The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Departmentby Mārtiņš Kazāks and Dainis Stikuts No. 4 • 20 May 2011Demographics – can one see a forest behind the trees? • The rebound effect of Latvian economic growth gets weaker. Future growth will increasingly depend on the economy’s fundamental strength, i.e., the ability of businesses to invest and export, as well as the ability of households to spend. Surprisingly, the weak economic growth in the first quarter of this year clearly shows a need to continue structural reforms. • Negative demographic tendencies are becoming an increasingly important challenge – they place an additional burden on the government budget and undermine economic growth. Moreover, this is not an abstract future question – the negative influence of this risk can be felt already now. When developing and implementing structural reforms, it is necessary to take into consideration demographic tendencies, both regarding the sustainability of social and pension systems and the effectiveness of regional administrative reform. critically low levels and need to renew them whenSlower-than-expected growth in the first recession comes to an end. This has provided aquarter of 2011 short-term support to economic growth. With thisAccording to a flash estimate by the CSBL, Latvian effect fading away, the economy can rely only onseasonally adjusted GDP increased by 0.2% the ability of businesses to invest and export, asquarter -on quarter in the first quarter of 2011. The well as the ability of household to spend. Domesticaverage quarterly increase last year was 0.9%, demand is still weak, while the growth of the smaller 1implying quite a rapid deceleration of growth this exporting sector is not able to compensate for theyear. Furthermore, Latvian economic growth is vanishing rebound effect. Furthermore, tax hikes insignificantly falling behind that of its neighbours – the beginning of this year are putting additionalEstonian GDP grew by 8% in annual terms (2.1% pressure on private consumption.quarterly growth) and the, Lithuanian economy by To conclude, the economy continues to recover6.9% (3.5%), while Latvia’s grew only by 3.4% from the recession and growth is expected to(0.2%). Last year, the average quarterly growth in accelerate somewhat in the second quarter of 2011Estonia and Lithuania was also stronger (1.7% and due to investments picking up. However, the need1.1%, respectively) than that of Latvia (0.9%). to implement reforms has not disappeared. TheThere are several factors that may explain this delay of qualitative structural reforms (tax policy,difference; for instance, the euro introduction and diminishing grey economy, improving quality andbetter fiscal situation in Estonia, the smaller effectiveness of higher education, etc.) would implyleverage in Lithuania (at the end of last year, slower and more volatile economic growth, fewerhousehold and corporate credit stock was 94% of jobs created, larger emigration, smaller pensions,GDP in Latvia and only 59% in Lithuania). However, and fewer resources for health care and education.it still does not change the conclusion that Latvia is Even if the revised GDP figures in June showfalling behind in the competition for improving the stronger first-quarter growth (e.g., adjusting theliving standards of inhabitants. effect of tax hikes and changes in the VATAlthough detailed GDP data will be published only drawback procedure to accrual basis), theon June 9, leading indicators suggest that thedeceleration of growth has been partly due to the 1 See a more detailed overview of manufacturing and exportrebound effect’s gradually vanishing, while developments in recent Swedbank Analysis, “Recenteconomic fundamentals are still quite weak. During manufacturing trends in Latvia – are there reasons to worry?”,the crisis, businesses reduce their inventories to May 2011. Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000. E-mail: firstname.lastname@example.org www.swedbank.com Legally responsible publisher: Cecilia Hermansson, +46 8 5859 7720. Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 4 • 20 May 2011conclusion will not change: back to work, the rest is living standards, so that inhabitants staynot deserved yet! economically active longer and are less dependent on the government budget, while emigrants returnThe challenge of demographics to Latvia.Negative demographic tendencies are becoming an Population in working age (15-74 yrs old)increasingly important challenge for the Latvianeconomy. During the last 20 years, the average age 80 2.0of inhabitants rose from 36 to 40 years. If the fertilityrate does not improve and/or immigration does not 78 1.9increase, this tendency will continue. In 2008, theshare of the population in the working age (15-74 76years old) peaked at 79.1% of the total population; 1.8during the next two years, it decreased by 0.3 74percentage point. The true situation is likely to beworse, as emigration flows increased during the 1.7recession (especially for those in the working age), 72 2which are underestimated by official statistics. 