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Lithuania - ECONOMY
In the early and mid-1990s, Lithuania's economy went through a dynamic transition from the centralized economy prevalent during Soviet control of Lithuania to a market-driven economy dominated by private enterprise and oriented toward trade with Western Europe and North America. This transition began in 1991, and the volatile first stage--structural adjustment--was largely complete as of 1994. During this period, the economy declined precipitously while the Lithuanian government implemented fundamental economic reforms, including price reform, privatization, government reform, introduction of the litas (pl., litai) as the national currency (for value of the litas--see Glossary), and trade adjustment. Dependence on Russian energy hampered Lithuania's economy at a crucial time of transformation from the centralized state-run economy to a free-market system. Industrial production in Lithuania dropped by 36 percent from December 1992 through June 1994.
Despite these grim statistics, Prime Minister Adolfas Slezevicius was determined to adhere strictly to International Monetary Fund (IMF--see Glossary) recommendations for a speedy transition to a market economy. Slezevicius maintained that former socialist countries that did not rapidly reform fared far worse than those that did. The IMF noted that substantial progress had been achieved in Lithuania between 1992 and 1994 and that, after successfully reducing inflation, the country was ready to turn its attention to reforming its tax, privatization, social security, and finance policies.
Economic recovery began at minimal levels in mid-1993 and continued subsequently as a result of an increase in foreign assistance, loans and investment, trade, and private-sector employment. Most foreign investment came from the United States, Russia, Germany, Britain, Austria, and Poland.
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During the early 1990s, the government launched a comprehensive program of market-oriented reforms, which included the privatization of state-owned enterprises, the lifting of price controls, land reform, and reform of the banking sector. Also, a new national currency, the litas, was introduced in June 1993.
Privatization occurred at a rapid rate in the 1992-94 period (especially with respect to farmland, housing, and small enterprises), and about half of the large and medium-size enterprises scheduled for privatization were sold through public share offerings. The Law on Initial Privatization of State Property of the Republic of Lithuania, passed in early 1991 and amended several times in 1993 (primarily with regard to land reform and restitution), served as the principal basis for undertaking privatization. To start the process, the law authorized the issuance of investment vouchers to residents of Lithuania, to be used for the purchase of housing or other property. Most housing property eligible for privatization had been privatized by the end of 1993. Large enterprises also were to be privatized, with priority given to purchases of shares by employees of those enterprises. The number of shares that employees had the right to purchase in companies being privatized was increased in 1993 from 30 percent of total shares to 50 percent. By November 1994, more than 5,000 enterprises, or 80 percent of the assets earmarked for privatization, had been sold off.
Lithuania sought to regulate privatization of agriculture and to liquidate collective farms. The 1991 privatization law initiated agricultural land reform based on the proposition that nationalized land must be returned while unclaimed land could be sold to prospective private farms on long-term installment plans. Agricultural privatization proceeded rapidly; by the middle of 1993, some 83 percent of the agricultural privatization program had been completed.
Corruption and violence occasionally marred the privatization process. There were difficulties with auction sales of enterprises because speculators and organized crime conspired in bidding, bribed officials, or scared away competition with physical threats. Nevertheless, by the middle of 1994 the government had privatized state property worth a total of 489 million litai (35 million litai in cash and 454 million litai in vouchers and other forms of compensation), allocating the cash received to national and local privatization funds.
The greatest difficulties in implementing Lithuania's privatization program were experienced in agriculture because rapid privatization caused fear and confusion in that sector. The laws provided for the dismemberment of collective farms but did not definitively ensure their replacement by at least equally productive private farms or corporations. The many small private farms that appeared on the landscape were inefficient. Conflicts frequently arose over title to land. Many new owners did not intend to cultivate the regained land or to actively engage in farming, and as a result tens of thousands of hectares were left fallow. Collective farm managers and their friends stole or cheaply acquired tractors, cattle, and other property.
Inflation resulted from the lifting of price controls and from the shortages that resulted from trade disruption around the time of the collapse of the Soviet Union. Inflation, which was 225 percent in 1991, increased to 1,100 percent in 1992, fell to 409 percent in 1993, and dropped further to about 45 percent in 1994. Wages remained stable in 1991 but declined 30 percent in real terms in 1992. Prices increased several times more than wage and pension raises.
