Why Latvia Succeeded and Southern Europe Failed

Anders Åslund Senior Fellow

Peterson Institute for International Economics, Washington, DC

Bank of Latvia Riga, November 2, 2012

Political Preconditions 1. Immediate cause of crisis: External (liquidity freeze) 2. Big real output shock bred action 3. New government March 2009 4. Comprehensive & front-loaded crisis program

restored confidence early 5. Equity 6. Good salesmanship 7. Sufficient international support

Early, Radical Fiscal Adjustment

• Fiscal adjustment 9.5% of GDP in 2009 & total 16% of GDP

• More expenditure cuts than tax increases (2/3 in total)

• Confidence restored by June 2009

2.8 2.1 1.5

0.5

6.7

2.0

0.7

0

1

2

3

4

5

6

7

8

9

10

2008 2009 2010 2011 revenue expenditure

percent of GDP

16% of GDP Fiscal Consolidation, 2008-11

Credit default swap rates peaked in March 2009

0

200

400

600

800

1000

1200

1400

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11

5-year, basis points

0

5

10

15

20

25

30

Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 RIGIBOR 3-month RIGIBOR 6-month RIGIBOR 12-month

percent per annum

Market interest rates peaked in June 2009

0

1

2

3

4

5

6

Jan-09 Mar May Jul Sep Nov Jan-10 Mar May Jul Sep

1st tranche of EC loan received 2nd tranche of EC

loan received

2nd tranche of IMF loan received

1st tranche of WB loan received

3d tranche of IMF loan received

3d tranche of EC loan received

4th tranche of IMF loan received

billions of euros

Foreign currency reserves bottomed out June 2009

Latvia Unemployment, 2008–2012

0

5

10

15

20

25

2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1

percent of labor force

Structural Reforms • Big, early expenditure cuts drove structural

reforms • Dismissed 29% of civil servants • Closed half state agencies • Deregulated & improved governance • Reduced public salaries by 26% & private

salaries by 10% in 2009

Equity • Maintained social safety net • Cut high salaries more than low ones and

social benefits • Increased indirect taxes, property taxes &

capital gain taxes • Prohibited double-dipping by senior officials • Action against corruption

Latvia: Set for Sound Growth since 2010

• Good governance • Competitive costs • Solid export expansion • Fast rising investment

Measures: Compare Latvia with PIG

• Budget deficit • Public expenditures • Governance • Labor costs

Latvia Brought Down Budget Deficit

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2005 2006 2007 2008 2009 2010 2011 2012E Latvia Greece Italy Portugal

Percent of GDP

Latvia: Public Expenditure as % of GDP Moderating

30

35

40

45

50

55

2005 2006 2007 2008 2009 2010 2011 2012E Latvia Greece Italy Portugal

Percent of GDP

0

10

20

30

40

50

60

70

80

90

Latvia Greece Italy Portugal Lower score indicates greater ease of doing business

Latvia: Best at Ease of Doing Business Ranking, 2013

Latvia: Sharply Falling Real Unit Labor Cost, 17%, 2008-11

80

85

90

95

100

105

110

2008 2009 2010 2011 Latvia Greece Italy Portugal

Index, 2008=100

Outcomes: Compare Latvia with PIG (2)

• Export expansion • Investment • Growth • Current Account

Rising Exports, Percent Change 2009 - 2012, yoy

-30

-20

-10

0

10

20

30

40

2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2

Perc

ent C

hang

e, y

oy

Latvia Greece Italy Portugal

YOY, Quarterly Statistics

Investment Recovering as % of GDP, Greece Just Falling

10

15

20

25

30

35

40

45

2005 2006 2007 2008 2009 2010 2011 Latvia Greece Italy Portugal

Percent of GDP

GDP Growth 2000-2012: Latvia Superior

-20

-15

-10

-5

0

5

10

15

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E

Latvia Greece Italy Portugal

Percent

Current Account Balance, 2007 & 2011: Latvia quick turn

-30

-25

-20

-15

-10

-5

0

5 Latvia Greece Italy Portugal

2007 2011

Percent of GDP

7 Lessons from Latvia for the World

1. Face reality and explain it! 2. Take early credible action to restore confidence =

measures depend on severity of crisis, 2-3 years 3. Early fiscal adjustment preferable 4. Better to cut public expenditures (2/3) than to

raise taxes

7 Lessons from Latvia for the World 5. Let expenditure cuts drive structural reforms 6. Make program equitable 7. Get sufficient international rescue financing up

front, but with conditions

Latvia: High Inflation Tamed, Only Brief Deflation

-4

-2

0

2

4

6

8

10

12

14

16

18

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E

Latvia Greece Italy Portugal

Average Consumer Prices, Percent Change