On 11 September the American, British, German, Irish, Norwegian and Swedish Chambers of Commerce jointly organized a pre-election debate where each of the six politicians present were asked how their parties would enhance the competitiveness of Latvia and how they would stimulate more foreign investment.
Almost universally there is an obsession with foreign investment. True, it can bring technology and new business practices that a country does not already have and whereas I am certainly happy with foreign investment, I am also happy with investment from domestic sources since overall investment is of importance for the country. And such investment is currently at an unsatisfactory level, c.f. the following graphs, thereby harming future growth.
Figure 1: Investment (Gross Fixed Capital Formation) as a share of GDP, 1995 – 2013
Source: Central Statistical Bureau of Latvia
From Figure 1: The share of investment in GDP is the lowest for more than ten years, with the exception of the year of full-blown recession, 2009.
Figure 2: GDP and investment (INV) in Latvia, 1995 – 2013, 2007 (peak year for both) = 100
Source: Central Statistical Bureau of Latvia and own calculations
From Figure 2: GDP is still some 9% from its peak in 2007 (mostly explained by overemployment in 2007 and a much smaller labour force today than then) but investment is no less than 41% below its peak in 2007 (which, admittedly, was unsustainably high due to an out-of-control construction boom) and, worse, declining again.
In short: Unsatisfactory and ominous for future growth.
Why? Many reasons (poor access to financing, too high interest rates, ultra-bleak economic outlook, too high labour costs and what have you) but one politician at the aforementioned meeting pointed another reason I would like to put forward here: Trust – or, rather – lack thereof. If business considers a country too onerous and/or too costly to do business in it will stay away or go to another country.
The World Economic Forum’s Global Competitiveness Report for 2014-2015 was released recently and, yes, once again-again-again Latvia, among 144 countries, has a really bad score on “Efficiency of the legal system in settling legal disputes”. It is ranked number 116, and, yes again, behind Mali (87) and Malawi (72) – and Mongolia (109) and Mozambique (103). Not to speak of – humiliation galore – Russia at 110. If businesses don’t believe in a fair, efficient, not-too-costly, not-too-slow judiciary they may choose to stay away. Simple!
A ranking of the EU countries may be illuminating:
Figure 3: Ranking, Efficiency of the legal system in settling legal disputes, World Economic Forum’s (WEF) Global Competitiveness Report, 2014-2015. 1 = best, 144 = worst
Source: WEF, 2014-2015
And I guess we are not really surprised: Countries with good rankings are mostly in Northern Europe; the poor rankings are held by Southern Europe and Eastern Europe.
What we should be surprised – and dismayed – about is how little has been done about this over the years because it has been an issue for about as long as I can remember (just like corruption, grey economy, energy efficiency, energy security etc.). Dealing with this is an example of a very positive structural reform and one that is necessary for future growth and convergence – but snails have been seen to move faster than Latvian policy makers in this area, to the detriment of business – this newspaper is unfortunately a good (i.e. bad and sad) example of this.
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga.
Note of caution: The WEF data is about perceptions; it is not hard data – might Latvian business people perceive their system to be worse than it is? May Estonians perceive theirs to be better than it really is? Perhaps, but the correlation with GDP per capita is so large as to say that this data, largely, holds.