A Latvian version of the New Deal would dig the country's economy out of the hole its in.
For its economic problems, Latvia cannot catch a break.
After passing one of the tightest post-Soviet budgets for 2010 in early December, the Constitutional Court will add further strain to the Latvian economy. The country’s highest court ruled last week that the government’s cutting down pensions violated a basic human right to social security.
In July 2009, the government cut pensions by 70 percent for those still working and 10 percent for all else. With the ruling not only does the government have to restore the previous pension levels by March 2010, but it also has to pay back lost pensions from when the cuts began. Compensation, to be made by 2015, is estimated at 100 million lats (€141 million).
That is good news to the elderly, especially those who rely on the payments as their sole source of income. Every country has an obligation to protect its citizens, and pensioners are among a society’s most vulnerable groups. Tough economic times are no excuse for mistreating the senior population. The ruling is just, on principle.
But just or not, the ruling will not spare Latvia from bleaker times ahead. Even with the economy expected to shrink 18 percent in 2010 and unemployment holding at a whooping 20 percent, Latvia already had to pass several tax hikes and spending cuts. Now the government will have to brainstorm how to pay an additional 20 million LVL for each of the next 5 years (100 million lats in total). In all likeliness, the budget will need to be revised and more tax raises and/or spending cuts in other sectors could be in store.
The additional budget strain could affect the €7.5 billion loan Latvia received from the International Monetary Fund and European Union starting in late 2008. Loan conditions require Latvia to reduce its deficit by 500 million lats next year; the IMF and EU were satisfied with the December budget and approved the next loan payment installment. With the new development, nothing is certain.
Two turns of events can help Latvia with the pension problem and move the country toward economic recovery. Latvia needs to re-negotiate with the IMF and the EU the terms of the loan agreement to allow for softer conditions. Then with more budgetary latitude, the government should revitalize the economy through a more robust public sector.
First, the IMF and EU need to relax their loan conditions before they handicap Latvia economically any more. Latvia does need to reduce the deficit and control spending, but too much too fast can stunt growth, lose jobs, and decrease investment in the short-, medium-, and long-term. Steep spending cuts and higher taxes over the next few years will prolong the effects of the financial crisis and not leave Latvia in a position of strength or growth when the worst is over.
Instead of the up-front deficit reduction conditions of the loan now, Latvia should request a graduated deficit reduction plan that is related inversely to rises in gross domestic product. Thus, as GDP rebounds, the government will take up more measures to lower its deficit. Economic growth will be faster and steadier this way. The Latvian budget, too, will be more flexible to deal with unforeseen conditions (like pension payments). Other harsh reforms demanded by the IMF, such as cuts to public sector wages and wage ceilings, should be allowed to be implemented over time as well.
For good reason, the IMF/EU loan should have some conditions — loans should not be a reward for bad behavior; however, the Latvian government still deserves deference in deciding what is best for the country. The IMF has said it is willing to discuss the consequences of the Constitutional Court ruling with Latvian leaders and is willing to reduce the loan conditions. The EU should also be pushed to show more leniency to Latvia as many member states, including France and Germany, have exceeded the rule on not exceeding 3 percent deficits at various times. Under new circumstances, Latvia should ask for a new deal.
Second, the Latvian government should develop a package of programs aimed at providing relief from the crisis and to help the economy recover. The IMF/EU loan brought some relief to the country’s financial problems, but mostly just staved off complete collapse. After negotiating looser loan terms, Latvia should seek to use the remainder of its loan to bring stability to the private sector and spur responsible growth through an active public sector.
Americans have learned probably better than anyone that sometimes a government needs to spend its way out of tough times. Ironically, deficit spending can grow an economy so much that a country can climb out of deficit. It is counterintuitive, for sure. Yet, the government can be an engine to the economy. This Keynesian economic model underpinned America’s response to the current financial crisis: a gigantic financial rescue package laced with new spending. But that is just the most recent example.
Franklin D. Roosevelt’s New Deal of the 1930s, the archetype of Keynesian economics, set the precedent for government intervention in correcting downward trends in the private sector. The New Deal consisted of various government programs and projects that set Americans to work and stabilized the economy. America clawed its way out of the Great Depression largely through New Deal spending.
Latvia needs its own New Deal, admittedly a scaled-down one. Instead of creating the acronym soup that characterized the US New Deal, Latvia can forgo creating new agencies and bureaucracies by working within existing structures. Yet many of the same strategies could work here.
Latvians could be put to work on restarting stalled construction projects, repairing roads, or even producing art. Locals could rebuild or repair schools, courthouses, parks, or other public facilities throughout the country. Still more could help in distributing food and clothing to poor areas, opening soup kitchens or homeless shelters, and retraining the unemployed for new jobs. The government could invest in transportation systems, renewable energies, construction, schools, and small- and medium-sized businesses. It could also provide housing assistance and alleviate some of the strains on the real estate market.
