chief of intelligence, “rather, it was the other way round.”

This was assisted by the fact that Estonia “regained” its independence of the interwar years from Soviet occupation and, through the Lutheran Church and periods of earlier foreign interventionism, understood European legal tradition. Politically, too, there was strong support for reforms across the political spectrum, reflecting the existential fear of failure with such a strong and menacing neighbour as Russia.

“We had no choice,” admits Mayor Raik about Estonia’s economic transformation. As someone whose parents were both geography scholars, “you only have to look at a map”, she says, to see why.

There were, observes Kross, three reform pillars:

  1. The currency had to be made convertible;
  2. Property confiscated by the Soviets had to be returned or compensated for; and
  3. The state got out of running businesses. In a country where two-thirds of homes were owned by the state, everything (bar the port of Tallinn and power) was privatised.

Mart Laar, a history professor, was just 32 years old when he took over as prime minister in 1992. He says, “We had a whisky in the cupboard that we agreed not to drink before fulfilling three goals: get Estonia independent, get our own currency, and get the Russian troops out.”

‘Shake things up’

Laar, a disciple of Margaret Thatcher, has three pieces of advice for others embarking on reform. “You have a limited time, perhaps a year, to do radical things.” He also, he says, learnt from Thatcher of the importance from time to time to “do crazy things, to shake things up” and not pay too much attention to public opinion.

Whatever one might feel about the substance of her reforms, Thatcher’s leadership style never sought consensus, which she famously described as, “The process of abandoning all beliefs, principles, values and policies in search of something in which no one believes, but to which no one objects.”

Instead, she sought to lead, employing her mandate to full and uncompromising effect.

Laar’s final piece of advice: to keep the course, you need to set in place rules and laws more than policy, which can be subject to leadership whims.

It was at first a painful process. It involved ending subsidies and protectionism and initiating a new currency, in part to curb runaway inflation, which reached 1,100% by 1992. A privatisation agency was established, prices were liberalised, monopolies curtailed, social welfare protections installed, especially on education and pensions, VAT and a 26% flat income tax were instituted, and the restitution of private property seized during the Soviet era was arranged.

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The approach, as per Laar’s advice, was radical by the standards of the day. While outside actors, including the IMF, advised against moving away from the rouble, for instance, this is precisely what Tallinn did.

Siim Kallas was the Central Bank governor at the time and, later, prime minister. In the 1980s, he worked at a savings bank “under a detested system, which kept your hands tied, where there was no freedom of decision-making, no freedom at all. The economy was immune to people’s views.”

The system of Soviet socialism was defined by the Russian term zostoy — stagnation: just enough to be stable but insufficient to be stable forever.

When the opportunity for reforms arrived, “we chose to start with Ground Zero rather than take any Soviet assistance. We did not take even a single rifle from them. This,” reflects Kallas, “was a good basis for radical decisions” which require “good ideas, implementation, public support and very good timing.”

To enable the currency reform, “we had to do something simple and fast”, which involved backing the new kroon with Estonian gold reserves held by the UK, US and Denmark for safekeeping before World War 2. “Along with privatisation, we were able to provide a favourable climate for foreign direct investment to flow into Estonia.”

While some might argue that Estonia’s small population — today 1.4 million — made this easier than in big, more complex economies, Kallas says that small size has its own complexities. “Everyone knows each other, and there are still many opinions, and being small means fewer resources to get things done.”

Difficult choices and painful consequences

The extraordinary thing is that a young government got all this done — and amidst great turmoil. A series of information panels at the entrance to Tallinn’s old town is a reminder of the difficult choices and the pain of the consequences of the early reforms. Between 1989 and 1990, for instance, the economy shrunk by 38%, with a rise in unemployment from virtually zero under the Soviet model. Now employment rates, at over 75%, are much higher than the average for advanced economies. Estonia tops the e-government rankings across the European Union.

In sum, growth matters, and strong growth matters more.

Despite being under the heavy hand of state socialism for almost half a century, Estonia’s performance is a testament to the liberating power of the market, and what happens when people choose their fate, and the government assists this process.

The shock therapy was made easier, says Riina Kionka, by the new-found political changes, with Estonians being willing “to eat potato peels since we have our freedom”, as the saying of the day went. This facilitated a “tiger’s leap” in technology, straight into digitisation, with a focus on e-government and, in education, coding and services.

Today, Estonia’s focus is on productivity growth. As the country scales the income ladder, this demands better institutions, a challenge in which it is not alone.

Singapore’s path to growth

As Singapore’s Prime Minister Lee Hsien Loong says, the drive for competitiveness is “a marathon without a finish line”. His country has responded to this challenge by continuously reforming, through labour-intensive manufacturing, for instance, in the 1960s which was coupled with a government plan for housing (giving all a stake in the system) and education (enabling continuous improvement), through creating a service economy to its focus, today, on green growth.

