After the recent Greek and French elections, it seems that the eurozone is no longer agreeing on austerity, as it has failed in some countries.
But Latvia is a notable exception that shows that the austerity policy is not doomed to fail. The country enacted fiscal cuts worth 18% of its GDP over 3 years and cut public sector wages by up to 40%. Its GDP fell as much as 25% in 2009, accounting for the worst recession in Europe. Despite all of that, the Latvian economy expanded 5.5% in 2011.
Latvian Economy Minister Daniels Pavluts explains to Bloomberg why austerity works in Latvia, but keeps pushing the eurozone into the crisis.
According to him, austerity succeeded in Latvia because the country is small and measures were taken at an early stage of the crisis. Besides, major government service and wage cuts were combined with structural investments to improve the business environment.
Currency devaluation was not seen as an option, as nearly all of the country’s loans are denominated in euros, he says.
People re-elected the party, which had carried out a severe austerity program. Many of them have lived through the Soviet rule and remember even tougher times.
Pavluts points out that the key for Europe is to balance austerity with pro-growth policies, but it will be more difficult for the eurozone because of its size and lack of political consensus.
Asked why austerity measures worked well in Latvia, Pavluts points out that a number of factors must be taken into account.
“We first of all decided to front load austerity measures. It really felt at the time like we had no choice, because we had difficulties in our treasury meeting our budget financing needs, and we had rescued one of our banks which had spectacularly failed. So essentially nobody would lend to us. So, at that time it seemed like the only option forward was to ask for the IMF to intervene which they did with the European Commission. There was really no other way but to try and create a strategy to rebalance our public finances which were out of balance.”
When asked if it is patience that Europeans should borrow from the Latvian people, Latvia’s Economy Minister stresses that the only way forward for Europe is to balance fiscal austerity.
“So, basically rebalancing their public finances, getting them under control and having smart, pro-growth policies in place, which does not necessarily mean fiscal irresponsibility. I think where Europe really struggles is given that our society is a small, mobile, adaptive society which has gone through a lot, it is far more resilient in terms of fast and difficult change. Some of the societies in Europe I think are not that flexible which is a huge issue. So I think its a matter of how civil society, how policy makers and stakeholders can get together and actually form consensus.”
Asked whether Latvia is still aiming to join the euro area, Pavluts says that joining the single currency is still one of Latvia’s main objectives.
“Now I frequently get asked, with what’s happening to the euro, why would you still have this as an objective? I always say this we have been effectively been a part of the eurozone by being pegged to the euro. On the other hand, all the things we have to do to get into the eurozone, putting our fiscal house in order, doing a number of other things, being conservative about our sovereign debt levels which are very low. All of this is actually good for our economy, look at the rating agency’s reactions. The things we’ve done have resulted in all three major credit ratings agencies moving us into investment grade. Now getting into the eurozone is the final step that we want to make in order to have availability of reasonable cost of finance, of having access to greater FDI (Foreign Direct Investment) flows, greater attractiveness of our country as an investment destination.”