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Europe no image

Published on May 24th, 2012 | by Katharina Obermeier
Image © [caption id="" align="alignnone" width="567" caption="© Saeima"][/caption]   In a previous post on this blog, I commented on the fact that good news rarely receives as much media attention as bad news. It is not surprising; therefore, that good news concerning a small Baltic country like Latvia has received next to no attention in the mainstream international media. It is a shame, because Latvia was essentially the Greece of 2008, with out-of-control government debt and collapsing creditworthiness. In fact, Latvia’s GDP contracted by nearly 25% between 2008 and 2011, much more than Greece’s has so far. Now, however, the country is firmly on the way to recovery, achieving the highest economic growth rate in the EU this year. Moreover, despite its limited exposure, this good news for Latvia has broader implications for the rest of Europe, revealing scenarios which might be useful to other EU member states. The crisis in Latvia began when the global financial crisis hit Europe, as capital was swiftly withdrawn from the markets and the indebted Latvian government could no longer borrow cheaply to cover its costs. Insufficient banking regulations meant that Latvian banks were brought close to collapse in the wake of the global crisis and markets lost confidence in the country’s economy. So far, this tale echo’s the situation in Greece and other EU countries currently in crisis. So, how were Latvia’s dire economic problems resolved? In late 2008, the EU established a programme of financial assistance for Latvia with the help of other international institutions and EU member states, which consisted of loans to the Latvian government and policies for structural and fiscal reforms. The loans acted as guarantees for Latvia’s debts, keeping the country from bankruptcy and restoring confidence in its creditworthiness. This was helped by the fact that Latvian leaders decided to keep their currency pegged to the euro, rather than allow it to devalue, which would have eased the adjustment but also would have undermined investor confidence and invited inflation. Importantly, the Latvian government also nationalised Parex Banksa, one of the country’s largest banks, which had collapsed in the credit crunch. In order to safeguard itself against such problems in the future, it strengthened supervision and regulation of the banking sector. And yes, austerity measures were also implemented. The government’s debt was reduced by a remarkable 15% of GDP in a few short years, through cuts in government expenditures, raised tax compliance and improvements in public sector efficiency. While this of course had harmful effects on Latvia’s provision of social services, these were partly off-set by the use of EU funds to finance temporary social work, develop or enhance retraining and education schemes and provide credit to small and medium-sized enterprises. And despite – or because of – the rapid debt reduction, the Latvian economy grew by 5% in 2011. In fact, now that the deficit is under control, the government can afford to cut taxes, further aiding its economic recovery. Obviously, no two countries in a financial crisis are exactly alike. Latvia, of course, is not a member of the eurozone, unlike Greece or Spain. However, the fact that it continued to keep the lat (its currency) pegged to the euro throughout the crisis essentially puts it in the same position as these other countries. Economists familiar with these countries would no doubt be able to pinpoint more differences between them, and it is worth noting that any economic policy should be tailored to the specific requirements of the country in question. However, there are broad fundamental similarities between the crises in Latvia and other EU countries, which means the lessons from Latvia should at least be considered in the context of these other economies. The Latvian experience demonstrates that, austerity measures are not necessarily incompatible with economic growth, that rapid debt reduction is important and that improved banking regulations and EU financial assistance can help create the right framework for economic recovery. Whether or not all or any of these factors are applicable to a country like Greece, is a question that Greek and EU leaders should explore.

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The Road from Greece to Latvia

© Saeima

 

In a previous post on this blog, I commented on the fact that good news rarely receives as much media attention as bad news. It is not surprising; therefore, that good news concerning a small Baltic country like Latvia has received next to no attention in the mainstream international media. It is a shame, because Latvia was essentially the Greece of 2008, with out-of-control government debt and collapsing creditworthiness. In fact, Latvia’s GDP contracted by nearly 25% between 2008 and 2011, much more than Greece’s has so far. Now, however, the country is firmly on the way to recovery, achieving the highest economic growth rate in the EU this year. Moreover, despite its limited exposure, this good news for Latvia has broader implications for the rest of Europe, revealing scenarios which might be useful to other EU member states.

The crisis in Latvia began when the global financial crisis hit Europe, as capital was swiftly withdrawn from the markets and the indebted Latvian government could no longer borrow cheaply to cover its costs. Insufficient banking regulations meant that Latvian banks were brought close to collapse in the wake of the global crisis and markets lost confidence in the country’s economy. So far, this tale echo’s the situation in Greece and other EU countries currently in crisis. So, how were Latvia’s dire economic problems resolved?

In late 2008, the EU established a programme of financial assistance for Latvia with the help of other international institutions and EU member states, which consisted of loans to the Latvian government and policies for structural and fiscal reforms. The loans acted as guarantees for Latvia’s debts, keeping the country from bankruptcy and restoring confidence in its creditworthiness. This was helped by the fact that Latvian leaders decided to keep their currency pegged to the euro, rather than allow it to devalue, which would have eased the adjustment but also would have undermined investor confidence and invited inflation. Importantly, the Latvian government also nationalised Parex Banksa, one of the country’s largest banks, which had collapsed in the credit crunch. In order to safeguard itself against such problems in the future, it strengthened supervision and regulation of the banking sector.

And yes, austerity measures were also implemented. The government’s debt was reduced by a remarkable 15% of GDP in a few short years, through cuts in government expenditures, raised tax compliance and improvements in public sector efficiency. While this of course had harmful effects on Latvia’s provision of social services, these were partly off-set by the use of EU funds to finance temporary social work, develop or enhance retraining and education schemes and provide credit to small and medium-sized enterprises. And despite – or because of – the rapid debt reduction, the Latvian economy grew by 5% in 2011. In fact, now that the deficit is under control, the government can afford to cut taxes, further aiding its economic recovery.

Obviously, no two countries in a financial crisis are exactly alike. Latvia, of course, is not a member of the eurozone, unlike Greece or Spain. However, the fact that it continued to keep the lat (its currency) pegged to the euro throughout the crisis essentially puts it in the same position as these other countries. Economists familiar with these countries would no doubt be able to pinpoint more differences between them, and it is worth noting that any economic policy should be tailored to the specific requirements of the country in question. However, there are broad fundamental similarities between the crises in Latvia and other EU countries, which means the lessons from Latvia should at least be considered in the context of these other economies. The Latvian experience demonstrates that, austerity measures are not necessarily incompatible with economic growth, that rapid debt reduction is important and that improved banking regulations and EU financial assistance can help create the right framework for economic recovery. Whether or not all or any of these factors are applicable to a country like Greece, is a question that Greek and EU leaders should explore.

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About the Author

Katharina Obermeier

Katharina considers herself a German-Canadian hybrid. She grew up in Germany and completed her BA in International Relations at the University of British Columbia in Vancouver, Canada. Politics, especially in relation to concepts of nationality, have always fascinated her, and she is particularly interested in international political economy. During her studies, she was an avid participant at Model United Nations conferences, and helped welcome international exchange students to her university. She is currently completing an internship at a Brussels-based trade association and hopes to work in European affairs in the future. In her political writing, Katharina marries social democratic principles with a keen interest in the European Union and its implications for European politics and identity. She writes to counteract simplistic ideas about politics and economics, continuously attempting to expose the nuances and complexities involved in these subjects.



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