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Austerity Policy in Latvia and Its Consequences

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Austerity Policy in Latvia and Its Consequences INTERNATIONAL POLICY ANALYSIS Austerity Policy in Latvia and Its Consequences INNA DOVLADBEKOVA September 2012 n Latvia witnessed rapid, but unbalanced economic growth after it joined the Euro- pean Union. During the global financial and economic crisis, the country witnessed severe economic decline. In 2009, GDP shrank by 17.7 per cent. n Until 2007 Latvia’s debt level was one of the lowest among EU member states. From 2008 until 2010 Central government debt rose sharply from 19.8 per cent to 43.9 per cent of GDP. n From 2008, restrictive fiscal policies were implemented which were among the most severe in Europe. Six consolidation packages were adopted from 2009 until 2012. Wage cuts in the public sector accounted for almost half of all spending cuts from 2009 until 2011, with wages falling by an average of 30 per cent. n GDP grew again by 5.5 per cent in 2011, the highest growth rates among the EU member states. However, GDP is still only at the level of 2005. n Unemployment is now a serious problem in Latvia. In May 2012, it stood at 15.3 per cent. During the past three years more than 100,000 inhabitants have left Latvia in search of work in other countries. Unemployment has changed from a cyclical to a structural phenomenon. n Public opinion research shows that more than half of Latvia’s inhabitants consider that the measures for overcoming the crisis are incorrect and even devastating. INNA DOVLADBEKOVA | AUSTERITY POLICY IN LATVIA AND ITS CONSEQUENCES 1. Introduction 2. General Economic Condition of Latvia The political situation during the pre-crisis period which Costs have increased and there are the first signs of slow- followed the elections to the ninth Saeima (Parliament) ing down in the development of the Latvian economy. in 2006 was very volatile in Latvia. The government re- signed as a result of extensive public protests and the Latvia witnessed rapid, but unbalanced economic political crisis in late 2007, thus making way for a new growth after it joined the European Union. From 2004 Cabinet of Ministers formed by Ivars Godmanis. The until 2007 GDP increased at an annual 10 per cent, one government and the parties that comprised it rapidly lost of the highest growth rates in the EU. High consump- popularity during the economic and financial crisis due tion and investments in real estate were the main driving to several unpopular decisions, such as tax rises, spend- forces of economic development. The global financial ing cuts for social security, the rising national debt and and economic crisis reached Latvia in the second half of the nationalisation of Parex Bank. Valdis Dombrovskis, 2008. Latvia witnessed the biggest decline in terms of a representative of former opposition party »New Era« economic activity in late 2008/early 2009: GDP fell by (Jaunais Laiks), became Prime Minister after the resig- 3.3 per cent in 2008 in comparison to 2007, but by far nation of Ivars Godmanis. The right-wing parties estab- the sharpest fall took place in 2009 when GDP shrank lished the »Unity« (Vienotība) coalition in March 2010, by 17.7 per cent. The government managed to stop the which won the elections to the tenth Saeima in October precipitous economic downslide in 2010, limiting the de- 2010. In 2011, for the first time in the history of Latvia, crease of GDP to 0.3 per cent. GDP fell to the level of the President exercised his constitutional right to call for 2004 during the crisis. the dissolution of the Saeima. The referendum organ- ised for this purpose resulted in 94.3 per cent of voters The government imposed a pro-cyclical fiscal policy dur- voting in favour of dissolution. The aim of this drastic ac- ing the period of economic growth. Government spend- tion was to restore trust in the state administration. The ing grew at an average rate of 20 per cent per year elections to the eleventh Saeima took place on 17 Sep- from 2006 to 2008 and the speed of growth of gov- tember 2011 and resulted in a »Unity« victory. A num- ernment spending was much higher than that of GDP. ber of right-wing parties, including »Unity«, »Zatlers› During the pre-crisis period government spending was Reform Party« (Zatlera reformu partija) and the National based on rising short-term budget revenues and gov- Alliance »All for Latvia!«- »For Fatherland and Freedom/ ernment spending policy was aimed at satisfying cur- LNNK« (Nacionālā apvienība »Visu Latvijai!