Why Latvia’s Austerity Model Can’t Be Exported

By Michael Hudson and Jeffrey Sommers
(Cross-posted from FT)

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 Latvia 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 toward 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 actually enabled Latvia to survive the crisis was 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 largest party opposing the austerity programme (Harmony Center) 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 was the “austerians.” While most voters dislike their economic policy, a majority is convinced that they are best able to resist Russia’s embrace. All other issues are a distant second for Latvian voters.

That said, Latvians have protested against austerity. On January 13, 2009, in the dead of winter, some 10,000 came out to protest in Riga. Teachers, nurses and farmers held demonstrations of their own. The police were called out to suppress protests over closure of a hospital.

After these protests subsided, Latvians resigned themselves and began to emigrate, voting with their feet. 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 that become evident with time: it has one of Europe’s highest suicide rates, preventable deaths and disabilities due to healthcare cuts, road deaths due to drunk driving, high crime due to prolonged unemployment and police budget cuts, less accessible, lower quality education and a skyrocketing 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 for other nations to absorb the outflow of émigrés seeking employment abroad. Such a country should be willing to see 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”.

The writers, a distinguished professor at the University of Missouri-Kansas City and associate professor at the University of Wisconsin-Milwaukee respectively, 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. 

12 responses to “Why Latvia’s Austerity Model Can’t Be Exported

  1. Pingback: Why Latvia’s Austerity Model Can’t Be Exported | The Wall Street Examiner

  2. “The writers, a distinguished professor at the University of Missouri-Kansas City and associate professor at the University of Wisconsin-Milwaukee respectively, have both advised members of Latvia’s government on alternatives to austerity. “

    Then clearly, Latvia’s government is not listening. No one from UMKC would advise Latvia to continue austerity or even to be financially associated with the eurozone. As I said way back on June 5, 2005, “Because of the Euro, no euro nation can control its own money supply. The Euro is the worst economic idea since the recession-era, Smoot-Hawley Tariff. The economies of European nations are doomed by the euro.”

    Latvia should begin to act like a Monetarily Sovereign nation. It should disconnect completely from the euro, abandon austerity, stop borrowing, pay all future bills in Lats and dramatically increase deficit spending — in Lats. That is its salvation.

    Can’t these people learn from the PIIGS that austerity and monetary non-sovereignty are the sure path to disaster? Jeffrey and Michael, you may have to shout a little louder.

    Rodger Malcolm Mitchell

  3. What are the options? If latvia adopts a sovereign currency ..would still be at the mercy of the financial elites i.e Trade embargoes/attacks on the currency? What would be a viable exit strategy for a small country like Latvia or Greece?

    • Specifically, who would apply trade embargoes? Latvia imports total about $1 billion per month. Who are the nations and the vendors who will not want Latvia as a customer?

      An what are the attacks on the currency? A Monetarily Sovereign Latvia wins either way. Depress the lat, and Latvia exports more. Inflate the lat, and Latvia can buy more, without inflation. The key for Latvia is Monetary Sovereignty.

      Rodger Malcolm Mitchell

      • @ RMM

        What interests have enforced the status quo??..Wouldnt it follow the same interests would circle the wagon Sryrianize,Libyanize and spread a new viral strain of the “Asian Flu” from the 90’s? The only EU member with a sovereign currency is the UK ( and coincidentally outside the Schengen area along with Ireland) I don’t see latvia having that kind of muscle. The reality of a non-aligned state is unfortunately dead for now isnt it?? Name a success if you will???

        • Jonathan,

          The following EU nations do not use the euro:
          Czech Rep.
          United Kingdom

          There is no motive to, as you say, “circle the wagons, Sryrianize,Libyanize and spread a new viral strain of the ‘Asian Flu’ from the 90′s? ” On the contrary, the EU nations need all the trading partners they can get.

          Rodger Malcolm Mitchell

  4. ? Michael Hudson himself has said its on big Asset grab..Fiscal austerity = recession/depression +Government insovlency = Fireside sales of public sector assets/shrinking of the public sector. Facilitating Commerce obviuosly is not the chief objective of speculators/financial elites..The UK is the only true sovereign currency issuer..maybe sweeden & denmark a distant 3rd. What is the litmus test for a sovereign currency? The ability to issue currency and levy taxes somewhat independently of the IMF/ECB………

    Czech Rep.

    The above countries are not even in the same club…During colonial times Currency boards were established to give the illusion of independence through printing currency with native icons.. when in fact controlled by British/Colonial dominant powers. The countries on your list are no more or even less sovereign than PIIGs which are officially part of the European monetary union.

    • Actually, Sweden is Monetarily Sovereign, and not a “distant” anything. It has the unlimited ability to pay any size debt denominated in krone. Same for Poland and the złoty.

      Other nations that still use their own currency, but pegged to the euro, are not Monetarily Sovereign. Pegging is equivalent to monetary non-sovereignty. Some nations are “planning” to adopt the euro at some future date, but still remain Monetarily Sovereign. Something tells me those plans now may be put on hold, as the euro requirement of monetary non-sovereignty, proves not surprisingly, disastrous. The euro, as we know it, is doomed.

      Getting back to your prediction, which was the subject at hand, I see no evidence that the EU will “apply a trade embargo” or pursue any other act of war on an otherwise friendly nation. Greece should get out just as soon as it can print up some drachmas. If it does resume Monetary Sovereignty, it soon will be one of the stronger nations in Europe.

      Rodger Malcolm Mitchell

  5. Probably you are unable to say what advice you gave them. So we will have to wait and see how this works out. Is it even possible to escape the wrath of the bankers and theTroika?

  6. Pingback: Paletleme Amirliği, 24 Haziran 2012 « Emrah Göker'in İstifhanesi

  7. Shelby Ruth Chapel

    Didn’t you say one of the problems with econ teaching is avoiding/ignoring history? Thought of you when I bumped into:
    google: markets and antimarkets in the world economy. (Manuel De Landa)
    “I believe it is not an exaggeration to say that in the last two or three decades, history has almost completely infiltrated physics, chemistry and biology. ”
    Goes on to elaborate on matters related to your interests.
    Take care, Shelby
    PS: Did you pick up my comment re how econ parasite behavior parallels bio parasites? In case I for got, info from “Parasite Rex.” (Carl Zimmer). I’m seeing little signs ‘hard sciences’ are smooshing into econ, sociology, etc. Very interesting.

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