Jeffrey Sommers/Michael Hudson: Latvia, the Austerians’ Potemkin Village

Yves here. I’m dwelling on the spectacular failure of Latvia in part because readers like the writings of Michael Hudson, but more important, because a major push is on to reimage the implosion of that economy as some sort of success, not unlike the claims the Chicago Boys made for their efforts in Chile. It also doesn’t hurt that this account, which is a considerably expanded version of a recent Financial Times op-ed, is vivid and pointed.

By Jeffery Sommers and Michael Hudson, a associate professor at the University of Wisconsin-Milwaukee and distinguished professor at the University of Missouri-Kansas City respectively, who have both advised members of Latvia’s government on alternatives to austerity. They are also contributors to the forthcoming book by Routledge Press: The Contradictions of Austerity: The Socio-Economic Costs of the Neoliberal Baltic Model. Cross posted from Counterpunch by permission of the authors

Austerity’s advocates are declaring victory with Latvia’s battle against the European economic crisis and advocating it as the model for Greece & Spain to emulate. Curiously, Latvians have been declaring this “win” by exiting their country.

The “austerians” are celebrating Latvia as the plucky country that through hard work and discipline showed the way out of the financial crisis plaguing so many countries. For austerians, Latvia represents a veritable Protestant morality play demonstrating that austerity works. Indeed, they hope the Latvian example will retread Margaret Thatcher’s “there is no alternative” tire for a European-wide scale austerity tour. Few writing on the subject unfortunately have the time on the ground to evaluate the economic and social costs of the Latvian model. While the Latvian government chose austerity, most of its people have not. Feeling there is no acceptable political alternative available, many elect to emigrate.

The European Commission and the IMF declared this victory with a public event in Riga on June 5th celebrating the Latvian model. The IMF head, Christine Lagarde, proclaimed Latvia “could serve as an inspiration for European leaders grappling with the euro crisis.” The IMF’s chief economist, Olivier Blanchard, followed with a mea culpa admitting initially he thought the Latvian peg and internal devaluation program a “disaster,” but now sees success.

To better appreciate Blanchard’s remarks one must bear in mind Latvia is one of the few countries following the 2008 crisis that actually attacked the IMF from the right on economic and social policy. In effect, Blanchard and the IMF are declaring, “our policies were too cautious on austerity, long live austerity!” For the IMF it reprises a familiar chorus harkening back to their greatest hits of the 1980’s and 1990’s glory days of structural adjustment.

A seat at the table of power routinely flatters pundits invited to these affairs. They dutifully report, rather than investigate, what they are told. On Latvia, The Economist, to paraphrase Paul Krugman’s characterization of US Congressman Paul Ryan, increasingly “looks like stupid person’s idea of what a smart magazine looks
like.” It provides its customary breezy reporting that gets anything of importance wrong. Meanwhile, big names (one is reluctant to say heavyweights) on the circuit, such as Chrystia Freeland of Reuters, embarrassingly, for anyone that might have bothered to query the hotel bartender or taxi driver of their views on Latvia, allege, “the harsh Latvian plan worked because the whole country was committed to it.” This reminds one of the Red Cross inspections of the Theresienstadt showcase concentration camp, who shown orchestras and clean conditions announced, “everything in order here!” Of course, Latvia is no concentration camp and its people not fascists. Indeed, Riga, its capital, is among Europe’s most beautiful, and if you have a bit of money, livable, cities. Meanwhile, others report the country feels like a prison. The reality is that there are several realities depending on one’s social class and income. To declare the “whole country” is “committed” to anything in this society deeply divided by class and ethnicity is lazy reporting at best.

In short, Latvia is not a model for austerity in Greece or anywhere else. The impression that neoliberal policy has been a success is debatable, and the claim that Latvians have voted to support it, false. Latvia’s solid economic growth since its economy plunged by 25 per cent in 2008-10 is billed as a success. Its unemployment during the crisis soared above 20 per cent as the shutdown of foreign capital inflows (mainly Swedish mortgage loans to inflate its real estate bubble) left Latvia with deep current-account deficits. It had to choose between devaluation and maintaining the euro peg. There are inherent problems with either choice, but the theological manner in which the choices have been made has been disturbing.

