Warren Weertman
Warren Weertman

Latvia and the politics of permanent austerity

In 2008 Latvia was hit by the economic crisis that saw its economy shrink substantially. In the fourth quarter of 2008 alone, Latvia’s GDP slumped by 10.5% compared to the same period in 2007. Prior to the financial crisis, the Latvian economy had been growing rapidly for a number of years.

In response to its economic problems, the Latvian government turned to the International Monetary Fund (IMF) for economic assistance in the form of a €7-billion loan. Naturally, the IMF rode into town with its usual offer of assistance tied to conditionality (i.e. austerity).

While Latvia is hailed as the poster child of how successful austerity programmes can be, the reality is a bit different. As a result of the economic crisis, the Latvian population has shrunk from nearly 2.2-million people in 2008 to about 2-million people in 2012. In effect, the Latvian population is back (in terms of size) where it was in 1957.

Whereas the collapse in the size of the Latvian population could be explained by deaths (in 2012 alone there were more deaths than births), the biggest factor in the reduction in the size of the Latvian population is the migration of people out of Latvia as a result of the economic crisis. Since Latvia is a member of the EU, Latvians have been able to escape the economic crisis as a result of EU rules around the free movement of people within the bloc.

As one indicator of the success of the austerity policies, austerians point to a fall in the Latvian unemployment rate from approximately 9.5% in 2008 to nearly 5% in 2012. That certainly is a success. But to credit the austerity programme is misleading. I would argue that the reason why the Latvian unemployment rate has dropped so dramatically is because people have left the country.

However, even with economic growth returning to Latvia (GDP growth was 5.5% in 2012), unemployment in Latvia is still high (bearing in mind the size of the population). It’s also import to bear in mind that the Latvian age dependency ratio has increased from 45.5% to nearly 46.78% in the period 2008 to 2012 alone. All of this would suggest, that the current levels of economic growth in Latvia are not enough to get people working and the economy growing again.

But Latvians, it seems, are suckers for punishment…

On 1 January 2014, Latvia joined the euro and ditched the Lat. That’s potentially good news, you would think. But the problem that Latvia will have is that, by joining the eurozone, the pain of austerity will continue for many, many, many years to come. How come?

Any government that issues its own sovereign currency (such as the Latvian government before 1 January 2014), when faced with an economic crisis has four choices:

  1. Induce inflation by printing money;
  2. Deflate the economy through austerity measures;
  3. Devalue their currency; or
  4. Default

Default is never a pretty option. However, by joining the Eurozone, the Latvian government will be giving itself only two choices, when faced with the next economic crisis:

  1. Deflation; or
  2. Default

The option of inducing inflation or devaluing their currency are taken away since these functions are handled by the European Central Bank in Frankfurt. Default is not an option for eurozone members. This means that Latvians, when faced with an economic crisis in the future will be left with three choices – austerity, austerity and more austerity.

The problem that Latvia has, however, is more than economic. As you would appreciate, given the size of its population, it will always be dwarfed by its much bigger neighbour – Russia. Given the history of Latvia and its absorption into the USSR at the end of World War II, this has resulted in a distrustful political elite that worry about when Russia might try to dominate Latvia again. This is, given the history of the place, understandable.

So when the option of joining the EU arose, naturally Latvia would chose to secure its political and economic future (free of Russian domination) by joining the EU. However, that membership has come at a cost, since one of the terms of its accession to the EU was that Latvia would need to join the Eurozone. At the time of joining the EU, this move probably made sense.

However, since the advent of the 2008 economic crisis, I would argue that one of the worst things that Latvia could have done on 1 January 2014 was to join the eurozone. A better policy choice, I think, given its commitments, would have been to delay joining the Eurozone until the economy was growing again and unemployment was under control (the optimal policy choice would have been to stay outside the Eurozone, but this isn’t really an option given the rules of joining the EU).

Unfortunately, this is not to be and instead Latvia will be heading down a path, starting 1 January 2014, that can only be described as politics of permanent austerity. If history is anything to go by, the future will not be pretty for Latvians.

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    • ian shaw

      The exact same thing has occurred by many other nations in Central and Eastern Europe I(like for instance in Hungary). EU membership and IMF loans brought loans with usurious interest rates, unemployment, and the destruction of the home-grown agriculture and industries in favour of aggressive multinationals and foreign banks. Besides, not being able to issue you own currency causes a devastating loss of national asset control. Spain, Portugal, Italy, once prosperous nations have also gone broke under the imposed and unelected yoke imposed by Brusssels, capital of teh EU..

    • Andrew Joubert

      I think you are being overly pessimistic. The slight signs of life in the Eurozone are not exciting, but are at least positive. I’d rather be in the Eurozone than the former Soviet bloc – vide the turmoil in the Ukraine.

    • Comrade Koos

      @Warren

      I think most sensible modern economists would agree with you. I have one foot in the John Maynard Keynes camp too. Austerity is not the answer.

      But I cannot help but ask; what would Karl Marx do?

      :-)

    • nguni

      The terms of joining the EU must have changed because there are several members who have stubbornly refused to use the Euro as their currency. Best known of course is the UK, but also Norway, Denmark, the Czech Republic (in contrast to its former other half, Slovakia), etc. As a small nation with a huge, unfriendly neighbour Latvia made the right choice.
      Because of Brit & American attitudes re the Euro the English press worldwide is generally very negative re its future. I personally took a big financial hit because of this Eurosceptism when I moved half my Euro assets to gold at $1700 a couple of years ago, there goes my hope of retirement with gold now approaching $1000 and the Euro >R15!

    • http://necrofiles.blogspot.com Garg Unzola

      But European nations don’t need to choose between being in the Eurozone or being molested by Russia on the other hand. Latvia was doing perfectly fine and did not need the Eurozone, neither does the Ukraine at the moment. Greece would do much better if they had an exchange rate working in their favour.

    • ian shaw

      Comrade Koos: what would Marx do?
      He would openly and publicly identify those who benefit from this system which undoubtedly makes some people the ultimate beneficiaries while whole nations become destitute. This does not say that I am advocating socialism of any form yet this constitutes the core of propaganda by the beneficiaries against any criticism.

    • ian shaw

      Comrade Koos: what would Marx do?
      He would openly and publicly identify those who benefit from this system which undoubtedly makes some people the ultimate beneficiaries while whole nations become destitute. This does not say that I am advocating socialism of any form yet this constitutes the core of propaganda by the beneficiaries against any criticism.

    • Comrade Koos

      Right now austerity is the mantra of the ruling classes (i.e Wall St bankers and financiers) .This is what Karl Marx would have said about the ruling ideas in a society:

      “The ideas of the ruling class are in every epoch the ruling ideas, i.e. the class which is the ruling material force of society, is at the same time its ruling intellectual force. The class which has the means of material production at its disposal, has control at the same time over the means of mental production, so that thereby, generally speaking, the ideas of those who lack the means of mental production are subject to it. The ruling ideas are nothing more than the ideal expression of the dominant material relationships, the dominant material relationships grasped as ideas.”

      Marx, German Ideology (1845)

    • Juan José Cruz

      Ask us Spaniards! Wow, it’s like a mirror reflection, -the mirror standing on Frankfurt.