For solution to euro crisis, look to…Latvia?

The following is a guest post by Ansis Spridzāns and Valentina Gevorgyan.

In 2008, Latvia, as a result of deteriorating economic conditions in the world and an international financial crisis that led to the collapse of the world’s second largest bank, faced an economic crisis. Although the reasons and the scale of events were different, we may draw certain parallels to the current economic crisis in Greece. Thus, analysis of the situation in Latvia may provide useful data for modeling of the future development and solution to the economic crisis in this southern country.

Latvia lived carelessly in the growth years prior to the crisis. While neighboring countries, including Estonia, undertook reforms, invested state funds in infrastructure and longterm projects, Latvia chose to lower taxes and increase social benefits. Government administrative staff reached an exaggerated size in attempts to compete with the private sector for the best employees by increasing salaries. Budget was run with a deficit.

In the autumn of 2008 Lehman Brothers defaulted and a wave of financial institution insolvencies shook the world. This worsened an already deteriorating financial situation, because the state had to solve problems in the banking sector, which occurred as a result of insolvency of the second largest bank in Latvia. The result was that the country found itself a few steps from a default situation and was urged to turn to the international community for financing. The response was positive and not only international financial institutions, but also several countries including Nordic countries and neighboring Estonia expressed their willingness to provide the necessary funding.

The main instruments used to deal with the crisis in Latvia in 2008 were budget cuts – sometimes mechanic, sometimes not – and structural reforms rather than the devaluation of the currency, which was advocated by prominent international experts. Nowadays this instrument is becoming popular in many other European countries. Similar to Greece, those cuts were marked by protests, though far less impressive in scale than the recent protests in Greece. The usual problem for budgetary cuts is that the cash-flow balance of the state requires results within a limited period of time, therefore it is almost impossible to undertake long-term projects, especially ones that require investment at the beginning, for example, healthcare and education.

The preparation of the budget for 2009 and 2010 seemed an extremely complicated task and imposed cuts under the supervision of the European Commission and the International Monetary Fund mission, requiring much political wisdom from politicians. The situation changed in 2011 – at the end of that year the European Commission and International Monetary Fund officially completed their regular mission to Latvia. The aftermath of the crisis in Latvia is that the mechanism of expense cuts and reforms functions in practice, and has been officially recognized by European Commission.

Although Greeks might not be in favor, it is likely that Greece will have to experience a similar reform process, particularly in respect to the administrative sector, budget and taxation policies, improving the business environment and other sectors mentioned in the report of the task force. This means it is unlikely that opposition to such reforms would be supported by governmental and parliamentary action, at least in the near future and as long as the EC task force works in Greece. The generally strict EC position against other PIGS countries, for example, Spain, also support this conclusion.

This opinion, however, may seem overly optimistic especially if one compares the almost non-existent protests in the streets of Riga even in the most extreme moments of the crisis to demonstrations in the streets of Athens. In addition, the two countries are different in size, historical experience and culture.

However, it is necessary to note that Europe does not have many real options. In the short term eurocrats have no option but to convince Greece and its citizens to liberalize their economy, and the Latvian experience may provide some guidance.

Ansis Spridzāns and Valentina Gevorgyan are a members of the NATO Young Atlanticist Working Group.