Prime Minister Slezevicius coped with the high rate of inflation by avoiding the temptation to promise compensation to pensioners and others whose savings were wiped out by inflation. He also avoided giving in to demands for increased subsidies and support for utilities and public transportation, which traditionally had been provided by the central government. The opposition, led by former Prime Minister Gediminas Vagnorius, was pressing for compensation to savers and investors, but the public voted not to support the measure in an August 1994 referendum. By adhering to Lithuania's structural adjustment program, which had been worked out in cooperation with the IMF, Slezevicius demonstrated his confidence in the reform process.
The litas was introduced as the new national currency on June 25, 1993. It became the sole legal tender in August 1993. The litas has been stable since then, maintaining a value of 4.0 litai = US$1 since its introduction.
Lithuania has made progress in reducing government expenditures to match government revenues. In March 1990, Lithuania began the difficult process of eliminating subsidies, introducing new taxes, and administering a new tax collection system. Personal income taxes, corporate profit taxes, and a value-added tax (VAT--see Glossary) were introduced. The personal income tax rate ranges from 18 to 33 percent. The corporate profit tax rate is 29 percent, with a discounted rate of 24 percent on retained earnings and 10 percent on the earnings of agricultural enterprises. The VAT is 18 percent, and there are excise taxes on alcohol, tobacco, petroleum, furniture, jewelry, land, and other items and transactions. Lithuania has been reluctant to reduce its high tax burden for fear of fiscal instability, but high taxes have led to an environment that encourages underreporting and corruption, stimulating the underground economy.
The budget of the central government ran a deficit throughout the late 1980s. The amount of the deficit at that time was relatively small--about 3 percent of the gross domestic product (GDP--see Glossary). The central government ran a budget surplus of 3 percent of GDP in 1991. The budget had a surplus in 1993 but a slight deficit--1 percent of GDP--in 1994.
After independence in 1991, the government began to restructure its expenditures. Subsidies were reduced from 37 percent of government expenditures in 1985 to 6 percent in 1992, while expenditures for the social safety net (social security, welfare, housing, and communal activities) increased from 15 percent to 32 percent of expenditures over the same period. These shifts in expenditures are a result of the central government's assumption of responsibility for the social safety net from enterprises that had been responsible for them during the Soviet period. Projected government expenditures in 1995 equaled 26 percent of GDP.
Prime Minister Slezevicius acknowledged that weakness in the banking sector was one of the most important challenges for his government and, if not properly supervised, could limit long-term economic growth. Lithuania needs to do more to live up to this commitment. Despite several bank failures, the number of banks increased from twenty to twenty-six from 1992 to 1994.
Significant factors guiding the reform of the banking sector are the technical advice and assistance of the IMF, which in October 1994 granted Lithuania a three-year US$201 million credit, and the reforms required for membership in the European Union (EU--see Glossary). The IMF has blamed the Bank of Lithuania's loose monetary policy in part for rising inflation. Some Western observers cite the central bank's institutional weakness and lack of autonomy as the main reasons for its ineffectiveness. The EU requirements are set forth in a white paper that describes the sectoral conditions that each prospective member of the EU must satisfy prior to joining. These requirements touch on every sector of the economy. Membership in the EU is a primary goal of Lithuania's domestic and national security policies. The white paper requires an efficient and open financial market and a banking system that encourages market-directed capital flows. Member states are required to pass and implement legislation concerning the soundness of banking institutions.
Lithuania's 1994 reform program included a review of the bank licensing system, privatization of the three state banks (Savings Bank, Agricultural Bank, and State Commercial Bank), a review of capital requirements to ensure compliance with international standards, and the introduction of new plans for accounts at the Bank of Lithuania and for commercial banks. The program also called on the government to pass stronger bankruptcy legislation and to ensure its enforcement.
After the Soviet Union took control of Lithuania's economy, it developed both light industry and heavy industry to tie Lithuania into the Soviet system. As a workshop for Moscow's military-industrial complex, Lithuania reaped significant rewards. Its people enjoyed one of the highest standards of living in the Soviet Union, similar to those of Estonia and Latvia. Especially on farms, goods became visibly more abundant and life grew more comfortable during the early 1970s. The reason was simple: Brezhnev's regime in Moscow reversed policies of farm exploitation and began subsidizing farmers instead. But a chronic shortage of necessities, the poor quality of goods, and the absence of many services kept the standard of living only at East European levels--not at those of the West.
During their control of Lithuania, Soviet officials introduced a mixed industrial-agricultural economy. In 1991 industry produced about half of GDP; agriculture and trade each supplied about one-quarter.
Lithuania's industrial sector produced 51.3 percent of GNP in 1991, but industrial production has subsequently experienced declines--by a reported 50 percent in 1993, for example. The sector employed 38 percent of the labor force in 1992.
Under Soviet rule, most economic activity was centrally managed from Moscow; Lithuania managed only 10 percent of its industrial capacity. Many industrial firms worked for the military. According to President Algirdas Brazauskas, who for many years had managed Lithuania's industries as the communist party's secretary for industry, Lithuania had a leading position as a maker of electronics for military and civilian use, and it had been a major supplier of specialized military and industrial technology to the Soviet Union.
In 1985, the year Gorbachev came to power, Lithuania accounted for just 0.3 percent of the Soviet Union's territory and 1.3 percent of its population, but it turned out a significant amount of the Soviet Union's industrial and agricultural products: 22 percent of its electric welding apparatus, 11.1 percent of its metal-cutting lathes, 2.3 percent of its mineral fertilizers, 4.8 percent of its alternating current electric motors, 2.0 percent of its paper, 2.4 percent of its furniture, 5.2 percent of its socks, 3.5 percent of underwear and knitwear, 1.4 percent of leather footwear, 5.3 percent of household refrigerators, 6.5 percent of television sets, 3.7 percent of meat, 4.7 percent of butter, 1.8 percent of canned products, and 1.9 percent of sugar.
Lithuania's key industrial sectors include energy (especially electric power generation), chemicals, machine building, met-al working, electronics, forestry products, construction materials and cement, food processing, and textiles (see table 27, Appendix). The country also has a ship-building capacity, with drydocks in Klaipeda for construction and repair of ocean-going fishing vessels. It has a large cement works and an oil-refining plant with an annual capacity of refining 11 million tons of oil. In the past, both facilities produced largely for export. Lithuania's electric energy comes from hydroelectric and thermal power plants fueled by coal and oil in Kaunas, Elektrenai, Mazeikiai, and Vilnius, as well as a nuclear power plant at Ignalina (see fig. 13).
The agricultural sector contributed 24.0 percent of GDP in 1992 and employed 19.0 percent of the labor force. Lithuania's agriculture, efficient by Soviet standards, produced a huge surplus that could not be consumed domestically. Traditionally, Lithuania grew grain (wheat, rye, barley, and feed grains), potatoes, flax, and sugar beets, and it developed dairy farming, meat production, and food processing. About 48 percent of the arable land was used for grain, 41 percent for forage crops, 5 percent for potatoes, and 3 percent for flax and sugar beets. Crops accounted for one-third and livestock for two-thirds of the total value of agricultural output. Lithuanian agriculture, which was collectivized during the early years of Soviet rule, became relatively efficient in the late 1950s when Moscow granted the communist leadership in Vilnius greater control of agricultural policy. Lithuanian farm workers were 50 percent more productive than the Soviet average but much less productive than their Western counterparts. Similarly, Lithuanian crop yields and milk production per cow, although very high by Soviet standards, ran either equal to or much below the yields obtained by Western farms. But even in Lithuania, one-third of agricultural production came from private plots of land and not from collective or state farms. Nevertheless, Lithuanian agricultural production was high enough to allow the export of about 50 percent of total output.
Significant reforms were introduced in the early 1990s, particularly after the restoration of independence, to reestablish private ownership and management in the agricultural sector. Although Lithuania succeeded in privatizing more agricultural land than Estonia or Latvia, agricultural production decreased by more than 50 percent from 1989 to 1994. One problem is that farms were broken up into smallholdings, averaging 8.8 hectares in size, often not large enough to be economically viable. A serious drought in 1994 further reduced agricultural output and cost farmers an estimated 790 million litai in production.
