The case of Latvia has begun to draw increased attention for the lessons it may hold for the rest of the Eurozone. While its story began in a similar manner to other troubled countries, such as Greece and Ireland, its outcome has been quite different.
The financial crisis hit Latvia particularly hard, contracting its economy by a brutal 25 percent and sending unemployment skyrocketing from six to 21 percent. At the height of the crisis, it was forced to accept a 7.5 billion euro bailout from the IMF. With its currency kept firmly pegged to the Euro, and thus unable to boost competitiveness by devaluing, Latvia looked ready to embark on the cycle of low growth, climbing deficits and political instability that has gripped the rest of the Eurozone.
Instead, it has bounced back with a vengeance. In 2011, growth had reached 5.5 percent and at the start of 2012 it has continued to accelerate to 6.8 percent. Unemployment is down to 16.3 percent and continues to drop. How did this turnaround happen?
The answer is that Latvia didn’t take any shortcuts. Admirably, it tackled its economic shortcomings directly - albeit painfully. While it accepted a bailout, it acted swiftly to make sure a second would not be necessary, implementing structural reforms at breakneck speed. It cut its budget deficit by 8 percent in one year, and by 15 percent total, through a mix of both spending cuts and tax hikes, as workers took difficult pay cuts to improve the economy’s competitiveness. Such an approach clearly contributed to the short-term recession, but set the foundations for a return to sustainable growth and Latvia’s re-entry into international capital markets in 2011.
The key to the success of these economic policies has been steadfast political leadership. Politicians willing to risk imposing greater pain in the short term in order to forge a lasting solution are few and far between, but the governing coalition led by Prime Minister Valdis Dombrovskis never wavered in either its determination to maintain its fixed currency nor in its enthusiasm for reform. Even though Prime Minister Dombrovskis rejects the word “austerity,” he and his team clearly saw that it was better to take bitter medicine down quickly. In a lesson to his continental colleagues, he has now been re-elected twice.
What are European leaders thinking when they argue that Latvia is not yet ready for Euro membership? European Central Bank Executive Board member Jorg Asmussen is technically right when he accuses Latvia of “not yet fulfilling all convergence criteria,” but compared with other Eurozone members, Latvia’s deviations are vanishingly small. Ireland and Spain, for instance, have deficit levels of 13.1 and 8.5 percent, while Latvia’s will fall under the 3 percent mark by the end of 2012. Latvia’s government debt levels are lower than Germany, France and Italy. Latvia’s inflation is barely above the convergence target and should be expected - and welcomed - as an indication of a rapidly growing economy.
Latvia has shown rare economic maturity and political dedication in bringing their economy in line with the highest European standards - and they did it when times were at their toughest. What more could Europe want in a partner? Indeed, perhaps Swedish Finance Minister Anders Borg put it best: “If Latvia cannot be a member of the euro area, then who can be?”
Painter is COO and a foreign policy expert at Blue Star Strategies in Washington, DC.