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