Lithuania receives more than 87 percent of its electricity from the Ignalina nuclear power plant. But Lithuania is highly dependent on fuels imported from Russia, and this energy dependence plagues Lithuania's industries. The trading relationship is unstable because political factors determine whether or not the supply will be interrupted. Energy use in Lithuania is inefficient by world standards, given Lithuania's level of economic development. In 1991 about one-half of the electricity produced at the 5,680-megawatt Ignalina nuclear power plant was exported to Belarus, Latvia, and Kaliningrad Oblast in Russia. But, partly because of reduced demand in the former Soviet republics and partly for political reasons, Lithuania's electricity exports declined substantially from 1991 to 1994.
Lithuania has large processing facilities for oil, which can be exported to the West through Ventspils (Latvia) or the new Lithuanian transport and storage facility at Butinge. Butinge is equipped with modern technology and was constructed by Western firms with funding provided by international financial institutions. This facility may allow more intensive utilization of the oil-processing facility at Mazeikiai, which has an annual capacity of 12 million tons, one of the largest in the Baltic region. Mazeikiai needs upgrading to operate profitably.
With the exception of forests and agricultural land, Lithuania is poorly endowed with natural resources. It exports some chemical and petroleum products, but its only significant industrial raw materials are construction materials, such as clay, limestone, gravel, and sand. Its peat reserves total about 4 billion cubic meters. There are moderate oil and gas deposits offshore and on the coast. In 1993 recoverable oil reserves were estimated at 40 million tons on the coast and 38 million tons offshore.
Lithuania may develop an important tourism industry if investments are made in its infrastructure to bring facilities up to Western standards. The resort town of Neringa was famous during the Soviet period for its excellent seaside climate. But Neringa fears the effects of too much foreign influence and wants special protection from an expected onslaught of foreign investors, most of whom come from Germany. In Vilnius and other cities, there is a shortage of quality hotels. State-owned hotels, of which there are still many, tend to provide inferior accommodations and service.
Lithuania had an estimated labor force of 1.9 million in 1994. Thirty-two percent of workers were employed in industry, 12 percent in construction, and 18 percent in the agricultural sector. Most of the remainder worked in a variety of activities in the services sector--14 percent in science, education, and culture; 10 percent in trade and government; and 7 percent each in health care and in transportation and communications.
Trade-union activities are specifically provided for in the constitution and are protected by legislation. The Joint Representation of Lithuanian Independent Trade Unions is an organization of twenty-three of the twenty-five trade unions and was founded October 22, 1992. Teachers and other government workers not involved in law enforcement or security work are permitted to join unions. Strikes and other confrontations between labor and management have occurred but are limited by the nascent free-enterprise system and the perception that employment alternatives are limited. Public employees organized strikes in 1992. Some Lithuanian trade unions are affiliated with international trade organizations, and organizational assistance has been provided by Western countries, especially the Nordic countries. Safe employment practices, regulation of workplace safety, and protection from reprisal by employers against employees who complain about illegal working conditions are provided for in the constitution. A minimum wage must be paid, and child labor is prohibited.
Lithuania's transportation system has great potential, and transit traffic by rail, road, and ship represents an important part of Lithuania's future development (see fig. 14). There were about 2,000 kilometers of railroads (1,524-millimeter gauge) in 1994, of which 122 kilometers were electrified.
There were 55,603 kilometers of roads in 1994, of which 42,209 kilometers were asphalted. The road system is good. The country is crossed by a route from Klaipeda to Minsk via Kaunas and Vilnius. A new international highway, Via Baltica, will stretch from Tallinn to Warsaw via Riga and Kaunas.
Lithuania has struggled, however, to develop its national airline, Lithuanian Airlines. Although an agreement has been reached with American Airlines, it may not be possible to restructure the company into a profitable operation because there is excess capacity in the region. Lithuanian Airlines had one B-737 and sixty-three Soviet-made aircraft in 1993. The main international airport is in Vilnius. A second international airport was opened at Siauliai in 1993. In addition to Lithuanian Airlines, service is provided by Aeroflot, Austrian Airlines, Drakk Air Lines, Hamburg Airlines, LOT (Polish Airlines), Lufthansa, MalÚv, SAS (Scandinavian Airlines), and Swissair. Destinations include Amsterdam, London, Paris, <"http://worldfacts.us/Denmark-Copenhagen.htm">Copenhagen, Berlin, Frankfurt, and forty-three cities throughout the former Soviet Union.
