The Council of Europe 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.