Cooperating Estonians and 'Exiting' Lithuanians: Trust in Times of Crisis

This paper argues that substantial differences in political legitimacy can help explain why Estonia dealt with the recent economic crisis more successfully than Lithuania. In the last crisis, Lithuania saw its budget deficit expand substantially, Estonia managed to keep the deficit under 3 percent of GDP and consequently was invited to join the eurozone as of 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 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 level of trust in political institutions in Estonia and Lithuania. As both countries implemented harsh austerity measures, Lithuanian society did not present open contestation (in terms of protests or electoral backlash), but resisted (or at least did not support the consolidation policy) by turning to shadow economy (as well as emigrating in large numbers). This also explains how Lithuanian state can at the same time be strong (in terms of reacting fast and possibly radically) but at the same time its efforts are often undermined in areas that require good state-society relationships. The discussion has several important implications. First, shadow economy, lack of tax compliance and emigration can be important indicators of legitimacy (as a form of “exit”), especially in countries that lack prerequisites for expression of open dissatisfaction (“voice”). Second, the importance of legitimacy might actually increase in “hard” times. Third, times of crisis might encourage the development of different equilibria (high trust-high performance virtuous cycle as well as low trust-low low performance one).