Latvia No Austerity Success

June 25, 2012
By

Jeffrey Sommers & Michael Hudson

Cross posted from the Financial Times by permission of the authors

Michael Hudson and Jeffery Sommers: a distinguished professor at the University of Missouri-Kansas City and associate professor at the University of Wisconsin-Milwaukee respectively, who have both advised members of Latvia’s government on alternatives to austerity. They are also contributors to the forthcoming book by Routledge Press: The Contradictions of Austerity: The Socio-Economic Costs of the Neoliberal Baltic Model.

Austerity’s advocates depict Latvia as a plucky country that can show Europe the way out of its financial dilemma – by “internal devaluation”, or slashing wages. Yet few of the enthusiastic commentators have spent enough time in the country to understand what happened. Its government has chosen austerity, its people have not. Finding no acceptable alternative, much of the labour force has elected to emigrate. This is a major factor holding down its unemployment rate to “just” 15 per cent today.

Latvia is not a model for austerity in Greece or anywhere else. Both the impression that neoliberal policy has been a success and the claim that Latvians have voted to support this failed model are incorrect.

Latvia’s one year of solid economic growth since its economy plunged by 25 per cent in 2008-10 is billed as a success. Then, unemployment soared above 20 per cent as the shutdown of foreign capital inflows (mainly Swedish mortgage loans to inflate its real estate bubble) left Latvia with a deep current-account deficit. It had to choose between devaluation or maintaining the euro peg.

It chose the latter in order to proceed towards euro accession. To meet the eurozone criteria it cut public sector wages by 30 per cent, driving down overall wage levels and consumption to match its low labour productivity. The doctrine was that this shock therapy and poverty would soon restore prosperity.

What enabled Latvia to survive the crisis were EU and IMF bailouts – whose repayments will soon fall due. Relatively low public sector debt (9 per cent of gross domestic product at the start of the crisis) also provided some protection from bond traders. Latvia’s problem was mostly private sector debt, especially mortgage debt, which is secured not only by property but by the personal liability of entire families of joint signatories. The bank insurance agency insisted on this measure as it saw unaffordable housing prices being inflated by reckless bank lending. (Its job was to protect the banks, not the economy.)

The resulting austerity programme is anything but popular. Latvia’s parliament often polls approval ratings in the single-digits. Yet the government has survived two elections. How is one to read this?

Chiefly by ethnic politics. The biggest party opposing the austerity programme (Harmony Centre) largely represents ethnic Russians and had no chance of winning given its focus on rights for Russian speakers. The smaller parties run by post-Soviet oligarchs also are seen as being in league with Russia and are widely resented for fiscal imprudence during the boom years, when oligarch-controlled parties were part of the governing coalition. So the only political force left is the “austerians”. While most voters dislike their economic policy, a majority are convinced that they are best able to resist Russia’s embrace. All other issues come a distant second for Latvian voters.

That said, Latvians have protested against austerity. In January 2009, in the dead of winter, 10,000 protested in Riga. Teachers, nurses and farmers held demonstrations of their own. The police were called to suppress protests over the closure of a hospital. After these protests subsided, Latvians resigned themselves and began to emigrate. Demographers estimate that 200,000 have left in the past decade – nearly 10 per cent of the population – at an accelerating rate that reflects the austerity being inflicted.

Why have so many left Latvia if it is such an economic success, with such popular support for austerity as the advocates claim? Birth rates fell during the crisis – as is the case almost everywhere austerity programmes are imposed. Only now is Latvia seeing the social effects of austerity. It has among Europe’s highest rates of suicide and of road deaths caused by drink driving. Crime is high because of prolonged unemployment and police budget cuts. There is less accessible, lower-quality education and there is a soaring brain drain alongside blue-collar emigration.

The moral for Europeans is that a Latvian economic and political model can work only temporarily, and only in a country with a population small enough (a few million) for other nations to absorb émigrés seeking employment abroad. Such a country should be willing to have its population decline, especially its prime working-age cohort. In Greece, this could only worsen an already serious demographic challenge.

Politically, it helps to be a post-Soviet economy with a fully flexible, poorly unionised labour force. Above all, the population needs to put an almost blind faith in “free market” central planners. Ethnic divisions can distract voters from complaints against austerity. Only under these political conditions can austerity be considered a “success”.

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