With the Latvian economy among the fastest growing in Europe, it is tempting to believe that Latvia not only has recovered from the crisis but also learnt a lesson—there are no shortcuts, fiscal and monetary policy has to be in harmony.
What could then more specifically be learned from the Latvian experience? First of all, that an internal devaluation works, provided the labour market is highly flexible, labour can easily move across the (EU) borders, and the economy mainly comprises small and medium size enterprises.
Nevertheless, an internal devaluation and the associated austerity measures require a strong political will, which in Latvia’s case was “supported” by external pressure from the EU, the IMF and others. Furthermore, irrespective of whether the devaluation is internal or external, the burden of the adjustment is disproportionally levied on the society’s poorest, something the Latvian population is painfully aware of.
The Latvian experience also shows that the political will to address the immediate crisis might be very different from the will to address its real root, lack of competitiveness. As the Finnish and Swedish experiences from the crisis in the early 1990s show, post-crisis policy-making is essential. Following major (external) devaluations, both Finland and Sweden undertook substantial institutional reforms, ranging from constitutional changes and EU accession to changed monetary and fiscal policy accompanied by severe austerity measures.
In addition to a recovery quicker than expected, the measures undertaken in the aftermath of the crisis paved the way for a period of long-term sustainable economic growth. In other words, to come out as a post-crisis winner, much more is needed than just short-term crisis management. Latvia has no doubt been successful in terms of handling the immediate crisis, but to what extent has it addressed its deep root—the fact that the Latvian economy (like the Finnish and Swedish ones in the early 1990s) is not competitive? Monetary policy has changed as a consequence of joining the euro-zone in 2014 and it is now essentially in the hands of the European Central Bank. In terms of fiscal policy, an independent Fiscal Discipline Council has been established to monitor fiscal policy-making. Otherwise, not very much has changed.
Overall policy-making is to a large extent still characterised by short-termism. Bureaucracy and administrative and judicial efficiency are essentially at the same (low) levels as prior to the crisis. The same applies to other areas of society, such as the political, educational and healthcare systems. If it fails to address these issues, Latvia will be doomed to low, long-term economic growth and remain a country whose main competitive advantage is low wages. Hence, Latvia will continue to be a country that forces the most ambitious part of its labour force to search for a better future elsewhere in the EU. This will continue until the next crisis hits the economy—a crisis that for sure will be different from the recent one, but whose root will be the same, lack of competitiveness.
On the other hand, if Latvian policy makers are ready to address the nation’s institutional shortcomings, then Latvia will provide the world with a real and unique lesson: It is possible for a small and relatively young democracy to let long-termism win over short-termism for the benefit of the nation and its entire population.