Klaipeda is the major coastal point, and Kaunas is the major inland port. Some 600 kilometers of inland waterways are navigable year round. Lithuania's merchant fleet consists of forty-four ships, totaling about 323,505 deadweight tons, including twenty-nine cargo vessel, three railcar carrier vessels, one roll-on/roll-off vessel, and eleven combination vessels.
Lithuania has begun to modernize its telecommunications industry. A law deregulating certain aspects of telecommunications went into effect in January 1992. Private investors now have the right to offer long-distance service to the public, but restrictions on the participation of foreign capital have slowed this type of activity. Both telecommunications and transportation will require large investments to modernize the infrastructure and to reform the enterprises. This sector is plagued with inefficiencies. Nevertheless, Lithuania's telephone service is among the most advanced in the former Soviet republics. There were 240 telephone lines serving 1,000 persons in the early 1990s. International connections exist via satellite from Vilnius through Oslo or from Kaunas through Copenhagen.
Lithuania has two television companies and five radio companies. In 1993 some 1.4 million television sets and more than 1.4 million radios were in use, or one per 2.7 persons. Two national radio programs are broadcast by the state-owned Leituvos Radijas ir Televizija. Radio Vilnius broadcasts in Lithuanian and English. There are national, regional, and minority language television programs.
Because of its small domestic market, Lithuania is dependent on trade to ensure its prosperity. It has made impressive progress since the late 1980s. Imports declined from 61 percent of GDP in 1980 to 23 percent in 1991. Most significant, trade was shifted to Western Europe from the former Soviet Union. In 1993 three-quarters of Lithuanian exports went to the other Baltic states and the other former Soviet republics. But this percentage is projected to drop dramatically so that most exports will be to the rest of the world by 1996. In the first half of 1994, the countries of the former Soviet Union accounted for about 53 percent of Lithuania's trade, and West European markets made up about 47 percent of Lithuania's trade (see table 28, Appendix). In previous years, trade with Western markets had made up only about 10 percent of trade.
According to 1994 estimates, exports totaled approximately US$1 billion, up from US$805,014 in 1992, and imports amounted to nearly US$1.3 billion, up from US$805,776 (see table 29; table 30, Appendix). Lithuania had an overall negative trade balance of US$267 million in 1994, according to IMF estimates. An estimated surplus of US$63 million in the services account and a deficit of US$192 million in the current account resulted in a negative balance of payments overall.
When the Soviet Union imposed an economic blockade on Lithuania in April 1990, many enterprises nimbly shifted production away from goods required under central planning (for example, computers for the defense industry) to consumer goods. These transformations demonstrated the flexibility of many enterprises under difficult circumstances and set the stage for economic growth and prosperity.
Tariffs are imposed on a wide range of imported goods, but they are scheduled to be reduced gradually until 2001, when Lithuania's free-trade regime will be fully implemented. The lowest tariff schedule applies to countries with which Lithuania has most-favored-nation status. These countries, about twenty in number, include the United States, Canada, Russia, Belarus, Ukraine, and Australia. A slightly higher tariff schedule applies to goods imported from about twenty countries with which Lithuania has a free-trade agreement, such as Estonia, Latvia and the members of the EU. These tariffs are scheduled to be reduced during the six years following 1995 and will be abolished for industrial products at the end of that time. The tariffs on food products imported from the EU are scheduled to be substantially reduced except for sugar, butter, and oil and for a limited number of other items.
Imports consist primarily of natural gas, oil, coal, machinery, chemicals, and light industrial products. Oil and natural gas are imported from Russia, natural gas is imported from Ukraine, and cotton and wool are imported from the Central Asian republics of the former Soviet Union. Lithuania exports primarily machinery, light industrial products, electronics, food products, and textiles.
On July 18, 1994, Lithuania signed a free-trade agreement with the EU that went into effect at the beginning of 1995. It calls for a six-year transition period during which trade barriers will be dismantled. The agreement grants Lithuania tariff exemptions on industrial goods, textiles, and agricultural products. Full membership in the EU is a primary goal of Lithuanian economic policy.
