Today, On May 27th in Riga, the Prime Minister of Latvia Valdis Dombrovskis and internationally respected economist Anders Ǻslund present their book “How Latvia came through the financial crisis”.
Latvia stands out as the East European country hardest hit by the global financial crisis as it lost approximately 25% of its GDP between 2008 and 2010. It was also the most overheated economy before the crisis. But in the second half of 2010, Latvia returned to economic growth. In his review of the book Minister of Foreign Affairs of Sweden Carl Bildt states: “The book tells the incredible tale of Latvia`s road to recovery”.
As Prime Minister Dombrovskis and A. Ǻslund stress in the book, “In the first half of 2009, Latvia was often in the news as the country worst affected by the global financial crisis and speculation reigned that it could be financially hazardous for the whole north European region. Today, Latvia stands out as an example of how crises should be resolved: early, fast, and surgically, mobilizing popular understanding and support.”
Commenting on the book, The European People`s Party president Wilfried Martens states that “The book offers a rare insider’s look at how a national government responded to the global financial crisis, made tough choices and led the country back to economic growth. This fantastic book is a dramatic story of success and resolution.” Sandra Kalniete, Member of the European Parliament from Latvia points out: “Latvia has something to be proud of. The ability to overcome the deepest economic crisis is our nation’s achievement. In order to restore stable growth in Latvia, it is important to continue the course undertaken, to join the eurozone – the core of European economic and political development.”
In his review of the book the former President of National Bank of Poland Leszek Balcerowicz emphasizes: “Economic and political lessons of Latvian stabilization and reforms go well beyond Latvia and are especially relevant for the members of Eurozone”. Dombrovskis and Ǻslund state in the book: “This small nation can hopefully offer Greece and other crisis countries in the euro area lessons of radical internal devaluation, because for the European Monetary Union members devaluation is not an option.”
Dombrovskis and Ǻslund emphasize that Latvia has done what many said could not be done stating that there are 9 lessons on the economics of financial crisis and its political economy one can learn after Latvia`s experience with the financial crisis in 2009.
1. A key lesson from Latvia’s financial crisis resolution is that devaluation is neither a panacea nor a necessity that many economists make it out to be. The financial crisis in Latvia, as well as in its Baltic neighbours Estonia and Lithuania, provoked a charged international policy debate. Numerous international economists argued that devaluation was not only necessary but also inevitable. By the end of 2009, however, it became clear that they were wrong.
The cure to overheating was to stop excessive short-term capital inflows, which did not require devaluation. In addition, the steady exchange rate parity forced Latvia to undertake long-overdue structural reforms.
2. Second, the Latvian people were motivated by their desire for full European integration with early adoption of the euro, which led them to focus on two nominal anchors: a fixed exchange rate and a budget deficit below 3 percent of GDP, so that Latvia could accede to the Economic and Monetary Union as early as possible.
3. Third, Latvia’s experience with fiscal adjustment shows the advantages of carrying out as much of the adjustment as possible early on. Hardship is best concentrated to a short period, when people are ready for sacrifice.
4. Fourth, more than three-quarters of the fiscal adjustment came from cuts in public expenditures, suggesting that they are economically and politically better than tax hikes. The most popular budget adjustments were cuts of salaries and benefits of senior civil servants and state enterprise managers as well as the reduction in public service positions.
5. Fifth, the large and frontloaded international rescue effort was appropriate and has been successful.
6. Sixth, Latvia, as well as its Baltic neighbors, showed that these vibrant democracies were perfectly capable of reducing their public expenditures by about one-tenth of GDP in one year.
7. Seventh, the benefits of stable government have been greatly exaggerated. Latvia benefited from being able to switch government quickly during the crisis. Thus, parliamentary systems with many parties, leading to coalition governments and frequent government changes, may be beneficial for the resolution of macroeconomic crises.
8. Eighth, the bottom line is that populism is not very popular in a serious crisis when the population understands the severity of the crisis and wants a sensible and resolute government that can handle the crisis as forcefully as is necessary. Therefore, the Latvian anticrisis government could win the parliamentary elections on October 2, 2010. The big losers in the 2010 elections were oligarchs who tried to exploit populism.
9. Finally, the international macroeconomic discussion was not useful but even harmful. Whenever a crisis erupts anywhere in the world, a choir of famous international economists proclaim that it is “exactly” like some other recent crisis—the worse the crisis, the more popular the parallel. Soon, prominent economists led by New York Times columnist Paul Krugman claimed that “Latvia is the new Argentina.” A fundamental problem is their reliance on a brief list of “stylized facts,” never bothering to find out the facts.
The book “How Latvia Came through the Financial Crisis” is published by the Peterson Institute of International Economics, a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems.
Additional information about the Institute can be found on the website: http://www.iie.com
Press Secretary of Cabinet of Ministers