Latvia’s government chose internal devaluation in order to proceed towards euro accession; and indeed this goal is more popular with Latvians given the people have lost their savings multiple times to devaluations and banking crises since the collapse of the USSR. To meet the eurozone criteria on inflation and deficits it cut public sector wages by 30 per cent, driving down consumption to match its low labor productivity.

What enabled Latvia to survive the crisis were EU and IMF bailouts (a “credit card” which for whom the Latvians did not utilize the full credit line extended) – whose payments will soon fall due. Relatively low public sector debt (9 per cent of gross domestic product at the start of the crisis) also provided some protection from bond traders. Latvia’s problem was mostly private sector debt; especially mortgage debt, which is often secured not only by property but also by the personal liability of entire families as joint signatories. The banks insisted on this measure as it saw unaffordable housing prices being inflated by reckless bank lending. For this, the Swedes, have thanked Latvia for taking on a Stockholm Syndrome view of the crisis, thus having Latvia fall on the sword of austerity to protect Swedish Banks and the Swedish economy. To be fair, the Latvians expect this gratitude to be returned by both euro accession in 2014 and continued Swedish liquidity supplied to the Latvian economy. Whether either of these is good for Latvia is contestable.

Yet, what of the contention that Latvia’s people supported austerity as distasteful, yet necessary? Latvia’s parliament often polls approval ratings in the single and low double-digits. Yet the government has survived two elections. How is one to read this? Chiefly by ethnic politics. Harmony Center was the biggest party opposing the austerity model—albeit often without consistently voicing any program. Moreover, the party (as with most in Latvia) contains its quota of grabbers and neoliberals as most of Latvia’s parties do. They largely represent ethnic Russians and had no chance of winning given its focus on rights for Russian speakers. Other previously powerful parties were run by post-Soviet oligarchs. They were rightly seen as being in league with Russian interests and are widely resented for fiscal imprudence during the boom years, when they were part of the governing coalition. So the only political force left was the austerians. While most voters dislike their economic policy, a majority is convinced that they are best able to resist Russia’s embrace. All other issues come a distant second for Latvian voters.

That said, Latvians strongly protested austerity. On January 13, 2009, in the dead of winter, 10,000 in Riga protested against austerity and corruption. Teachers, nurses and farmers held demonstrations in the months following. The national police were called to suppress protests over the closure of a hospital in Bauska; fearing local police might not do what was “required.” Police detained one economist for two days for his remarks on the economy, meanwhile there is evidence a foreign economist in Riga critical of Latvian economic policy had his phone tapped. Latvia is by no means a police state, but neither is it innocent in matters of controlling public opinion either.

Latvia’s policymakers in the main are neither saints nor sadists. Indeed, some genuinely care about the country’s future. Their Prime Minister leading the austerity charge is by all accounts a paragon of integrity. Unfortunately, he has come under the policy counsel of Anders Aslund, now seeking to salvage his place in history given he was one of the chief proponents of the failed shock therapy in 1990’s Russia.

Too many in Latvia, however, take a view of the poor and of the country’s speculators that would comfortably fit in the pages of Ayn Rand’s Atlas Shrugged. This is especially true of Central Bank, which has dominated economic policy since Latvia’s independence in 1991. For Latvia’s elite, the internal devaluation and austerity program have become something of a vanity project. Coming of age during the 1980s when the USSR was crumbling and the US neoliberal model ascendant, they fully internalized market fundamentalism as a rigid dogma to advance liberation from the Soviet occupation. The chief criterion for its selection seems to be it was the model that looked most different from Soviet policy. To see their austerity model heralded by the IMF and ECB today is seen as vindication of their worldview, and repudiation of the putdowns heaped on them by chauvinistic occupiers in the past.

Elites aside, many emigrated. After these protests subsided, Latvians resigned themselves to the situation and left. Demographers estimate that 200,000 have departed the past decade – roughly 10 per cent of the population – at an accelerating rate that reflects the austerity being inflicted. Latvian demographers estimate that at least 200,000 have left Latvia the past decade, Moreover, birth rates declined from already low numbers. If a similar percent left the US, some 30 million would exit. Where would they go? Mexico? Surely, this model cannot be reproduced in any sizeable country.

Why have so many left Latvia if it is such an economic success as the advocates claim? Latvia experienced the full effects of austerity and neoliberalism. Birth rates fell during the crisis – as is the case almost everywhere austerity programs are imposed. It continues having among Europe’s highest rates of suicide and of road deaths caused by drunk driving. Violent crime is high, arguably, because of prolonged unemployment and police budget cuts. Moreover, a soaring brain drain moves in tandem with blue-collar emigration.

