1. Economics
November 4, 2014

Chart: Joining the EU caused a property bubble in the Baltics

By City Monitor Staff

Construction spending is generally a pretty good proxy for how well a city’s economy is doing. When things are going well, investors pile in, governments and companies start throwing up new buildings, and the share of local GDP coming from the construction sector will grow; that investment should, in turn, help drive more growth. When it works well, it’s a virtuous circle.

Unfortunately, it sometimes doesn’t work well. Take a look at this graph showing the history of the construction sector in the three Baltic capitals.


By way of comparison, here’s a second graph showing GDP growth.

So, what’s going on here? Well, in 2004, the three Baltic states – Estonia, Latvia, and Lithuania – joined the EU. Suddenly they were in a single market with rich western Europe; and EU structural funds, which are meant to upgrade infrastructure and boost economies in poorer regions, helped drive a construction boom.

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The boom, though, soon turned to a bubble. A combination of strong growth and loose lending standards meant that, between the autumn of 2005 and the summer of 2007, house prices in Estonia had climbed by around 75 per cent. In Latvia, between 2005 and early 2008, they nearly doubled.

Bubbles, however, have a nasty habit: they burst. The Estonian market was already deflating by late 2007, an early harbinger of the credit crunch. The other two Baltic states kept booming for another few months but, by the autumn of 2008, they too were plunging.

In 2009 the three countries’ respective GDPs fell by between 14 and 18 per cent. By 2011, commercial rents had fallen by as much as a third. Unsurprisingly, with those who’d invested in the region’s property market losing shirts left, right and centre, nobody much wanted to build anything, and new developments ground to a halt.

By 2011, though, things had started to recover, and in February of that year, Ričardas Čepas, chief executive of property consultancy Newsec Baltics, was telling the Financial Times of his “relief that the market has bottomed out”. What’s more, despite the building boom, all three cities remain under-supplied with the modern housing, offices and infrastructure links that you’d expect further west.

So, with the global economy starting to recover at last, construction is beginning once again. It’s not just buildings, ether. The EU has backed plans to build the excitingly named Riga Northern Transport Corridor, a 30km tunnel to divert traffic from the city’s old town. Vilnius is working on 30km bypass (but above ground, and to the south), funded by the EU Cohesion fund. The Lithuanian government is also trying to attract €340m worth of investment for a new power plant in the city (as well as €200m for another in the second city of Kaunas).

The boom may be some way off the scale of that seen in 2006 – but this time, it might prove more sustainable.

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