Of Latvian growth and convergence 47

Latvijas Valsts prezidents Andris Bērziņš zāļu tirgū pie medus burciņām. Foto: Evija Trifanova, LETA
Morten Hansen

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.


Source: Eurostat

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

 

Komentāri (47)

lasis75 23.07.2013. 14.39

it’s not worth to reflect on every stupid argument this Lemberg’s press secretary makes. He is not my president of Latvia. He is a head of kolkhoz “Padomju Latvija” brought here by time machine from 50 year old past due to some cosmic misunderstanding.

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    Andris > lasis75 23.07.2013. 18.33

    I actually wanted to say the same. The matter of the article is nihil, and so the article itself is meaningless. Waste of time.

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Pastniece 24.07.2013. 13.09

Hansen’s ranking is an unfair metric. Let us imagine a dancing contest with three competitors: A, B, C. In the first year A dominates receiving 10 points out of the 10 possible, B comes second with 5, and C is last with a measly 2. The next year the ranking stays the same, however A, B, C get 10, 9 and 8 points respectively. Saying that B and C did the same for both years seems unjust.

A control variable seems necessary, could it perhaps be the GDP of USA?

Also a poor country joining the EU should bump Latvia up a few points, so all the Balkan countries becoming members might actually fulfill Berzins’ criteria for political existence which makes him a strong proponent for the enlargement of EU.

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    Pastniece > Pastniece 24.07.2013. 15.26

    @pingvīns: I’m not saying that the GDP of a EU member relative to the EU average is a bad indicator, my point is that an evaluation of success strictly based on the ranking in a list is too simplistic. In my example C went from 40% of the average to 89%, it’s quite different than just saying that C was last for two years in a row.

    I agree with you on enlargement, I overestimated the Balkans. Perhaps it’s time to invite Turkey and North Africa or else we disappear.

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    Dace > Pastniece 24.07.2013. 14.07

    GDP of US also moves as GDP of every EU country, so average of EU is not that bad indicator. And yes, future EU enlargement would lower average level but not significantly.

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    Dace > Pastniece 24.07.2013. 17.28

    Evaluation of success is hard in any way. We can assess country by its standing in comparison with others, or by its former self ( Latvia in 1995 and 2013 ). And yes Turkey, Ukraine and bunch of Middle east would give Latvia a pretty decent position in graph.

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    Dzintars > Pastniece 24.07.2013. 15.24

    Sure, for most there have been some convergence although the ranking hasn’t changed that much. But the degree of convergence is for some very minimal and recently there has even been divergence. I thought of putting in some graphs of this but I couldn’t produce some satisfactory ones…

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Dace 23.07.2013. 19.28

This is a north western european cluster which is doing well. Countries bordering with rich countries tend to be rich, and other way around. There is not even one relatively poor country in this NWE cluster. So there is no much reason to expect that Romania and Bulgaria will catch up Sweden or Denmark. Baltic states is in somewhat better position, because Baltic sea region is in better shape than South eastern Europe. And btw, Slovenia and Czech Republic are both close to “core”. It sounds a little deterministic, but…just look at map.

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    Ieva Leinerte > Dace 23.07.2013. 20.43

    Interesting point. Are you ready to invest in Polish Economic Tiger? They have a long border with Germany. Personally, I would prefer Australia, Anglo-Saxon and outside of NWE.

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    Ieva Leinerte > Dace 25.07.2013. 03.56

    Actually, my point is slightly different. After the sins of mid 20th century we are bound by Political Correctness and our economics research reminds the astronomy of 13th century – kind of – do what ever discovery you want, just do not forget that you live a flat disc-shaped Earth.

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    Dace > Dace 23.07.2013. 22.12

    I’m not saying that border with rich country is enough,though border with Germany is big strenght for Poland. And of course, growth rates in NWE is not very high to say the least. On the other hand, if we look at foreign direct investemnt, that NWE is doing pretty well. And, consider regions with high living standarts. Europe, North America, East Asia. There is no single rich country in Latin America or Africa. Ok, Africa is not very good example, but Latin America is a good one ( ok you will say that Mexico has a border with US…but as i said geographic proximity is not enough ).

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