«-»Tēvzemei rent needs instead of ensuring sustainable development. un brīvībai«/LNNK), formed a coalition. Since Latvian so- Maintenance costs dominated expenditure and wages ciety is ethnically split into two camps – Latvians and increased by more than 20 per cent per year, the high- Russian speakers – this was also a key determining prin- est point being 40 per cent in 2007. Wage increases in ciple shaping the coalition. The government consisted the public sector were faster than in the private sector of parties oriented towards the Latvian electorate and as a result. The budget deficit was 0.4 per cent of GDP »Harmony Centre« (Saskaņas centrs) and the »Union in 2007, but it increased to 4.2 per cent in 2008 and 9.8 of Greens and Farmers« (Zaļo un Zemnieku Savienība) per cent in 2009 as the economic situation deteriorated were left in opposition. After Valdis Dombrovskis was and budget revenues dwindled. The decrease in tax rev- appointed Prime Minister the government continued to enues from all tax categories entailed an increase in the implement the austerity policy under his guidance. After budget deficit. The government managed to bring down the elections, both experts and the majority of the eco- the budget deficit slightly – to 8.2 per cent of GDP – by nomically active inhabitants of Latvia (71 per cent) con- implementing budget consolidation measures. A signifi- sidered the governing coalition to be unstable. However, cant decrease in the budget deficit – 3.5 per cent of GDP according to Prime Minister Valdis Dombrovskis, the coa- – was achieved in 2011. lition is engaged in constructive work and the govern- ment will be able to solve current problems successfully. Until 2007 Latvia’s debt level was one of the lowest among EU member states, at a mere 9 per cent in 2007 (lower debt levels were found only in Estonia and Lux- 1 INNA DOVLADBEKOVA | AUSTERITY POLICY IN LATVIA AND ITS CONSEQUENCES embourg). Latvia’s high budget deficit and the attraction gest adjustments in its current account, from a 22.5 per of funding from international lenders during the time cent deficit in 2006 to an 8.6 per cent surplus in 2009. when its borrowing capacity in international markets was The current account surplus was 3.0 per cent of GDP in limited set the stage for a rapid increase in the national 2010.4 In terms of wages, pay rises were very high during debt. Central government debt rose sharply from 19.8 the pre-crisis period: the growth rate was 32 per cent in per cent to 43.9 per cent of GDP from 2008 until 2010.1 2007 and 20.5 per cent in 2008. Moreover, the speed External debt dominated in the state debt structure and of pay rises was more rapid than the increase in produc- its proportion increased from 48 per cent in 2008 to 86 tivity, which hovered around 6–7 per cent. This pushed per cent in 2011; this can be explained by the attraction inflation into the two-digit range and economic com- of international borrowing and the issue of eurobonds. petitiveness deteriorated as a result. Wages shrank sig- nificantly during the crisis, especially in the public sector. Private sector debt increased significantly shortly after Latvia joined the European Union. The increase was fuelled by a rapid increase in cheap and easily available 3. Budget Consolidation loans. The amount of private debt was 127.5 per cent of GDP before the crisis and increased during the crisis The government implemented a restrictive fiscal policy from 132.1 per cent of GDP in 2008 to 147.4 per cent in from 2008. Six consolidation packages were adopted 2009.2 Private debt decreased slightly to 140.9 per cent from 2009 until 2012 with the purpose of ensuring mid- of GDP in 2010 as a result of commercial banks making term financial sustainability. Generally, consolidation accruals for doubtful debts and a decrease in lending. measures in the amount of 16.6 per cent of GDP were implemented from 2008 until 2011: 6.6 per cent con- With regard to the special budget for social insurance it cerned budget revenues and the remainder budget ex- should be mentioned that a surplus had been forming in penditure. Fiscal consolidation in Latvia was among the the special budget since 2002 but unemployment grew most severe in Europe. and household incomes shrank as the crisis set in. This entailed a decrease in the special budget revenues and Within the framework of budget adjustments several since 2009 the special budget has not been able to cover changes were introduced in tax legislation which took its costs. Thus savings from previous years are being used the form of tax increases or expansion of the tax base. to balance the budget. Value added tax was raised from 18 per cent to 22 per cent, while the reduced tax rate was increased from 5 The labour market witnessed a sharp decline in demand per cent to 12 per cent; the reduced tax rate for electric- as economic activity contracted. This entailed significant ity and natural gas was abolished.
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