Why Latvia succeeded and Southern Europe failed

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Presentation by Dr. Anders Åslund, Senior Fellow, Peterson Institute for International Economics (USA) at Bank of Latvia conference ""Economic Adjustment under Sovereign Debt Crisis: Can Experience of …

Presentation by Dr. Anders Åslund, Senior Fellow, Peterson Institute for International Economics (USA) at Bank of Latvia conference ""Economic Adjustment under Sovereign Debt Crisis: Can Experience of the Baltics Be Applied to Others?
Riga, November 2, 2012.

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  • 1. Why Latvia Succeeded and Southern Europe Failed Anders Åslund Senior Fellow Peterson Institute for International Economics, Washington, DC Bank of Latvia Riga, November 2, 2012
  • 2. Political Preconditions1. Immediate cause of crisis: External (liquidity freeze)2. Big real output shock bred action3. New government March 20094. Comprehensive & front-loaded crisis program restored confidence early5. Equity6. Good salesmanship7. Sufficient international support
  • 3. Early, Radical Fiscal Adjustment• Fiscal adjustment 9.5% of GDP in 2009 & total 16% of GDP• More expenditure cuts than tax increases (2/3 in total)• Confidence restored by June 2009
  • 4. 16% of GDP Fiscal Consolidation, 2008-1110 percent of GDP98 76 6.7543 2.02 0.7 2.8 1 2.1 1.50 0.5 2008 2009 2010 2011 revenue expenditure
  • 5. Credit default swap rates peaked in March 20091400 5-year, basis points12001000800600400200 0 Jan-08 Mar-08May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10May-10 Jul-10 Sep-10 Nov-10 Jan-11
  • 6. Market interest rates peaked in June 200930 percent per annum2520151050 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 RIGIBOR 3-month RIGIBOR 6-month RIGIBOR 12-month
  • 7. Foreign currency reserves bottomed out June 20096 billions of euros54 4th tranche of IMF loan received 3d tranche of EC3 loan received 1st tranche of WB loan received2 3d tranche of IMF 2nd tranche of IMF loan received loan received 1st tranche of EC1 loan received 2nd tranche of EC loan received0Jan-09 Mar May Jul Sep Nov Jan-10 Mar May Jul Sep
  • 8. Latvia Unemployment, 2008–201225 percent of labor force20151050 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1
  • 9. Structural Reforms• Big, early expenditure cuts drove structural reforms• Dismissed 29% of civil servants• Closed half state agencies• Deregulated & improved governance• Reduced public salaries by 26% & private salaries by 10% in 2009
  • 10. Equity• Maintained social safety net• Cut high salaries more than low ones and social benefits• Increased indirect taxes, property taxes & capital gain taxes• Prohibited double-dipping by senior officials• Action against corruption
  • 11. Latvia: Set for Sound Growth since 2010• Good governance• Competitive costs• Solid export expansion• Fast rising investment
  • 12. Measures: Compare Latvia with PIG• Budget deficit• Public expenditures• Governance• Labor costs
  • 13. Latvia Brought Down Budget Deficit Percent of GDP 0 -2 -4 -6 -8-10-12-14-16-18 2005 2006 2007 2008 2009 2010 2011 2012E Latvia Greece Italy Portugal
  • 14. Latvia: Public Expenditure as % of GDP Moderating55 Percent of GDP5045403530 2005 2006 2007 2008 2009 2010 2011 2012E Latvia Greece Italy Portugal
  • 15. Latvia: Best at Ease of Doing Business Ranking, 2013Lower score indicates greater ease of doing business Latvia Greece Italy Portugal 0102030405060708090
  • 16. Latvia: Sharply Falling Real Unit Labor Cost, 17%, 2008-11110 Index, 2008=100105100 95 90 85 80 2008 2009 2010 2011 Latvia Greece Italy Portugal
  • 17. Outcomes: Compare Latvia with PIG (2)• Export expansion• Investment• Growth• Current Account
  • 18. Rising Exports, Percent Change 2009 - 2012, yoy YOY, Quarterly Statistics 40 30 20Percent Change, yoy 10 0 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 -10 -20 -30 Latvia Greece Italy Portugal
  • 19. Investment Recovering as % of GDP, Greece Just Falling45 Percent of GDP40353025201510 2005 2006 2007 2008 2009 2010 2011 Latvia Greece Italy Portugal
  • 20. GDP Growth 2000-2012: Latvia Superior15 Percent10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E -5-10-15-20 Latvia Greece Italy Portugal
  • 21. Current Account Balance, 2007 & 2011: Latvia quick turn Latvia Greece Italy Portugal 5 Percent of GDP 0 -5-10-15-20-25 2007 2011-30
  • 22. 7 Lessons from Latvia for the World1. Face reality and explain it!2. Take early credible action to restore confidence = measures depend on severity of crisis, 2-3 years3. Early fiscal adjustment preferable4. Better to cut public expenditures (2/3) than to raise taxes
  • 23. 7 Lessons from Latvia for the World5. Let expenditure cuts drive structural reforms6. Make program equitable7. Get sufficient international rescue financing up front, but with conditions
  • 24. Latvia: High Inflation Tamed, Only Brief Deflation18 Average Consumer Prices, Percent Change16141210 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E-2-4 Latvia Greece Italy Portugal