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Why Latvia’s Austerity Model Can’t Be Exported

by Michael Hudson and Jeffrey Sommers, New Economic Perspectives

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 labor 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 labor 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 program 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 program (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 programs 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 health care 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-unionized labor 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”.

Editor’s Note: 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.  Hudson has been a previous contributor to Global Economic Intersection. (See bio below.)

Related Articles

Latvia’s Internal Devaluation:  A Success Story? by Mark Weisbrot and Rebecca Ray

Analysis and Opinion articles by Michael Hudson


About the Author
Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Distinguished Research Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003), Trade, Development and Foreign Debt (1992 & 2009) and of The Myth of Aid (1971).

ISLET engages in research regarding domestic and international finance, national income and balance-sheet accounting with regard to real estate, and the economic history of the ancient Near East.

Michael acts as an economic advisor to governments worldwide including Iceland, Latvia and China on finance and tax law. He gives presentations on various topics at conferences and meetings and can be booked here. Listen to some of his many radio interviews to hear his hyperspeed analysis of the geo-political machinations of global economics. Travel costs and a per diem are appreciated. Dr. Hudson writes at Michael Hudson.com.


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