Open letter: the state of the Latvian economy

This open letter was published in Diena on 10 September 2009.

Latvia is stuck in a depression trap. GDP fell by 19,6% in the second quarter of 2009; retail sales are down 28%; and unemployment is already 13-14%. But unlike most European states which are trying to reflate their way out of recession, Latvia is caught in a cycle of budget cuts and falling spending. The latest fiscal tightening announced at the end of June, the second such package already in 2009, cut another €700 million from the budget, and will mean that 10,000 state teachers will lose their jobs, one third of the national total. The government has cut pensions by 10%; remaining public servants have had their wages cut by 35%.

Latvia does not want to devalue its way out - that would lead to huge losses for holders of domestic foreign currency loans and for Scandinavian banks who have invested heavily. Nor does Latvia want to abandon its objective of joining the Euro zone, scheduled for 2014; even though this forces it to continually cut towards a budget deficit of only 3% of GDP by 2012.

But deflation risks leading to a protracted depression that will have catastrophic consequences. If the national currency, the lat, goes down, then many neighbours and other fixed peg states (the other Baltic states, Bulgaria) may follow.

This should be of concern to the European Union for a number of reasons. It could undermine the fragile progress made in social integration, a process in which the EU has made considerable political and economic investment. Young Russian-speakers are bearing the brunt of unemployment, especially in the collapsed construction industry. Latvia faces an upcoming electricity shortage, and Gazprom has been lobbying for it to build gas- rather than coal-fired power stations - at a time when the EU is encouraging all member states to invest in energy security. Most worryingly of all, the population, having seen the failure of communism, is in danger of concluding that capitalism and the free market economy are failing them too. Democracy has not brought the social justice many hoped for. Can the EU continue mouthing its guiding principles and idly stand by while one of its members is having its statehood seriously eroded by the economic downturn?

There are two alternative solutions. The European Commission, IMF and the Nordic countries have generously provided loans to cover part of the budget deficit and stabilise the banking sector. But there needs to be greater flexibility about the Maastricht criteria, particularly for those countries that have linked their currency to the euro with a fixed peg and cannot use currency fluctuations to deal with the crisis.

Second, the Latvian government does not have the money to stimulate the economy itself. Labour and infrastructure costs have declined, but low credit ratings leave Latvia unattractive to foreign investors. One way forward is through special and bilateral guarantee funds to stimulate the entry of companies from the old Western member states (the model could apply throughout Eastern Europe), with the guarantee fund financing a certain percentage of the relevant costs. Germany recently approved such a fund - at € 3.5 billion - for companies dealing with Russia.

The positive short-term effect would be assurance that the markets will not collapse. Western companies will see their export markets recover. The long-term effect would be closer integration between the West and East of Europe.

Signed:

Asger Aamund, President and CEO, A. J. Aamund A/S and Chairman of Bavarian Nordic A/S 

Martti Ahtisaari, Chairman of Crisis Management Initiative and former President of Finland

Svetoslav Bojilov, Founder of Communitas Foundation and President of Venture Equity Bulgaria Ltd.

Emma Bonino, Vice President of the Italian Senate and former EU Commissioner
Charles Clarke, MP and former UK Home Secretary

Sarmite Elerte, Chair of the National Council on Culture, Latvia

Uffe Ellemann-Jensen, Chair of the Baltic Development Forum and former Danish Foreign Minister

Anna Ibrisagic, Member of European Parliament

Olli Kivinen, Finnish writer and columnist

Gerald Knaus, Chair of the European Stability Initiative and Open Society Fellow

Mark Leonard, Executive Director, European Council on Foreign Relations

Leoluca Orlando, Italian MP and President of the Sicilian Renaissance Institute

Albert Rohan, former Austrian Secretary General for Foreign Affairs

Giuseppe Scognamiglio, Head of Institutional and International Relations, UniCredit

George Soros, Chair of the Open Society Institute

Loukas Tsoukalis, Professor at the University of Athens and President of ELIAMEP
Vaira Vike-Freiberga, former President of Latvia