The troubles that the Southern states of Europe are facing today have to some extent already been faced by countries in the North-East. Austerity packages, belt-tightening and bail-outs sound all too familiar to Latvia, one of the Baltic tiger economies that suffered a rapid fall from grace in 2008.
When the Soviet Union collapsed, Latvia made rapid progress in joining the international community: 1999 saw it become a member of the WTO, and 2004 saw it join both NATO and the European Union. But by now, international investors were seeking outlets for their money and reckoned on Latvia's rapid development. Recognising Latvia as a beautiful gem in the Baltic, money poured in and prices and rents
sky-rocketed.

Real GDP in Latvia grew year-on-year by 7.2% in 2003, 8.7% in 2004, 10.6% in 2005, and 11.9% in 2006. 2007 saw growth again exceeding 10%, but then in 2008 the bubble burst. Latvia recorded a plunge of minus 18%, and saw the largest unemployment levels in the EU. Standard and Poors gave Latvia a credit rating of 'junk'.

Rescue Packages

The IMF and European Union came in and Latvia received a bail-out rescue package on the agreement that it underwent austerity measures. The currency of Latvia, the Lat, was also pegged to the Euro, bringing with it numerous benefits. With a peg to the Euro, the Lat was now a stabilised currency, moving with the Euro. This brought guaranteed stability and helped the export-dependent economy start trading again, as people knew the price for goods and could clearly predict future costs.

The Euro-peg also helped control inflation, and stopped government fiddling by using monetary policy to try and manipulate the economy. This helped Latvians get the economy back onto its feet. The government set about pursuing business-friendly policies, and the people of Latvia, rather than waiting for the government to rescue them, themselves set about rebuilding their economy. The results are obvious: the World Bank’s ‘Ease of Doing Business Index’ ranks Latvia in 21st place; neighbouring Estonia, by way of contrast, is in 24th position, Spain is in 44th place, Italy in 87th and Greece is in 100th position.

Policies that work

Latvia underwent an internal devaluation and saw its labour costs fall, whilst the end of the speculative property price bubble enabled small business to flourish. During the peak-growth years, rents had become so extortionate that no business could afford to start operating in rented premises; the crisis opened doors of opportunity to those with vision.

The Prime Minister of Latvia, Valdis Dombrovskis, rather than be hounded out as a consequence of the austerity measures, has overseen two election victories and in 2011, Latvia recorded growth of over 5%, amongst the highest growth rates in Europe, and, whilst unemployment is still high, it is declining. Some noted that the government was careful to make sure that everyone suffered in the recession: that bankers, politicians, teachers and doctors all saw their wages fall, that all felt they were in the crisis together.

Different to Greece

While of course instant parallels are drawn to Greece, there are some key differences. Latvia had low public debt levels and few feared a sovereign default. Latvia has also enjoyed the freedom of not having unions, having the effect of developing personal responsibility more. Finally, they had already learned many harsh lessons from the transition from communism to capitalism in the 1990s. They knew the best way was to deal with things quickly and sharply, and that government is not the answer to all problems.

Lessons to learn

Whilst there are key differences, there are stand-out lessons from Latvia’s experience for Europe. Firstly, austerity worked: and it worked best when it was applied immediately. Britain’s politicians could learn a lot here also: a short, sharp recession and a housing price crash would solve many of Britain’s problems, and lead to years of future growth, instead of as at present, protecting those who foolishly and willingly smothered themselves in debt, with the consequence of ten to twenty years of stagnation and lost opportunities for the young.

Many also felt that had Latvia abandoned its peg to the Euro, then its recovery would also have been faster. Latvia is still committed to becoming a member of the Euro in 2014, though with every passing minute this decision looks stranger and stranger. Without its own currency, Latvia would lose a potentially key tool in managing its economy, and also be stuck into the very system which is preventing Greece from devaluing and managing its crisis better, and also sucking Spain and Italy down.