The IMF and EU should allow the Latvian government some deficit spending to launch its own New Deal instead of crippling it with tough deficit reduction measures. The American New Deal worked because it provided relief, reform, and recovery—three things sorely needed in Latvia. Some relief measures could be taken up immediately by creating new jobs and providing direct assistance. With reform already underway, recovery could be right around the corner.
The Constitutional Court’s ruling may not have made Latvia’s budget woes any better, but it could be the impetus for some drastic changes. To deal with the unexpected pension expenses, Latvia has grounds to negotiate a new deal with the IMF and EU for softening strings attached to the financial rescue loan. That could open the way for a New Deal in Latvia, which can give the country some relief and begin some recovery. Latvia needs a new deal and New Deal.
Michael G. Dozler is a graduate student of international affairs who received a Fulbright research grant for study in Latvia.
Disclaimer:
Views expressed in the opinion section are never those of the Baltic Reports company or the website’s editorial team as a whole, but merely those of the individual writer.
Latvia does not need a “New Deal”. Redenominate all debt to Lats, devalue the currency, and tell everyone “Thank you”.
Some other things are more important:
First and foremost, Latvia should reduce its post-Soviet style corruption which is actually the base cause of the current crisis. The total leniency to corruption, whis was symbolically reflected in the hilareous election of a bribe-taking doctor to the position of state president in 2007 should be reversed. Directly related to corruption is protection of oligarchs and their minions and circles, e.g. in all kinds of tax loops, total deafness of government and law makers on issues of progressive income tax, etc. And, last but no least, devaluation of lat or not, the absurdity of drastically raising all taxes and duties in the time of recession must be dealt with and reversed. With the current budged and tax policies, a recovery is simply unimaginble.
Olgers is right. If that is done… Oh, how I wish it would…
this author knows nothing of economics. keynsian economics was abandoned in th 70’s because it leads to more unemployment and inflation
and the new deal failed to produce any real economic recovery for almost a decade. it was only after ww ii that the US finally pulled out of the depression.
Re. Olgerts comments– My company has been trying to develop a pharmaceutical project in Latvia for a couple of years. We obviously misjudged the post-Soviet style corruption level that seems to pervade the business and government culture. Our initial assessment was that Latvia was a great place to do business— educated workforce, safe, etc. As we started down the path of developing the project we started picking up the clues— minor graft at the local level for zoning approvals, requests of kickbacks for financing, etc. At this point I doubt we will build the facility— crap economy and corrupt infrastructure.
Re: “this author knows nothing of economics. keynsian economics was abandoned in th 70’s because it leads to more unemployment and inflation”
The reasons for it being abandoned were as much political and interest based as anything.
Re: “and the new deal failed to produce any real economic recovery for almost a decade. it was only after ww ii that the US finally pulled out of the depression.”
The New Deal halted the economic bleeding. Put millions back to work. Put in place regulations permitting the greatest economic boom capitalism every experienced following WWII, only dismantled by Reagan, Bush, Clinton, & Bush. The New Deal itself failed to solve the Great Depression fully because it failed to spend enough. WW II increased spending by multiples of the New Deal and the economy recovered. Following WW II spending was greatly reduced, the economy fell in 1946/47, the spending was resumed, and with it the post-WW II boom…
it halted the economic bleeding? what would you call a doctor who halted your bleeding after an accident but was so inept that with his fumblings you had to stay in the hospital for 10 years?
and trying to say that government regulation “permitted” the greatest economic boom in history makes no sense. if government regulation were the main driver behind economic prosperity then countries like India and China would be the richest in the world. instead, they wallow in poverty. the only reason those countries have shown imporvement is because they have somewhat relaxed their governmental control of the economy.
I agree with the fact that if the government spends a lot of money, the economy will grow in the short run. just like if you get a new credit card your lifestyle will improve in the short run. however, there are consequences to making irresponsible decisions, like spending more than you make. in the 1970’s many world economies paid the price with very high unemployment and inflation. they tried to solve the problem with government regulation in the form of price and wage controls. things got even worse. the keynsian scam of spending your way out of problems was exposed.
there is a reason that the imf doesn’t allow countries to run new deal programs when it gives out loans. the economists there have read history books and know that the new deal didn’t work. the only people who are ever for this new deal hogwash are political academics who are often quite ignorant in economics.
The LAST thing Latvia needs is a New Deal.
Robert Greene says:
December 28, 2009 at 6:05 pm
Latvia does not need a “New Deal”. Redenominate all debt to Lats, devalue the currency, and tell everyone “Thank you”.
Devaluation is a must, but the problem with redenominating all debt to Lats is the huge different in interest rates.
