Would the Latvian model fit Spain?

The EU says Madrid could learn from the adjustment program imposed on the tiny Baltic state Economists are skeptical about the benefits of austerity

Luis Doncel
Brussels -
A Latvian worker in a wood-processing factory
A Latvian worker in a wood-processing factoryReuters

There is hope for Spain, at least that's what Olli Rehn believes. Writing in his blog on August 6, the EU's commissioner for economic affairs said Spain need not resign itself to soaring unemployment levels and weak economic growth. But recovery will require Spaniards to make sacrifices - such as a 10-percent salary cut - following the examples of Ireland and Lithuania, which he describes as "two success stories."

The difficulty with Rehn's example is how he measures Ireland and Latvia's success. In the first place, the austerity measures applied to the two countries have sent poverty to record levels: 40 percent in the case of Latvia, making it the EU's second-poorest member state. That said, Latvia is now growing faster than the EU average, although that isn't necessarily saying much. Meanwhile, Ireland remains mired in recession, with ever-worse poverty and unemployment.

Kevin O'Rourke, who teaches Economic History at Oxford University, questions Rehn's analysis, suggesting that the reality of Europe's economies is much more complex. "If three consecutive quarters of shrinking GDP are a success, what does Rehn judge to be a failure?" he asks. He also says wages have not fallen in Ireland, and that the only country to really implement across-the-board pay cuts is Greece. "And after looking at the impact on its economy of those wage cuts, it's clear that another strategy is going to have to be thought out. Europe's leaders need a lesson in basic economics." Austerity, he says, is driving down demand and consumer confidence.

But Brussels has decided that Ireland is its star pupil, unlike problem child Greece, having brought its spending under control since the taxpayer had to pump billions into a banking system that had sent the public deficit to above 30 percent of GDP.

The European Commission (EC) also believes that creating jobs is important: last year saw unemployment continue to rise, although this year there has been a slight improvement. But the simple truth is that after following the IMF's recommendations for the last five years, Ireland remains firmly in recession.

Ireland is stuck in recession, with ever-worse poverty and unemployment

"Austerity measures have seen the biggest transfer of resources from the middle and working classes to the upper classes in the history of the country. The winners have been businesses, above all the multinationals, as well as the wealthy," says Séan Healy, director of the think-tank Social Justice.

Latvia has managed, as Rehn points out, to emerge from the recession that hit the country in 2009. The Baltic state's economy grew faster than any other in the EU last year, and is set to do so again this year. "The high degree of flexibility of its labor market, the decentralization in salary formations, and the commitment to fiscal consolidation have allowed for a relatively rapid adjustment, despite requiring radical changes to the economy," the EC notes.

Unemployment in Latvia is still around the 15 percent mark, but government figures suggest it will start to fall soon. The country's perceived success means that it will be allowed to join the euro next year, despite opposition from most of the population, who fear it will send prices spiraling upward.

That's the good news, or at least the way that the EU sees things, which largely fails to take into account the impact on ordinary lives of the "adjustment." The government in Riga has sacked a third of its civil servants, and those lucky enough to hold on to their jobs have seen their pay cut by up to 40 percent. In short, Riga has cut welfare and raised taxes. Purchasing power has shrunk across the board, driving down internal demand, which in 2009 fell by 27 percent.

The mass exodus of Latvians in search of work largely explains the modest fall in unemployment in recent years. Between 2000 and 2011, the population fell by 13 percent to just over two million, the same figure as in the 1950s. Surprisingly, Latvians have not staged strikes or street protests, like the Greeks, but seem to have accepted their fate with resignation. They even re-elected the government that imposed the austerity measures.

"The reforms have come at a high cost. They have exacerbated inequalities between regions and social classes. At the same time we have to accept that the longer reform was put off, the longer it would have taken to emerge from the crisis generated by a gigantic property bubble," says Martins Kazaks, chief economist at Swedbank.

Leaving aside the question of the measures applied to Latvia and Ireland, Rehn's arguments have raised doubts about the ability to impose a model that has had some success in a country of a few million people on one with a population of 46 million. Sources in Brussels say that Rehn, when he defended the IMF's recommendation that Spain cut salaries, was simply trying to start a discussion about what measures would help the Spanish economy recover, rather than apply the Latvian solution wholesale.

The Spanish response has been negative, with labor unions, politicians and economists reacting angrily. "Applying the Latvian example to Spain is an insult to our intelligence. If this is all that the EU can offer, then I would rather opt out," says José Carlos Díez of Icade business school.

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