Even though Lee Kuan Yew (LKY), as the head of the team which put Singapore on the growth path, had a reputation for uncompromising leadership, the administrative approach has been at least as bottom-up as top-down, where incentives have played a critical role in performance.

“This required an effective civil service,” observes Barry Desker, who has served in a variety of senior roles in business and government in Singapore, “which has underpinned whatever has been attempted by LKY and his political colleagues, to create the conditions that allows talent to rise, properly paid and not needing to seek ‘extracurricula income’.”

Tharman Shanmugaratnam served as deputy prime minister and minister of finance before becoming senior minister in the Singapore government in 2019. He says, “Building state capacity requires both quality and incentives.” This system is dependent on “selection on merit, the development of people and rewarding performance” within “a culture of working as a team across government”.

In setting the direction of policy, the Cabinet operated as a “collective”, avoiding the adoption of five-year planning documents, but rather “spending a lot of time” discussing and iterating developments in a “model of anticipating the next opportunity”. In the process, the Cabinet “didn’t disagree infrequently”. But these differences were not based on a “belief system, but rather around fundamental, practical dimensions rather than ideological questions.”

And like the civil service, the Cabinet is assessed on performance metrics, bonuses being awarded “in a private matter in consultation with the PM” Shanmugaratnam says.

Just as West Germany did with the Stasi, Estonia ensured the compliance of the civil service in the wake of the Soviet occupation and nullified the threat of divided loyalties by dismissing anyone who had worked for the KGB. By comparison, notes Eerik Cross, in those countries where the security services were not properly reformed — including Russia, Belorussia, Georgia and even Ukraine — “they take it back”.

Lessons from other countries

There are different lessons from other countries. Mexico benefited from the external discipline of the North American Free Trade Agreement (Nafta), even though its social and educational provisions have been gradually diluted down to a trade agreement. As a consequence, while 75% of Mexico’s economy falls under Nafta rules, less than 14% of its workers benefit from this access, says Luis Rubio, chairman of Mexico Evalua, a think tank focused on public policy monitoring and evaluation, and a former chairperson of the Mexican Council on Foreign Relations.

Nafta did work, however, inasmuch as Mexico’s survival depended on it, and the presence of foreign firms proved important not only as a source of technology, trade and employment but also in the anti-corruption fight.

Mexico’s reforms were enabled, at least at the start, by having a political class that provided “top cover” to the technocrats negotiating reforms and agreements such as Nafta. The same applied to other notable reformers such as Poland, where President Lech Walesa and the Solidarity movement enabled the political context for technocrats such as Leszek Balcerowicz, who managed the details of reforms.

Solidarity’s victory precipitated the fall of the Berlin Wall and widespread political and economic change across the Soviet-controlled Eastern Bloc. Since 1990, the per capita income of Poles has risen from $1,720 to $15,720 by 2020, or from 40% to 143% of global GDP.

“I am most proud,” says Walesa, “of the fact that I was able to achieve the transition from the bad, Putin-like era, to the new brave one.”

Balcerowicz became the minister of finance in Poland’s first non-communist government in 1989. Armed with an MBA from New York, he went from working at the Institute of Marxism-Leninism to Solidarity by the early 1980s. Widely credited with steering the free-market reforms which set Poland on its path as a success story, he has since served as chairperson of the National Bank of Poland and twice as deputy prime minister of Poland.

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In 1988 he was, he says, a 41-year-old economics professor “with a hobby of economic reform. We all thought,” he reflects from the Warsaw School of Economics where he now teaches, “that Poland would persist as it was. However, the basic conclusion we reached was that economic liberalisation matters for results from reform; the variable is whether the political regime allows the necessary reforms to happen. Without political liberalisation there could be no changing the economic structure.”

The European Union, through its acquis communautaire — the evolving body of common rights and obligations that is binding on all the EU member states — can offer a similar external discipline. Given the level of domestic political resistance to its fiscal reforms, it is uncertain that Greece, for instance, would have undertaken its painful adjustment without European incentives and disincentives.

A perfect storm

All of this matters for Africa.

The continent’s countries are today vulnerable to a perfect storm of a burgeoning youthful population, insufficient infrastructure, benign donor neglect and more malign foreign interference.

This has its roots in decades of weak economic performance. Africa’s share of global per capita income has halved to just 15% since the heady days of independence in 1960. That’s not to say things have not improved. They just have not improved at the same rate as the rest of the world.

African excuses for such failure have focused, understandably, on external factors. Change the world, and the unfair and uneven distribution of benefits, so the argument goes, and Africa can prosper.

But from similar domestic environments and in the same world order, countries across Asia, Europe and Latin America have developed by leaps and bounds. This would suggest that, for at least some countries, Africa is poor because its leaders have made this choice.

