The Latvian Economy

Something is afoot in Latvia. According to the latest Eurostat data on annual wage costs, in the first quarter of 2007 wages in Latvia were up by an astonishing 32.7% when compared with the first quarter of 2006 (for a simple graph of the course of Latvian wages since 2001 try this) . Without knowing anything more about Latvia it is obvious that something important is happening here, and that the situation as it stands is clearly unsustainable.

And it isn’t only wages that seem to be spiraling out of control. Consumer price inflation has been steadily increasing, and now runs at an annual rate of around 9% (graph here), while the current account deficit (currently around 25% of GDP, chart here, graph here, also see the chart comparing Latvia with the other EU8 countries here) has also shot up, while domestic consumption is rocketing, fueled by an inward flow of bank funds and remittances (see table) and this rapid growth in domestic consumption is producing an upward spiral in house prices (see graph) – Latvia (Riga) was number one in the most recent Knight Frank global housing index at a staggering annual increase rate of 62.1% – and this spiral may well constitute a bubble.

Worse, 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, and guess what, despite all the protests from the Economist that demographic changes don’t have important visible economic impacts, the key to the Latvian problem is a demographic one: essentially they are running out of people. Running out of people that is if they wish to sustain their current high levels of economic growth and experience “catch up” growth to bring their living standards alongside those of their Western European EU neighbours. A simple example should suffice: during 2006 Latvian employment was increasing at an annual rate of around 70,000, but if we look for a moment at live births – see chart – we will see that since the early 1990s Latvia has been producing children at an annual rate of under 40,000 and that by 2006 this number is down to 21,000.

What follows below the fold are a series of observations and policy proposals which are based on a much more extensive economic analysis I carried out for Global Economy Matters, which can be found here.

Meantime Latvian Prime Minister Aigars Kalvitis seems to have come up with his own solution:

Prime Minister Aigars Kalvitis, speaking in a radio interview over the weekend, appealed to Latvians to do their part in bringing down inflation and stop spending so much money. Kalvitis asked Latvians to be more thoughtful about borrowing money to buy big-ticket items, warning them that the future generation may be forced to foot the bill. Continue reading

Go West Young Man

My preocupations about the impact of demographic change on German society are already pretty well known. Well if Germany as a whole has a sizeable problem, the former East German Lande have a huge one. The state-owned KfW development bank project in a report out today (German only unfortunately, an English version of the press release is here) that the while the population of the old West Germany will drop by six percent between 2002 and 2050, that of the six eastern states will decline by a whopping 25%. Not to mention the fact that those who remain are likely to be even older on average than their Western counterparts. As a consequence the available workforce is likely to fall by a staggering 55%.

The issues raised by this research are large and important. Is, for example, East Germany now in irreversible decline? Can this process repeat itself elsewhere (including between rather than within nation states) as younger, more highly skilled and more mobile workers leave ageing and relatively more depressed areas etc?

The issue of migration from East to West Germany been receiving attention for some time now. Frank Heiland in a survey “Trends in East-West German Migration from 1989 to 2002” (follow the link and go to Volume 11 article 7) argues that there have been two waves of East-West migration The first one, 1989-1990, was triggered by the opportunities and uncertainties before the Reunification; the second one, since 1997, coincides with economic stagnation in the East and improving job prospects in the West.
Continue reading