Ten years – not-so-impressive economic development

More stable growth has a better long-term track record

Ten years ago Latvia joined the European Union and I think we are in for all sorts of commemoration of that event. And, mostly, rightly so. Personally, I think Latvia made the right choice in joining the EU and I also find there have been many positive developments since then. I have to struggle, however, to make economic development one of the major successes.

In normal times – of which we haven’t had much for the past ten years – one would expect poorer countries to grow faster than richer and more mature ones, reflecting a catching-up process. A graph like Figure 1 below should thus be expected, roughly, to be the opposite of a graph of GDP per capita and to some extent it is: Of the ten fastest growing EU economies since 2004 we find eight eastern European (aka rather poor) countries, including all three Baltic ones.

Latvia, overall 9th in terms of accumulated growth, should have done better given its rank as 4th poorest in terms of GDP per capita but lacks behind both Estonia and Lithuania, among others.

Advocates of devaluation and/or floating exchange rates will point to the apparent success of Poland – more than twice the growth than Latvia and certainly a significantly better performer – as a demonstration of that country’s floating rate as a shock absorber; having the zloty depreciate during the financial crisis to soften the impact on the Polish economy. But that example is of course immediately countered by the evidence of Slovakia: Even higher growth since 2004 but with a fixed exchange rate and for the past five years the euro.

Rather, the graph displays reasonably well the long-term negative effects of credit booms times that ended in collapse. Slovakia, Poland, quite a bit richer Czech Republic and much richer Sweden did not experience a credit boom-bust cycle while countries like the Baltic ones did, and so did e.g. Spain, Greece, Ireland and Denmark.

OK, this is slightly back-of-the-envelope ‘analysis’ but it largely confirms that a more stable economic development has a better long-term track record than one of boom-bust.

And, as so often before, long shadows hang over the Latvian economy from (lack of policy decisions from the economic heydays before 2008: A very procyclical fiscal policy that exacerbated both bomm and bust and a lack of willingness to dampen the credit boom via e.g. taxation of land, real estate and capital gains.

And these are the results. Let’s hope that 2014 – 2024 will be better. Some will claim I should have used growth of GDP per capita in Figure 1 instead of growth of overall GDP. This would indeed have flattered the picture for Latvia since the country has seen a sharper population decline than other countries – but that is hardly an achievement, is it???

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga.