The Europe Council has confirmed that Latvia will be accepted into the Eurozone from 1 January 2014. Commission Vice-President Olli Rehn has called the Baltic nation “a success story” and said that its “shows that a country can successfully overcome macroeconomic imbalances, however severe, and emerge stronger.”
At a time when calls for a change in policy direction grow stronger every day, when the Eurozone heads towards recession with the European youth unemployment rate at 23%, pro-austerity officials badly need a success story. Latvia would seem to fit the bill; having weathered its fiscal crisis to return to modest growth, it could be the model student for the indebted European periphery. But those looking to the Baltic for proof that ‘austerity works’ should look a little closer.
Much like Ireland, Spain, Portugal and Greece, Latvia experienced a short period of intense growth, with a property market bubble fuelled, in the Latvian case, by cheap credit from Swedish and German banks. When the credit stopped, the economy did too and the Government nationalised Parex, the country’s second largest bank, taking on its Euro-denominated debt. Private debts were transformed into public liabilities, creating a fiscal crisis. So far, so familiar.
After the dissolution of the incumbent administration, the newly-elected coalition government responded with an aggressive austerity strategy. They targeted healthcare, education and public administration, with 30% cuts to public sector numbers and wage-reductions of 40%. Unlike in many other public-debt troubled countries, Latvia also squeezed old-age pensions, causing significant hardship for retired citizens. Despite IMF suggestions, currency devaluation was ruled out of the question and corporation tax remained unchanged at 15%. GDP shrank by a quarter over two years, leaving one in five workers unemployed.
But the last three years have seen the country return to growth. The volume of exports is greater than pre-crisis levels, and Government spending is within sustainable levels. So it’s clear enough why Latvia gets full marks from the European Commission; it offers a welcome vindication of their policy lessons. However the growth has not translated into improvements in jobs or living conditions. As Armands Strasz, economist and member of Reform Task Force Latvia puts it, “Latvia is a model student, but the professor is pretty wild”.
Although unemployment has dropped to 13%, this is not due to a healthy economy adding jobs. In fact, the number employed was at 900,000 in February 2013, down 20% from the 2008 high. Instead, the export-led recovery is itself lead by emigration, with over 115,000 moving abroad for work since the onset of the crisis. The country’s population is just over 2 million and the social spending forestalled by their departure might well be the margin between surplus and deficit. Businessman Janis Oslejis comments, “If these people had remained in Latvia we would be bankrupt by now.”
But depopulation has its own costs; the shrinking labour force will hinder the development of the economy, while an ageing population will be increasingly difficult to support. The Latvian Government has made efforts to attract emigrants to return but Oslejis doesn’t believe they will be effective. Contrary to popular perceptions, return migration to Eastern Europe due to the crisis was insignificant. Only some returned, and many of them just to look for other destinations.
“There are no economic offers, there is no better work. The foreign banks still control the economy. The regulator is the same. There is a fear that the crisis may double dip. There is no incentive for people to return”.
Exports have increased, but Oslejis suggests that this may have reached its limit.
“People have turned to export because this is the only sustainable market. We have more exports now than before than crisis, but for this to continue we would need more investment, because we have run out of production capacity.”
He suggests that the economy badly needs a resumption of lending to business in order to create jobs and calls for the State to fill the gap. “We spent something like 30% of GDP to bail out the banks and can’t spare a couple of percent to invest in the economy.”
In the meantime, an anaemic stability is the new normal. “The economy will continue to go on, but it will stay and operate at a much lower level of industrial output. You can say the overcoming of crisis has been good for the elite, but the poorer people have suffered a lot.”
But it is not everyone who is suffering. The wealthiest in society have maintained and increased their riches and lengthened the gap between them and the rest of society. The country’s GINI coefficient (the measure of inequality) became the highest in Europe in 2011.
Strasz suggests that those looking to Latvia as an example should look closer. “If someone wants to try to recreate what Latvia has done, they have to see the consequences. The financial sector can be stabilised, but the people are still suffering.”