Estonia is rich because its leaders made that difficult choice. It was not easy, and it could easily have slipped back into old Soviet habits without firm leadership.

For South Africa, aside from the obvious point that the window for reforms is open only for a limited time — should the government want to use it — is the essential point about leadership and vision. It is necessary not only to describe a pathway to the future, looking a decade out hence, but for this to be informed by a sense of realism. In this, leadership has to do just that, lead, rather than facilitate and mediate. There is no need to seek confrontation, but also no point in trying to avoid it all the time.

There is also a need to plan rather than simply set out promises and goals. A believable narrative involves, also, speaking more about accomplishments — or runs on the board — rather than aims.

South Africa is, sadly, not unique. In Argentina, the government has got stuck because structural reforms are unpopular and leaders are shortsighted. The margin for manoeuvre is very small, argues its former minister of finance Alfonso Prat-Gay, in those societies mired in high levels of poverty “where the margin for error is correspondingly huge”. This results in “structural reform usually occurring out of panic and desperation rather than out of hope”.

There is a need to realise, however, that political suicide will occur even if leaders don’t carry out reforms, and that risking one’s support base is worthy of the national interest. There is a need to understand that overall success depends fundamentally on the success of business and that popularity depends on the success of reforms. A blunt style of communication of the problem and the pain of the solution might well help. Equally, while business usually has made its own contribution to the mess, it would do well to get more transactional with the government.

Narva’s cotton mills in the sprawling Kreenholm plant, once the biggest in Europe employing in its pomp 10,000 workers, made it the leading industrial city in Estonia. Oil shale made it a centre, too, of electricity production. The first railway in Estonia, completed in 1870, connected Narva to Saint Petersburg just 130km away, and also to Tallinn.

But it has suffered in recent times. As Mayor Raik, a former minister of the interior, notes, the population has declined from 85,000 to 54,000 over the last 30 years as younger people, particularly, leave for Tallinn or leave Estonia altogether.

“Narva needs direction, a vision built on its port, railway and electricity, but also good government, good education, good housing, good healthcare and good policy,” Raik says.

The Soviets had grand plans to reindustrialise Narva, including the establishment of a uranium processing plant, but these were never implemented. Instead, the plant was opened in the Baltic port of Sillamäe, just 30km away. It is a monument to Soviet achievement and its excesses, in more ways than one.

In the centre of Sillamäe, opposite the Stalinist-classicist Palace of Culture, stands a giant statue of Prometheus, the Greek god and bringer of fire, holding aloft the symbol of an atom. This Soviet piece of “art” was opened in 1987, a year that marked both the 70th anniversary of the October Revolution and the 40th anniversary of Sillamäe’s founding, seemingly a desperate act of propaganda at a time when the writing was already on the wall for both the Sillamäe plant and the Soviet Union as a whole and the dust from the previous year’s Chernobyl disaster had barely settled.

The plant’s twists and turns are a metaphor for the Cold War period and Estonia’s changing fortunes. A former oil shale processing plant in Sillamäe was rebuilt by the Soviets in 1948 as Kombinat No 7 to extract uranium oxide from the locally mined shale, later focusing on enriching uranium from elsewhere. As such, Sillamäe was a “closed city”, officially off the map and guarded within a military perimeter, just as much of the Baltic coastline was closed to the public during the Soviet era.

Until its closure in 1989, the plant produced nearly 100,000 tonnes of uranium and over 1,300 tonnes of enriched uranium, which was used in some 70,000 nuclear weapons.

Today, Sillamäe has the feeling of a Potemkin village, its facades resembling a fake film set, given the absence of people along its broad, neo-classical avenues. While its central Lenin Avenue has changed its name to Viru Boulevard, there remains a Gagarin Avenue after the first man in space, and Soviet motifs can still be spotted.

Kombinat No 7 was privatised in 1997 as the “Silmet” facility and was bought by a US firm for processing rare earths. A great tidy-up of the toxic waste left by the Soviet plant was initiated to prevent seepage into the Baltic.

Cleaning up the sludge and not looking backwards is a key message from all reformers.

Riina Kionka, the former EU ambassador to SA, and foreign policy adviser to Estonia’s President Lennart Meri who oversaw the reforms during the 1990s, says, “Although it’s important to look to the present, it’s more important to look to the future, and to conceive of a place where you want to be in 10 years, realising that where you end up depends on your choices today. Estonia, too,” she says, “was colonised, but it’s important to own the future rather than to dwell in the past.”

One notable difference between Africa and the class of performers is in the learned helplessness of decision-makers. Hopefully, the next generation of African leaders can put this right before the development hole gets even deeper.

This article originally appeared on the Daily Maverick