Just because you do not subscribe to it, does not mean Keynesian economics has been disproven, abandoned, or is hogwash or a scam. As Jeff said, the stagflation of the 1970s was caused equally by political events (such as the oil crisis) as economic policy. And to say that the Keynesian economic model is not present in the current response to the financial crisis in the USA, UK, France, and others is an exercise in delusion. In fact, the very idea of the IMF giving a bailout loan to a troubled country is an example of Keynesian economics. Seems like Keynesian economics is alive after all.
Regulation can provide the conditions for amazing economic prosperity. Too much can hurt it (in India and China for example–that’s why steps toward deregulation are paying off). Too little can make it vulnerable (as in pre-Depression USA). The reforms of the New Deal provided enough regulation for stable growth without stunting it.
No one said the New Deal would fix the economy overnight but it brought jobs and hope. Those are two things I think Latvia could use. Try telling the millions of Americans who survived because of the New Deal that it didn’t work (and try not to get a black eye). And as Jeff said, WWII only amplified the basic underpinnings of the New Deal–that some measure of government intervention and spending can improve the economy. It took a while to recover from the most severe economic depression in the modern world, how could it not? It will also take some time in Latvia.
A New Deal in Latvia won’t be a silver bullet, but it can stop the bleeding. After that, the country still has a long way to go–just as the US did. As Olgerts said, there is political corruption to address. But might it be better if some of that money fell into the Latvian economy rather than the pockets of corrupt politicians? I know some unemployed people who would think so.
i never said that keynsianism isn’t in existence today, just that it was discredited. politicians love keynsian stimulus packages because it is like a free ticket for them to waste money on what ever they want and it makes it appear that they are doing something about the problem. it is done for theatrics to keep uneducated people voting for them. During the arab oil crisis Tobin, one of the leading keynsians of the time offered the solution of wage and price controls. Nixon knew from his experience during wwii when he was incharge of implementing price controls that they did not work. yet in the 70’s he implemented them anyway. theatrics, even though they may be harmful, are what inspire hope and create a feeling of change. a boring painful solution to stagflation, like the one proposed by volcker that actually worked, cost jimmy carter his re-election.
if monetarist philosophy had been implemented at the start of the great depression it never would have happened. Bernanke himself admited this to congress.
Rather I agree on most of the comments than on the content of this article. Except from problems like corruption, there may be just another simple reason why Latvia cannot get out of the current situation on its own but has to hope others will drag it out of the pit with their own recoveries. The reason: the lack of leadership and vision in Latvia. No one knows how to (re)act on the current situation, especially economists. And no one even attempts to (re)act. They’re just waiting and hoping for better times…
I can also just emphasize what Olgerts and Frank Will have said – it is needed to reduce to high level of corruption and shadow economy.
It seems that even EU and IMF negociators are blind on this spot, as KNAB is a victim of the general cutbacks and losing power by that, SRS probably as well. These agencies need more support and money in this situation, and not less.
Of course, that is a effect which Latvian politicians do not feel unhappy about, as corruption is daily business (e.g. for hidden party financing) for at least several of them. A new deal, like described by Michael, would do nothing but washing increased state expenses into the pockets of Oligarchs and party financing, how it has been done the years before. A general distribution of “wealth” to the public, e.g. local craftsmen or other small business people, would not happen (except you father is the driver of a minister).
Latvia needs to be pushed URGENTLY to fight more and broader against corruption on all levels, to control party financing and expenses more strict and to improve fair competition in all levels and areas of their economy. If this is not been done, no real “New Deal” would ever help.
“I agree with the fact that if the government spends a lot of money, the economy will grow in the short run.”
The “short run” proved to last 25 years after WW II and produced the greatest economic expansion in world history…
“there is a reason that the imf doesn’t allow countries to run new deal programs when it gives out loans.”
The IMF has been completely discredited. Their programs have produced no significant growth nor development the past 2 decades…
“if monetarist philosophy had been implemented at the start of the great depression it never would have happened. Bernanke himself admitted this to congress.”
This is a counterfactual with no basis in fact. How would monetarist policy have halted the Great Depression. The Great Depression was global. Indeed, what economic history reveals is that where state intervention was strongest, recovery was greater, not the reverse. Bernanke got both the Great Depression wrong, and his response to this crisis. Both were precipitated by the development of income gaps (high inequality) and the corresponding asset inflation they caused. Having done nothing to resolve this core issue, we will not see returns to high growth…
jeff,
your theories are based solely on political theory. high inequality caused the great depression? high inequality causes asset inflation?
governments can not conjure up wealth by simply printing money and giving it to people. nor can they make a country wealthier by stealing money from the rich and giving it to the poor. the economic expansion after wwii can only be explained by massive increases in productivity. scientific innovation led to the creation of new industries and processes, creating new jobs and higher wages as workers became more productive.