The moral for Europeans is that a Latvian economic and political model can work only temporarily, and only in a country with a population small enough (a few million) for other nations to absorb émigrés seeking employment abroad. Such a country should be willing to have its population decline, especially its prime working-age cohort. In Greece, this could only worsen an already serious demographic challenge.

Politically, it helps to be a post-Soviet economy with a fully flexible, poorly unionized labor force. Above all, its cultural and policy elite needs to put an almost blind faith in “free market” central planners. Ethnic divisions can distract voters from complaints against austerity. Only under these political conditions can austerity be considered a “success.”

On balance, the Latvian model has done much harm. Demographically, in terms of its future, one can even argue that the country is being euthanized. The fact that the point is even debatable hints at the huge costs and risks the country has undertaken with its neoliberal program since 1991 and austerity following 2008. To be fair, one must also give the Latvian government their due. After the calamitous crash following 2008, their economy is now growing again. While much Latvian growth is linked to unsustainable clear-cutting of timber to satisfy West European demand (though Latvia has plenty of forest for managed logging), other sectors are growing too, such as food exports, along with some rebound of its small manufacturing sector. Transit and the emergence of a new Silk Road is yet another growth area.

One must also note that Latvia’s options are circumscribed by the limitations imposed by Article 123 of the EU treaty. This removes currency autonomy and domestic credit creation for national development. The treaty locks countries like Latvia into an embrace of private credit markets that forces governments to pay rents to bankers rather than financing their own development where possible. What additionally holds production back more than anything are regressive tax policies that place Latvia’s tax burden on labor. Thus, this makes labor expensive, preventing advantages that could accrue from lower labor costs. Meanwhile, speculators get a free ride on taxes.

Latvia’s growth, however, is tenuous. It is exceptionally dependent on a rogue financial offshore industry that destroys wealth in other countries. Production is also disproportionately geared to exports, even for a small country. Yet, even if growth continues it will be years before they reach pre-crisis level of GDP. Thus, victory laps on recovery, let alone advocacy for others to follow the Latvian path, is premature at best, and reckless at worst.

Latvia has many strengths: an impressive reservoir of human talent; a highly developed aesthetic and design sense rivaling the Scandinavians; an embrace of innovation and approach to tasks with a perfectionist sensibility; and geography facilitating trade. Yet, its government’s advocacy of austerity is decidedly not among those assets.

While the Latvian model is not exportable, might it deliver economic recovery in the highly specific conditions of that country? Too early to tell. What is possible, however, is that even if it does, the price paid for it might be too few people to sustain the country into the future. Europeans should reject Latvia as a model to emulate. Instead, they should engage a wholesale reorganization of European Union rules facilitating national development to liberate its member states from usurious ties to European banks currently delivering its people into penury.

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  1. Leo Eleba

    One of the first things explained is that the Latvian competitivity is based on a massive devaluation.

    How is that supposed to be applicable to Euro countries ?

  2. rkka

    “Moreover, birth rates declined from already low numbers.”

    Births have declined over 20% since 2008, and they were never high to begin with.

    Deaths in Latvia now exceed births by over 1.5 to 1.

    A triumph of austerity! Business is booming!

    Unless you will need a labor force in a generation. Or customers.

    1. J Sterling

      Everyone knows the solution to a labor shortage is new immigrants from an even poorer country who, with no loyalty to the native workers, can be relied on to take any wages however low without striking.

      Bertolt Brecht once sarcastically suggested that if the government is disappointed in the people, it should dissolve the people and elect another one more to its liking. The labor employing elite has taken this suggestion at face value.

      1. McKillop

        Yes; then the native population will exercise xenophobic attitudes towards the immigrants -especially if they are brown-skinned, and religiously cohesive.

  3. Jim Haygood

    ‘… blind faith in “free market” central planners.’

    Oxymoron of the decade, if not the century. Well done!

    ‘Latvia’s government chose internal devaluation in order to proceed towards euro accession; and indeed this goal is more popular with Latvians given the people have lost their savings multiple times to devaluations and banking crises since the collapse of the USSR.

    Fair enough. But this sentence contradicts the entire thesis of the essay, that Latvia’s internal devaluation is a ‘central bank vanity project.’

