Two steps forward, one step back

 

… is not a bad way to think of Latvian growth in the years to come. There will be more convergence with the EU28 average, Latvia will overtake structurally flawed countries like Greece but there will also be severe constraints to future growth; constraints that will be hard to ameliorate.

Start with another well-known picture: Latvia’s GDP development since 2005. The economy peaked in the first quarter of 2008 then contracted by 22.6% until the second quarter of 2010 – an ultra-deep but relatively short recession. The economy has since regained 16.9% of this loss but remains by the third quarter of 2013 still 9.5% below the peak.

Figure 1: GDP in Latvia, Q1 2008 = 100

Source: Central Statistical Bureau and own calculations

Some commentators like to ridicule Latvia for still being below the peak of 2008 but I find it a rather strange benchmark for success or not. The situation in 2007 was hardly sustainable with a massive credit boom, a current account deficit or more than 20% and a sizzling, red-hot labour market, plus, what is not so often mentioned but is of crucial importance: A level of employment that Latvia can never reach again. I have written about it before but I think it can be repeated since it will act in years to come as a “one step back” example for Latvia’s economic growth.

At the end of 2007, see Figure 2, some 1,080,000 persons were employed – today even the labour force is much smaller than that number, partly because of migration and partly because of unfavourable demographics that were not created by the recession but rather by the transition process from the late 1980s when birth rates started to fall sharply.

Figure 2: Labour force and number of employed persons (1000s) in Latvia, 2005 – 2103, quarterly data

Source: Central Statistical Bureau

And the “one step back” impact will continue, see Figure 3. The 15 – 19 year olds will enter the labour market in next few years while, roughly speaking, the cohort of 60 – 64 year olds will leave. That’s 100,000 entering and 123,000 leaving (yes, not all will enter the labour market and not all 123,000 were in the labour market but there will still be a negative impact on the labour force).

Figure 3: Number of persons in 5-year age brackets in Latvia by 2013

Source: Central Statistical Bureau

This is troublesome but then look at differences in the size of age groups entering/leaving in about a decade’s time: About 150,000 50 – 54 year olds, less than 100,000 10 – 14 years olds. The labour force is about 1,000,000 today, measures like higher retirement age (very much needed) will ameliorate this a bit but there will still be a crunching effect – and it will slow the impact on GDP per capita and thus catch-up of the Latvia economy.

Catching-up in some ten years is often mentioned but it is just not going to happen and the labour market development is one of the reasons.

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