Tuesday, June 26, 2007

Latvian economy

Good overview of problems facing Latvian economy is today published by Edward Hugh, motivated by Eurostat data that in the first quarter of 2007 wages in Latvia were up by an astonishing 32.7% when compared with the first quarter of 2006.
The conclusions that he makes are very saddening:
"there is some sort of consensus among experts and analysts that there may be no easy policy remedy available, that the problem may be structural".
The main structural issue of course being labour supply. With 70 000 to 100 000 Latvians working abroad and 70 000 new jobs created in 2006, it is easy to see that a country of 2,4 million is lacking resources.
The other conclusion of this analysis as well as IMF and BICEPS reports is that the Latvian anti-inflation plan will not help, but neither would probably anything else.
And again the only suggestion given is relaxing the immigration policy to allow an inward flow of migrant worker to compensate to the very sudden outflow of Latvian workers.
"This short term advantage may be important, since longer term solutions like increasing the human capital component in the economy and moving up to higher value activity need much more time, and what is at issue here is transiting a fairly small economy from an unsustainable path to a sustainable one."
The idea is to use the countries ability to control the number of immigrants as a sort of soft landing gear, not as a long term solution.
Although, the author offers some positive remarks about the actions of Estonian government (planned doubling of immigrants' quota), i think the problems are pretty much the same here. Especially as Estonian and Latvian economies are linked through trade, investment, but also in the mindset of our foreign investors. So any crises in Latvia could seriously affect our economy as well.

It is high-time for the Estonian and Latvian governments to stop the populist game with luck and admit that the only way to sustain our economic success currently is controlled migration of labour. Controlled in terms on numbers not education or skill level. Only this will allow our companies to produce goods that are competitive on world level, only this will allow our brightest heads to concentrate to activities that are most value-adding, not rake higher wages on construction sites.

Clearly, another issue affecting the economies of Estonia and Latvia, are the low interest rates we enjoy due to our currency-peg to Euro. This Economist article reminds us of the rule of thumb that in a neutral monetary policy short term interest rates should equal nominal economic growth. With Estonian nominal economic growth of 19% in Q1 of 2007, interest rates of 4,25% must clearly create oversupply of money, resulting in strong inflationary pressures and misallocation of investment.

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