Latvia: Political, economic and financial integration – and then disintegration? The Legacy of 1989, 9 November 2009, Copenhagen Morten Hansen Head of Economics Department, Stockholm School of Economics in Riga

Latvia: Just a few facts - on a per capita basis the most talked about country the past year Population GDP App. 0.1% of World GDP Economically the size of North Dakota GDP per capita App. 50% of EU27 average 3 rd poorest in the EU

President of the Republic of Latvia, Valdis Zatlers Speech to the Latvian parliament (Saeima), 18 June 2009: “The question is really before us: Will the Latvian state, will our country exist or not exist?” “We have lacked political will, we lack economic and entrepreneurial far- sightedness, we have governed our country poorly, indeed”

Latvian economic growth, 2004-I – 2009-II, year on year Biggest boom turns to the (2 nd ) biggest bust…

Latvian GDP, quarterly, constant prices, seasonally adjusted Bombed back 4 years….

Then: The Baltic Tigers A quick “ What happened for Dummies ” Biggest credit boom in Eastern Europe  Biggest property boom Biggest consumption boom Biggest overheating (wages, inflation) Strongly procyclical fiscal policy The wish for fast income convergence

Why Latvia stands out Credit booms in all three Baltic countries - but biggest in EE and LV Procyclical fiscal policy in LV and LT World financial crisis  Domestic financial crisis in LV; nationalization of Parex Bank

IMF/EU, Sweden, Denmark, Estonia, Czech Republic, Poland, World Bank, EBRD – strong solidarity 7.5 bill. EUR, 27-month Stand-by arrangement (35% of LV 2008 GDP – huge package) Parex and other banks Public finances Balance of Payments Maintain the fixed exchange rate, opt for internal devaluation to regain competitiveness – undoing the wage excesses of the past

Commissioner Joaquin Almunia: “Just tighten (pull) enough and you will get the money” Tough but necessary measures: Cut public sector wages Cut pensions Close hospitals Close schools 20-40% wage cuts in the private sector not unheard of A tale of reforms that were not done in the “ years of abundance ”

Lessons from transition Fast transition: Market economy Trade integration Slow: Income convergence – but it is the overriding objective Overlooked: Financially uneducated population – exacerbates the credit boom Downplayed: Reform fatigue, advisor fatigue Poor governance Demand side effects vs. supply side effects

Latvia and EU integration 1 April 2004NATO 1 May 2004EU 21 Dec. 2007Schengen 2014(?)Euro adoption The EU may not be overly popular (but where is it?) but no alternative is envisaged No going back… NATO more important….

Some conclusions and comments Firmly anchored in the west No alternative to the EU But: Hitler >< Stalin Nord Stream 2004: The right(?) time to join politically - but too early from an economic perspective? Massive income differences will persist and be troublesome