Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

Abstract: Historically, the Baltic Sea Region (BSR) has been an institutionally homogeneous economy, integrated economically and culturally through the sea lanes of the Baltic. After WWII the BSR was broken up into a dual economy, consisting of a poor Soviet block of centrally planned economies, on the one hand, and the industrially advanced BSR economies Finland, Denmark, Germany and Sweden, on the other. 1990 saw the break up of the soviet political system. The liberated, but poor formerly planned economies were left to restore their institutions on their own to that of a market organization. 60 years of Soviet isolation had left the formerly planned BSR economies in an industrially backward state. Critical market functions did not exist, and corrupt institutions made normal business life impossible. Catch up with Western industrial economies therefore became a policy priority. During the 1970s also Western economies introduced elements of central planning in their industrial policy repertoires on the belief that it would improve economic performance. Policies to support “plans” by definition meant restrictions on entrepreneurial activity. By the Soviet break up, however, stagnation had also brought the need for entrepreneurship onto the policy agenda of Western nations. Obstacles to economic progress were gradually being dismantled. These shifts in policy attention in turn relate to the current discussion about globally increasing inequality. Are the economies of the world economy converging onto the same national standards of living, as was believed not long ago, or diverging. The industrial dynamics of the BSR pits those two hypotheses against each other. Will the previously centrally planned soviet economies of the BSR catch up with the living standards of the more market governed Western economies, or lag further behind? Perhaps some “mixed” Western economies with large and rigid public production of welfare services have got stuck with problems similar to those of the formerly planned economies? Do some formerly planned economies that have taken on a strong pro market policy agenda exhibit a superior catch up record to those that have not? The contrasting policy experiences among the BSR economies allow us to compare the catch up records in terms of policies chosen. The formerly planned Baltic economies, excepting Russia, were institutionally and industrially roughly on par with Denmark, Finland and Sweden before the Soviet occupation. The industrial backwardness of the formerly planned economies at the time they were liberated was therefore due to constraints on entrepreneurial initiatives, once imposed by the Soviet Union. So by definition there is a policy task of some magnitude to undo that heritage. More precisely asked, central planning in the formerly planned economies stifled entrepreneurial activities. Can the obstacles to catch-up in the transition economies through an entrepreneurially moved reallocation of resources then be overcome through centrally directed policy? If not, which is a key question of this paper, how can the diverse information and knowledge embodied in the agents of markets be mobilized for that task? Who knows best, the central policy maker, supported by his economic advisors, or the collective knowledge of all economic actors as intermediated through dynamically competitive product and factor markets. The historic developments in the BSR have therefore accidentally staged a unique economic policy experiment that allows us to distinguish between the relative roles in economic progress of improvements in local entrepreneurial environments (a policy task) and of individual entrepreneurial action. In carrying out that analysis we draw on the detailed statistical analysis in Braunerhjelm & Eliasson (2011). The Swedish evolutionary micro firm to macro model has provided a theoretical structure, both to support our reasoning on the catch-up dynamics, and to provide quantitative evidence for the empirical evaluation. Empirical research suggests that growth through entrepreneurial new firm formation is a slow process that may however suddenly and unexpectedly gain momentum. The import of new technology is the fast way to catch up. Both forms of innovation and entrepreneurship, however, benefit from the same positive entrepreneurial climate. On this we found that successful catch up among the formerly planned BSR economies still has a long way to go, and that political impatience in waiting for the dividends of economic liberalization to become available may have been destructive. Policy focus should therefore be set on the local entrepreneurial environments which are in great need of continued improvements to support both new firm formation for long run development, and to induce immediate FDI for the short term. More flexible labor markets will be required to support continued reallocation of resources from inefficient “soviet” installations to productive businesses of western quality. Significant remaining obstacles to trade and ownership transactions across BSR internal borders will have to be removed, so success in catch up should be expected to differ significantly among the BSR countries. We therefore propose a policy competition among those countries in improving their entrepreneurial environments to beat each other in catch-up performance. This policy competition is best enacted individually, without any delaying cooperation among the competing economies and, if individually enacted in a competitive spirit, will benefit both the winners and the entire BSR economy.

Keywords: Central planning; Commercialization competence; Competence bloc; Dual economy; Entrepreneurship; Experimentally Organized Economy (EOE); Foreign Direct Investment (FDI); Policy experiments

JEL-codes: L16; L52; M13; N20; N40; O50; P21; P51

46 pages, July 9, 2012

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