The Latvian economy: my part in its downfall

By bne IntelliNews June 9, 2011

Mike Collier in Riga -

By writing a book called How Latvia came through the financial crisis Latvian Prime Minister Valdis Dombrovskis is taking a risk. The title's use of the past tense leaves him open to accusations of hubris, whilst it also hints at a Spike Milligan-esque How I won the war swagger curiously out of keeping with this most mild-mannered of politicos.

The tome - written in collaboration with Swedish economist Anders Aslund - provides a handy reference guide to the complexities of Latvia's rapid economic descent and continuing slow crawl back from the abyss.

It's not hard to see why such a volume is required. In a recent BBC radio broadcast, Andrew Hilton of the Centre for the Study of Financial Innovation in London bemoaned the pointlessness of asking Greece to "impose austerity that no other country has ever experienced in peace time." Clearly little Latvia escaped his notice. Whilst the Greeks were asked to consolidate their budget by 7.5% of GDP in the first year of their bailout programme (but managed just 6%) Latvia achieved fiscal consolidation of 9.5% in the same period, while so far consolidation totals around 15% of GDP.

"The idea to write a book came in spring last year when there were clearly the first signs of the stabilization of the economy," Dombrovskis tells bne in an exclusive interview. "My office contacted Anders Aslund, whom I had met before and who was one of the few prominent economists who argued against devaluation. His reaction was immediately positive. Basically we were exchanging notes. I wasn't dictating, we had a couple of meetings and did a lot of emailing."

"The title was the last thing we wrote..." Dombrovskis points out. "If we talk about the financial crisis, this is clearly over. There is no sign of financial instability and the budget deficit is down to manageable levels."

The book concludes that nine lessons can be learned from Latvia's experience in the crisis, the most important of which is probably a strong argument that a currency devaluation really can be resisted if the alternative route of internal devaluation is seriously pursued.

"The nine points are what we learned from the crisis when it became clear that the strategy was working. In 2009 we were working more in a crisis management mode and taking decisions to avoid the insolvency of the state," says Dombrovskis.

Despite still being outside the eurozone, Dombrovskis believes member states of the single currency might benefit most from Latvia's example. "We can make a comparison with Greece. It is in the eurozone and has to reform in order to stabilise its finances. Maybe they have not been too successful so far but it's quite clear there is no other way for them. We could have discussed devaluation, but unless they want to quit the eurozone they don't have that option, so eventually it will be internal devaluation and reform.

The new author also suggests that the question of devaluation should be considered from outside the arena of bankers and politicians. "To an extent we can see the social consequences of devaluation in Belarus. Some economists were saying devaluation was a very easy solution - at least for the central bank and government - but certainly it's not an easy solution for the general population, who see their savings and incomes halved overnight."

"Devaluation always tends to hit the least protected members of the population hardest, and doesn't really deal with your structural problems," he continues, turning back to his homeland. "Being a small, open economy means that the effect of enhanced competitiveness following devaluation will disappear very quickly, and then you're back to the same problem and having to devalue every decade, or every five years."

At times in the book it feels that the authors - or rather Aslund - is a little too keen to point out the flaws in the 2007 forecasts of rival economists such as Paul Krugman and Nouriel Roubhini. Whilst that may be a valid observation, it becomes repetitive and starts to sound like backbiting in an insular circle of professional rivals.

It also grates that a couple of the items on the list of lessons (such as Latvians' supposed euro-enthusiasm and the benefit of having revolving-door governments) are so debatable. However, Dombrovskis gamely defends his co-author, before making a final bid to justify his claim that he can now look back at Latvia's crisis.

"If we talk about the economic crisis then the recession was over in the second half of last year by the accepted definition of two quarters of successive growth. In the last quarter we had growth of 3.6%. Clearly there is still high unemployment and related social and emigration problems, but we are back to economic growth, so we are in a post-crisis period," Dombrovskis says.

Unsurprisingly, that's not the view of Janis Urbanovics, leader of the Harmony Centre opposition party that will be Dombrovskis' main rival in September elections: "I'm afraid I haven't read the book he is promoting, along with some other people who believe the crisis is over," Urbanovics tells bne, "but it seems to me the prime minister is playing a rather poor joke."

Dombrovskis' and Aslund's 9 lessons from the crisis

1. Devaluation is not the necessity that many economists make it out to be.

2. Euro adoption plans helped by providing a fixed exchange rate and a budget deficit target.

3. It is better to carry out as much of the adjustment as possible early on.

4. Cuts in public expenditures are economically and politically better than tax hikes.

5. The large international rescue effort was appropriate.

6. Vibrant democracies are capable of reducing their public expenditures by 10% of GDP in one year.

7. The benefits of stable government have been exaggerated. Latvia benefited from being able to switch government quickly.

8. Populism is not popular when the population understands the severity of the crisis.

9. International macroeconomic discussion was not useful but even harmful.

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