Does austerity work? As many Tea Party activists and conservative economists suggest that the solution to America’s economic ills is a large spoonful of the bitter medicine of austerity, it is a question worth asking. A few months of misery may be worth it if the result is strong growth and full employment. First witness for the austerity prosecution is Latvia, for which some extravagant claims are being made. The economy of the former Soviet satellite and current member of the European Union was nose-diving in 2008-9. Now it is growing again.
Latvia’s premier, Valdis Dombrovskis, has written a self-congratulatory book, How Latvia Came through the Financial Crisis, with the help of Anders Aslund of the Peterson Institute, who claims that if America followed the Latvian example we would all be better off. Aslund extrapolates from the Latvian example, “Keynesian thinking has been tested, and it has failed spectacularly.” So what does Latvia’s experience of austerity really tell us? As you might expect, things are not quite as rosy as they are made out to be.
Back in 2008-9, Latvia was at its lowest ebb, losing a fifth of its output in just two years. Its second largest bank went bust, leaving thousands of Latvians without their lives’ savings. Unemployment was above 20 per cent, and 40 per cent among the young. Credit froze and construction, which prior to 2008 was booming thanks to low interest rates, collapsed. In December 2008, the Latvian government won a €7.5 billion bail-out from the IMF, the World Bank, and the EU – worth more than a third quarter of its annual GDP of $28.25 billion – on the condition that it introduce “structural reforms” and a generous, temporary safety net to offset the harsh effects of austerity. The reforms meant slashing public spending from 44 per cent of GDP to 36 per cent and removing legal safeguards from trade unions to reduce labor costs. By early 2009, violent rioting erupted on the streets of the capital, Riga.
As the rest of the world’s economy has slowly stabilized, fed by stimulus measures in the United States and elsewhere, so has Latvia’s. Latvia has bounced back from the dark days of 2009, but there has not been a recovery to pre-2008-9 levels. Instead, GDP has stabilized at a “new normal,” a substantially poorer level than before. And growth is now slowing. Although public spending has been cut, public debt, at 39.1 per cent of GDP, is now much the same as at the depth of the Latvian slump because the economy is much smaller than before. The Latvians are not feeling prosperous. Unemployment last year was a whopping 15.5 percent, the same as the previous year, and long term unemployment is soaring. Taking advantage of the EU’s free market in labor, increasing numbers of Latvians are emigrating to find a job. Inflation is running at 4.6 per cent and rising.
Economics is best understood as a moving picture rather than a snapshot, and the most generous assessment of Latvia’s attempt to dig itself out of the mire suggests that it is too early to say whether austerity has worked. It is certainly not such a clear and unambiguous success that it warrants becoming the model for vast and dynamic economies such as the United States. Latvia is a little larger than West Virginia with a population the size of New Mexico. Its population, or at least its older population, still lives quiescently under the pall left by decades of Soviet, then Nazi, then Soviet occupation. Many of the changes it has made since 2009 are one-off reforms, for example dismantling generous welfare provisions such as retirement at 60, inherited from communism. Its application of the rule of law – a sure sign of whether a country is truly free – is patchy.