Lithuania did not acknowledge responsibility for any debts of the Soviet Union. The international community supported its contention that it should not be responsible for debts incurred while it was "occupied." International financial institutions, especially the IMF and the World Bank (see Glossary), issued credits to Lithuania after independence. Lithuania's total debt, which was about US$38 million at the beginning of 1993, mushroomed to US$500 million by the end of 1994. Increases in the debt to US$918 million by the end of 1996 are projected. As a percentage of GDP, the debt will rise from 3.6 percent to 10.6 percent by 1997. However, repayment terms are manageable, and the proceeds of these credits fund needed and productive investments. The large inflow of foreign credits and investments is responsible for maintaining living standards at an acceptable level in the wake of a steep decline in production in 1992 and 1993 and negative trade balances.
The largest foreign investor is the United States tobacco and food services company Philip Morris, which purchased the state tobacco company in Klaipeda for US$25 million in 1993. Foreign investment was critical in maintaining public support for economic reform during the first years after independence and resulted in an influx of hard currency (from foreign assistance, loans, and investment) and increased activity by the private sector. Most foreign investment came from Britain, Germany, the United States, Russia, Poland, and Austria (see table 31, Appendix). Total foreign capital invested in the country was estimated to be 551 million litai in November 1994. About three-quarters of the foreign investors were involved in joint ventures.
Lithuania's Law on Foreign Investments, introduced in 1990 and amended in 1992, guarantees the unrestricted repatriation of all after-tax profits and reinvested capital. A new draft of this law places restrictions only on foreign investment in sensitive industries, such as defense and energy. Foreign investors receive generous profit tax rebates of up to 70 percent. A draft amendment to the constitution would lift the prohibition on landownership by foreigners. Nevertheless, in part because of the growth of organized crime, Lithuania's ability to attract more foreign investment has been impaired. Neste, the Finnish oil company that operates twelve gas stations in Lithuania, halted future investment after an attack, presumably carried out by organized crime, on a company representative in Klaipeda in October 1994.
Lithuania in 1994 received a number of foreign loans, including ECU10 million (for value of the European currency unit--see Glossary) over fifteen years from the European Investment Bank (EIB) for reconstruction of the airport in Vilnius and an ECU14 million loan from the EIB for reconstruction of the port of Klaipeda. Other foreign loans included a US$25 million agricultural sector loan from the World Bank, and loans of ECU22 million and ECU9 million from the European Bank for Reconstruction and Development (EBRD) and Japan's Export-Import Bank, respectively, for the modernization of the country's telecommunications system. The EBRD also disbursed US$6 million in 1993 as part of an ECU36 million energy infrastructure loan. By February 1994, the World Bank had disbursed US$45 million of a US$60 million import rehabilitation loan approved in 1992. Lithuania obtained an ECU33 million loan in 1994 from the EBRD to improve safety at the Ignalina nuclear power plant and a seventeen-year US$26.4 million loan to refurbish its coal- and oil-fired power plant.
Lithuania experienced initial difficulties with economic reform, especially with reform of agriculture, because of the government's insistence that social welfare levels be retained and that privatization of enterprises would be subject to regulations forbidding the elimination of jobs and employee services. Mistakes in fiscal policies, especially those committed by the Bank of Lithuania, and the increase in energy and other prices by Russia, as well as difficulties with payments for goods exported from Lithuania, also fueled inflation, promoted a black market, and emptied the stores. Production decreased. In 1993 industrial production dropped more than 50 percent compared with 1991. Agricultural production declined by 39 percent. Unemployment, including partial unemployment, rose from 9,000 to more than 200,000. By the end of 1992, the lack of heat and shortages of hot water in wintertime were conspicuous evidence of a deep economic crisis in the land.
Nevertheless, the economic decline was considered to be of a temporary nature, caused by the difficulties of the transition--common to former Soviet states--to a free-market economy. The IMF and the World Bank were satisfied with priva-tization and reform efforts, and the latter provided a development loan of US$82 million. On a scale of zero to ten, Germany's Deutsche Bank in 1991 ranked Lithuania's potential for agricultural production as ten and for industrialization as approximately eight. Promising sectors for future profitable investment include building materials, electricity, transportation, and tourism.
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