According to BNS on 18 July 2013, Latvia’s president, Andris Bērziņš, provided this rather ominous statement:
If we do not achieve the average EU level in ten years, Latvia will cease to exist politically, said Latvian President Andris Bērziņš in an interview with Latvian commercial LNT television on Thursday.
I cannot assess the politics of this statement but I can reflect on the economics of it. By “average EU level” I presume the president refers to GDP per capita. Here Latvia stands at 61% of the average of EU28, see Figure 1.
Figure 1: GDP per capita in EU28 at Purchasing Power Standards (i.e. at comparable prices), 2012. Luxemburg excluded.
Latvia thus needs to close a gap of 39 percentage points or, put in a different way, needs to grow 64% faster (= 100*39/61) than the Union as a whole over the next decade. This amounts to just about 5 percentage points per year; i.e. if the Union grows by 2% per year, Latvia must grow by 7% per year in order to catch up within ten years.
The Latvian economy actually grew on average 7.6% per year between 1997 and 2007 so is it likely with a return of such growth rates?
I don’t think so and here are just a few reasons:
Not only was the boom period much characterized by a credit boom – one could say that in Latvia it even coincided with the creation of the banking system for others than a select few. Banking assets (loans) grew by several hundred per cent between 1997 and 2007; this will not take place again.
It was also a period that created exceptionally low interest rates. These rates are still (reasonably) low and thus cannot go much further down, triggering another wave of loans.
From the preceding boom there are still a lot of overleveraged borrowers.
The preceding boom unfolded while allowing many economic indicators to reach unsustainable levels – a massive current account deficit, high inflation in a fixed exchange rate economy, an overheated labour market and highly procyclical fiscal policy. This will hopefully not be allowed again.
International macroeconomic indicators look rather dire for the time being (and this won’t be over soon), thus don’t expect the export miracle to just continue.
And really high growth rates are typically easier to obtain the further behind a country is and Latvia is not as much behind as it was in 1997; far from.
But in particular I would like to address what I consider a fallacy, namely the idea that a country is destined to catch up. Evidence speaks strongly against this idea.
With the use of Eurostat and in particular the publications called ‘European Economy’ from the EU Commission I looked at the rankings of GDP per capita for what was then the E15 countries (i.e. before the 2004 enlargement) for the period of 1960 to 2013. Countries change rankings but not all that much. I’ll spare you the details but here are some findings:
For all those years Greece and Portugal have only ranked between 13 and 15. At still only 75% of the EU average Portugal is the not-so-shining example of essentially no catching up.
Spain has always been number 12 or 13 – for 53 years!
Denmark has never been lower ranked as number 6, Sweden, with a few exceptions, never worse than 7.
Finland never worse than 11 but never better than 7.
One country has defied the trend: Ireland has moved from a position of number 14 in the 1970s (i.e. poorer than Greece) to number 3 (although its GDP overstates income per person in Ireland by being quite a bit above GNP but still well done).
Another country is the overlooked success story: Austria, from number 9 in the 1960s to the second richest country in the EU today.
A few countries with secular decline: France and the UK (but the latter has been around position 10 already since the 1970s and was only higher in the 1960s).
All in all, a very good predictor for a country’s income per person ranking in 2012 is its ranking in 1960…. Not so good if this should also hold for Latvia. It may not be so but it is still a potentially huge mistake to believe that convergence ‘just’ happens. It is policy, institutions etc., etc., etc. that matter so the question is: Does Latvia do enough?
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga