Broad-based growth, but…

First the good news: The Latvian economy is still growing at a very respectable 5.0% – should be the highest growth rate in the EU – as was publicized by the Central Statistical Bureau a few days ago.

More good news: Growth continues to be broad-based. Figure 1 shows the development of GDP and its main demand components since the economy peaked in the first quarter of 2008. Exports started growing form Q1 2010, helping GDP to grow from Q3 2010 and private domestic demand – consumption and investment – started picking up from Q1 2011. Even public spending is adding to growth now and has done so since Q2 2011.

Figure 1: GDP, Private consumption (C), Private investment (I), Government spending (G), Exports (EX), Imports (IM). Rescaled so that Q1 2008 = 100 for all variables.

Source: Central Statistical Bureau of Latvia and own calculations

The bad news is that this growth has not decreased the unemployment rate all that much – the most recent figure says 16.4% (Q2 2012), down from 20.7% in Q1 2010 – fine but hardly brilliant.

I thought Figure 2 could shed some light on this. When GDP grows faster than GDP per employee, as it did during the boom until 2008, employment has to increase – in other words, when the blue line is above the red line, employment increases and vice versa.

Figure 2: Growth rates (annual) for GDP and GDP per employed person, quarterly data

Source: Central Statistical Bureau and own calculations

Growth in GDP per employee is also one way of looking at productivity growth and as can be seen from the boom days this was quite high, typically some 5-7% per year. This is good since it speaks of pretty fast catching up (similar growth in GDP per employee in e.g. the Nordic countries is substantially smaller) but one may also argue that it is a bit bad in its own sort of way: Only when the economy grows REALLY fast will it add jobs, otherwise it will ‘just’ add GDP, a sort of jobless growth.

And there is no reason to expect growth rates like 2002 – 2007 any time soon: Credit growth rates of 50+-% did a lot of that job then; today credit growth is negative (see Figure 3) as some borrowers deleverage and others are written off and I don’t see this phenomenon changing very soon.

Figure 3: Credit growth rates (annual) for loans to resident financial corporations, to non-financial companies and to households

Source: Bank of Latvia

In short, GDP is increasing (fine) but it mainly comes from productivity and not from new jobs (not so fine) and the unemployment rate is thus unlikely to come down fast any time soon (also not fine) except for small additions to the labour force in years to come (blame transition 20+ years ago) or for continued migration (hmmm…).

Note 1: Of course I cannot exactly know that GDP per employee should again grow some 5-7% per year on average but why not? Latvia still has a lot of catching-up potential (yes, that euphemism for saying that it is still a poor country) and thus productivity growth should be quite a bit higher than in the richer parts of Europe.

Note 2: GDP per employee seems to be increasing really fast right now but I want to wait before I really want to use that data – it is mainly a result of data on employment being adjusted downwards in the light f the 2010 census.

Note 3: Some may find it strange that GDP per employee fell during the crisis – GDP decreased, of course but also productivity? Individual productivity should not be affected of course, rather, overall productivity declining is explained by relatively many high value-added jobs vanishing during the crisis.

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