Financial Crisis Latvia

After five years of financial crisis, the European record is in: Northern Europe is sound, thanks to austerity, while southern Europe is hurting because of half- hearted austerity or, worse, fiscal stimulus. The predominant Keynesian thinking has been tested, and it has failed spectacularly.
The starkest contrasts are Latvia and Greece, two small countries hit the worst by the crisis. They have pursued different policies, Latvia strict austerity, and Greece late and limited austerity. Latvia saw a sharp gross domestic product decline of 24 percent for two years, which was caused by an almost complete liquidity freeze in 2008. This necessitated the austerity that followed.
Yet Latvia’s economy grew by 5.5 percent in 2011, and in 2012 it probably expanded by 5.3 percent, the highest growth in Europe, with a budget deficit of only 1.5 percent of GDP. Meanwhile, Greece will suffer from at least seven meager years, having endured five years of recession already. So far, its GDP has fallen by 18 percent. In 2008 and 2009, the financial crisis actually looked far worse in Latvia than Greece, but then they chose opposite policies. The lessons are clear.
A successful stabilization program must appear financially sustainable so that it can restore confidence among creditors, businesses and people. Usually, a sound stabilization program can revive economic growth within two or three years, as Latvia’s did. A few rules of thumb need to be followed. Latvia did them all; Greece not at all.

Regain Confidence

To regain confidence fast, reforms should be front-loaded. In 2009, Latvia carried out an arduous fiscal adjustment of 9.5 percent of GDP, 60 percent of the total needed, while Greece foolishly tried to stimulate its economy, as Spain, Slovenia, Cyprus and other southern crisis countries did at the flawed advice of the International Monetary Fund under Dominique Strauss-Kahn, who was then the managing director.
In a severe crisis, it is much easier to cut public expenditures than to raise revenue. Moreover, taxpayers think the government should tighten its belt when they are forced to do so. Cuts in public spending accounted for two-thirds of the Latvian fiscal adjustment. It decreased government expenditures from a high of 44 percent of GDP in the midst of the crisis to a moderate level of 36 percent of GDP this year. Latvia has kept a flat personal income tax now at 21 percent and a low corporate profit tax of 15 percent.
Greece, by contrast, maintained high public expenditures of 50 percent of gross domestic product in both 2010 and 2011, when it was supposed to be pursuing austerity. It should cut its public spending to 40 percent of GDP to become financially sustainable. Then the Greek crisis would end. Greece has carried out a fiscal adjustment of 9 percent of GDP to date, but that is too little and too late. It is less than Latvia did in the first year, and Greece needs to do more.
An advantage of sudden and sharp cuts in public expenditures is that they can’t be even, as some items can’t be cut. Therefore they drive reforms. The Latvian government hit hard at the stifling bureaucracy that swelled during the preceding boom. It fired 30 percent of the civil servants, closed half the state agencies, and reduced the average public salary by 26 percent in one year.
It prohibited double-dipping by officials, who had earned more in fees from corporate boards of state-owned companies than in salaries. The ministers took personal wage cuts of 35 percent, while pensions and social benefits were barely reduced. The cuts prompted deregulation, and Latvia saw a boom in the creation of new enterprises in 2011.

About basicrulesoflife

Year 1935. Interests: Contemporary society problems, quality of life, happiness, understanding and changing ourselves - everything based on scientific evidence.
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2 Responses to Financial Crisis Latvia

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