    If you’re gonna take potshots at Latvia, best use a rifle with a scope instead of a flintlock blunderbuss. And maybe get an editor …

    1. j.grmwd

      The thesis of the article is that the Latvian austerity experiment has not been a success under any reasonable definition of the word success. And, that to the extent it has been more successful than other austerity experiments, it is due to factors specific to Latvia. This is the case whether the policies have 99%, or 1% public support. And whether or not they were implemented by broad popular acclaim or a cabal of central bankers.

  4. Adam (ak)

    The following may be also relevant to understand what is really going on:

    “The loss of population is attributed to a low birth rate, meaning that not enough children are being born to replace persons who die, as well as to emigration. According to the census, 119,000 of the lost population is due to the birth rate, while emigration is responsible for 190,000.”

    “The greatest decrease in ethnic population has been among Russians. Almost 147,000 fewer ethnic Russians lived in Latvia in 2011 than in 2000, a decline of 20.8 percent. Ethnic Latvians decreased by about 86,500, or 6.3 percent.”

    If austerity helps in driving the Russians away then it is obvious why so many Latvians support the policy even if they are not better off in the short run.

    Disclaimer: I do not support either side.

  5. docG

    Thanks so much for this very enlightening take on what is really happening in Latvia. Your analysis is well written, convincing and to the point.

    My only quibble is that you are much too vague about the root cause, taking the term “austerity” at face value — as though there were some deep seated need for “austerity” due to some fundamental “economic” problem produced by some vaguely understood banking practices.

    As I see it, the root problem is not austerity or even banking, but something much simpler:

    “The root cause of the so-called “economic crisis” was neither banking nor the Euro nor monetary policy, nor fiscal policy, nor the Fed, nor Goldman Sachs, nor J. P. Morgan Chase, etc. (though all the above contributed mightily to the depressing outcome), but the relentless ratcheting up of that age-old resource of the wealthy and privileged: the ruthless and relentless exploitation of labor.”

    (from the latest post on my blog, Mole in the Ground)

    What has happened in Latvia is essentially no different from what is currently in process throughout Europe and indeed the USA and the world at large. The ratcheting of pressure on vulnerable workers throughout the world, forcing them to compete with one another in a vicious race to the bottom. Vulnerable, yes, but not exactly helpless, as I will explain presently.

    1. jeffrey sommers

      The 1st half of the 20th century was hard on many. Not fair to say Latvians killed any significant number of Jews. While Nazi occupiers launched the holocaust in Latvia, the number of Latvians complicit was not greater than anywhere else in Europe.

      One should bear in mind that thousands of Latvians were victims of at the hands of the Soviets.

      1. Adam (ak)

        I am sorry the statement that Lavians were not responsible is factually incorrect, SOME ethnic Latvians were responsible for killing Jews in an organised manner:

        I agree with the second half – I would not blame ALL the Latvians for the atrocities and we must keep in mind that Stalin murdered a lot of them on a scale which can be compared with the Holocaust of the Jews (in absolute, not relative numbers as in relative numbers the fate of Jews and Gypsies/Roma was absolutely unique).

        Whether it was better or worse than in other occupied countries like Poland – I don’t know. My family lived and was persecuted under both Nazis and Soviets not far away from the country we are talking about.

        I would argue that any attempts to understand why the majority of population in Latvia supports austerity and any measures to tightly integrate with the EU must be put in the historic context.

        The article leaves an impression that there is a “class” struggle between “the Latvian polulation” and “the overlords from the EU”. In fact there is no “Latvian society” but at least 2 distinct ethnic groups – Latvians and Russian-Speakers. I am referring to the following sentence: “After these protests subsided, Latvians resigned themselves to the situation and left” – mostly not Latvians, Russian-speakers living in Latvia are NOT Latvians.

        The EU overlords were invited to defend the ethnic Latvians from their Russian neighbour – the price paid by the Latvians was assigning all the relevant assets to Swedes and Germans. The Russian-speaking minority is still treated as agents of Russia. (I do not judge this from the moral point of view, to me all of this is deeply immoral and profoundly saddenig).

        Because the Western Europeans have assets there, they are more likely to defend their interests and look after the “serfs”. Latvia was never an independent country before 1918 and the late development is just a repetition of the old pattern from the times of Duchy of Courland

        While the article presents a sound interpretation of the macroeconomic development, a Western reader may be left with an incorrect impression about the wider context.