70 1.6Population age structure, thousand persons 1990 1995 2000 2005 2010 100+ Share in total population Number of persons, million Source: CSBL 90 In this newsletter, we will point to two areas where in our opinion the demographic aspects have not 80 been sufficiently discussed. The first one is the sustainability of the current pension and social 70 security system. With the employment rate (i.e., the share of taxpayers) diminishing, the existing 60 pension system will not be able to sustain the currently rather high ratio of average pension to 50 monthly average net wage (about 66% last year). 40 Although employment will grow in the nearest future and the share of employed in the private sector of 30 the total number of inhabitants is likely to increase, demographic tendencies suggest that in the long 20 term this share will decrease. This implies that someone employed in the private sector will need to 10 support more employed in the public sector, pensioners, children, and other dependents. 0 50 40 30 20 10 10 20 30 40 50 Employment and pension/net wage ratio, % 1990 2010 2050 forecast 35 80 Sources: CSBL, Eurostat forecastContinuously high unemployment (a job-seekers’ 30 70rate of 16.9% in the fourth quarter of last year) andslow job creation provide incentives to emigrate, 25 60undermining the economic growth potential. Thedeclining share of taxpayers in the total populationis putting an additional burden on the government 20 50budget. The long-term challenges are to increasethe fertility rate, reduce emigration, and improve 15 40 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 102 Hired workers in the private sector, % of population E.g., according to the CSBL, 10,700 persons emigrated from Average pension / average net monthly wage (rs)Latvia last year (net outflow of 7.9 thousand), while other Source: CSBLindirect estimates point to tens of thousands of people movingabroad. The currently occurring Population Census is expectedto shed more light on the actual number of emigrated. 2 (3)
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 4 • 20 May 2011 Employment and productivity in agriculture and fishing (2010) 400 40 300 30 200 20 100 10 0 0 RO PL LV LT BG SI PT EE GR C Z HU AT CY SK IE ES IT DE LU UK BE FI NL FR DK SE Productivity in the sector, % of EU average Employed in the sector, % of total employment (rs) Source: EurostatIn order to maintain the current pension/net wage It is expected that, with the agriculture sectorratio in times when the number of taxpayers developing (small farms disappearing ordeclines, taxes might be increased. However, by consolidating into bigger ones), it will become moreincreasing taxes the motivation to emigrate or move productive and less labour intensive, naturallyto the grey economy increases – this solution leads resulting in the migration of inhabitants (especiallynowhere. youth) from rural areas to regional centres. If the demand for this labour is not there, these peopleConsequently, a decline in the pension/ net wage are likely to emigrate, worsening demographicproportion (implying lower living standards for tendencies. In order to proactively lower these risks,pensioners) is inevitable. This can happen either in one of the possible solutions is to develop athe current way, i.e., not indexing pensions and regional development policy that promotes a higherbenefits due to inflation, or in a more appropriate concentration of labour and financial resources thanway to our mind, i.e., evaluating the validity of currently. It is necessary to continue with regionaladditional pension supplements for different income administrative reform, significantly reducing thegroups, assigning social benefits according to the number of municipalities, in order to be able torecipient income level, and strengthening the increase the critical mass of resources, attractingmotivation of the social benefit system’s participants investments and creating jobs.to become employed (e.g., requiring unemploymentbenefit recipients to participate in public works).The second area that has not been sufficiently Mārtiņš Kazāksdiscussed is regional development. For instance, Dainis Stikutslabour productivity in Latvia’s agricultural sector islower than in other European countries –productivity is lower only in Rumania and Poland.This outcome can be interpreted in the followingway – currently there are too many people workingin agriculture and thus their incomes are quite low.SwedbankEconomic Research DepartmentSwedbank AB. SE-105 34 Stockholm. Swedbank’s monthly newsletter is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported inLegally responsible publisher this publication. However, we cannot guarantee the accuracy or completeness of the reportCecilia Hermansson, +46 8 5859 7720 and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages,Martiņš Kazāks, +371 6744 5859 direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter.Dainis Stikuts, +371 6744 5844Lija Strašuna, +371 6744 5875 3 (3)