An austerity measure too far

For readers of this column it is well-known that I support the Latvian austerity programme – not because I get some perverse satisfaction from seeing the budget axe in use but because Latvian public spending had been allowed to enter a completely unsustainable path in the ‘fat years’. I have mentioned it e.g. here.

Some austerity measures are also needed for 2012, fine, but this one I cannot support. In order to cut 17 mill. LVL it is proposed that the Guaranteed Minimum Income (GMI) of some 40-45 LVL per month should be removed from the state budget and be made the responsibility of the municipalities instead. This is not good economics and it definitely lacks in fairness – here a few arguments.

Without exactly knowing it I am sure that recipients of GMI are not evenly spread out across the country. If so, some municipalities will be very hard hit while others will not. But why should municipalities with many such people bear the burden of what is a national issue? Centralized burden-sharing is one part of national solidarity where less prosperous areas benefit from more prosperous ones.

The prosperity of the latter is actually relying on the existence and functioning of the not so well-off regions. Think of it like this: Riga is by far the richest region in Latvia in terms of GDP per capita (see graph below), reflecting that it has a bigger share of high value-added activities than the rest of the country (banking, consulting, accounting, education; what have you). But this is still reliant on that other parts of the country provide relatively low value-added activities such as agriculture. Without the regions, Riga wouldn’t prosper the way it does. I can provide relatively high-value added hot air as an economist exactly because someone else grows wheat and raises cattle. In that sense it is fair enough that there is redistribution from Riga to the regions. Same with GMI recipients – one should not see it in terms of financing as a regional issue but as a national issue.

GDP per capita in Latvia and by regions of Latvia, 1000s LVL, 2008

Source: Central Statistical Bureau of Latvia

Note: 2008 data are the most recent data available 

Note 2: Riga’s GDP per capita is undoubtedly larger than in any of the regions but may be somewhat inflated by inhabitants of e.g. Pieriga adding to GDP via working in Riga.

It is also easy to imagine that some cash-strapped municipalities might find it hard to find the money for these payments thus contributing to making the already most unequal country in the EU even more so.

Allow me a whiff of populism and suggest an alternative consolidation measure such as a higher tax on cars. From an economic perspective this would represent the Mother of All Examples of a situation where one LVL to a GMI recipient represents far more value than the one LVL taken from the tax payer – a classical reason for income redistribution. The tax payer loses one LVL but has plenty of them already – one lat thus represents rather small value. For the GMI recipient one lat may not be the difference between life and death but 40 LVL might be.

So, scrap this idea and find a better and fairer consolidation measure.

Morten Hansen is Head of Economics Department, Stockholm School of Economics in Riga