        Economics cannot be separated from politics especially in places like Latvia. As I mentioned, austerity may make sense to some Latvians but not in economic terms…

        1. jeffrey sommers

          @Adam. While getting a bit off topic, I doubt there would have been ethnic cleansing in Latvia without the German occupation. Were there anti-Semites? Sure. Are there still? Yes. But, it’s not exclusive to the Latvia. The killing of Jews in Latvia during WW II was organized by Germans. Would likely not have happened without them.

  6. LillithMc

    I hate to mention that in my lifetime Latvians marched 30,000 Jews into the woods and shot them including my husband’s relatives. They may not have the most integrity in their social decisions.

  7. LeonovaBalletRusse

    Thanks for the uber-reality check. Why do the egregious lies of Lagarde and Blanchard make me see “heads on pikes?”

    1. jeffrey sommers

      To be sure 2009 & 2010 were exceptionally rough on the Latvians. That said, the mood on the ground has improved this year. There are also some signs of economic success.

      That said, by no means neither can it be called an unqualified success nor a austerity a policy most Lavians approved of at the time.

      Problem with Lagarde, Blanchard, etc., is they never leave their 5 star hotels or the company of local government handlers telling them they are dizzy with success….

  8. WorldisMorphing

    That’s odd .
    I distinctly remember looking up Latvia in wikipedia following my reading of Paul Krugman article on Latvia’s heralded success, and I distinctly remember the wiki page’s economy section being a little different from today’s.

    I recall learning minor things such as the fact that Latvia is a net exporter of electricity (thanks to hydro-elec. power) and some things that are fuzzy right now, regarding shale gas and such…
    They’re not a ‘Koweit’ like state, but certainly have some nice-to-have potential going on for them as a lowly populated country with resources.

    For some reason, I recall feeling the Latvian model was non-exportable too at the time …

  9. Strategist

    >>> The Economist, to paraphrase Paul Krugman’s characterization of US Congressman Paul Ryan, increasingly “looks like stupid person’s idea of what a smart magazine looks like.”

    Hear, hear. I don’t know about increasingly, though. Ever since I first saw it at school in the 1980s, The Economist has always been an appalling, absurdly self-regarding, not-even-one-tune-more-like-one-note pile of crap selling stupid people what they think smart looks like. The worst magazine in the world. The pits.

    1. C

      I think Krugman was actually referencing Newt Gingrich when he said that. But still in principle I agree.

  10. Eric

    When I read references to Ayn Rand or slogans about neoliberalism, I can only conclude this is another piece that is mainly written for US internal consumption, part of the ideological war between Republicans and Democrats.
    Please Americans: do us a favor and stop abusing European economic problems as ammunition for your internal debates.
    I can assure you that 99.9% of Europeans never heard about Ayn Rand, and are also not interested in her extreme ideas.
    If people in European countries really believe austerity is a problem, they will at some point vote for governments that will either start printing money or borrow more money.
    But this can only be done if you have your own currency (or in the case of Latvia abandon the peg). So countries who want to adopt this policy should leave the euro first.
    And here is the problem: voters in those countries do not want to leave the euro. They want debt pooling, and if possible more debt, and expect that the ”rich” North will pay for it. Obviously, the North will never go along with this.
    Personally I think the debate about austerity or not is a gross simplification of the difficulty of getting rid of a debt overhang after the debt bubble has bursted. If you really want to solve it with more government spending, Japan is your example. But there is another problem here: even if the over indebted periphery would leave the euro, they still couldn’t borrow, as these countries have a trade deficit and not enough market confidence to attract more foreign money at cheap rates. They simply are not Japan (export country) or the US (reserve currency status). You can look at at what rates the periphery had to borrow before they entered the euro and that was at rates above 6% that are now seen as unsustainable!
    Summarizing: the periphery, but also Latvia, can drop the euro (peg) and start printing in their own currency if they don’t like austerity, as thats the only realistic option they have. The result will be their currency will sink like a stone. And if they really thought that would be such a great alternative, they would have chosen this path already.

  11. gopher

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  12. Haigh

    Austerity. A dysphemism employed by those with an aversion to the financial goal of matching fiscal expenditures to tax revenue. If there was any evidence that dollar for dollar, money spent via public policies had the same impact on the standard of living as private investment in productive enterprise it would be a bit easier to consider the argument.

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