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Wednesday, July 29, 2009

Is It Hot In Latvia In August?

Well the big news this morning is that the IMF mission to Latvia has finally reached agreement with the Latvian government on a new policy package that will give the country access to about $278 million in new financing. Details of the deal are scant at the moment, since the Letter of Intent will not be published until the IMF board approves the agreement, but it seems the terms of the IMF deal are (on the face of it) tough: additional budget cuts worth a reported 500 million lats ($1.02 billion) for 2010, a progressive income tax with the possibility of an increase in VAT if the cuts do not reduce the budget deficit to the stipulated level.

Really, this agreement changes very little in my opinion. As Capital Economics' Neil Shearing points out, many people are assuming that with the rapid Current Account adjustment in many CEE countries, the threat to external financial stability has largely gone away. But as Neil argues, while theoretically, it should be enough for the countries just to move back to balance, practical experience from Argentina etc suggests that as recovery arrives the CA tends to move from large deficit to large surplus. And this of course means exports growing at a much faster rate than imports. This is the only practical way to pay down the debt.

And as Afoe's own Claus Vistesen puts it:

This is all about the composition of the external balance and what kind of extensions foreign creditors give. Now, the benefit of the peg is of course that you can begin to accumulate foreign assets at reasonable valuation to your liabilities. HOWEVER, the only way to reasonably begin this process is of course to actually begin accumulating those assets and in order to so so, you need productive investment targeted at foreign operations and this is very difficult unless the "internal devaluation" has run its course. Essentially, domestic investment to serve foreign markets are not productive until deflation has taken its toll.

So basically the message is, whatever the final details of the new agreement, stay tuned and keep watching, since all of this is far from over.

Edward Will Not Be Going To Latvia In August

The little news of the day is that I will not be attending the conference on Latvia's economic future which members of the Peoples Party are trying to organise for August, even though I was invited. As the Latvia Daily Diena (Latvian only I'm afraid) which reports on the preparations for the conference puts it "E. Hugh, who declared himself a defender of the lat devaluation, however, declined to participate, adding he'd like to maintain political neutrality." Well, this is fair enough as a presentation of my opinion, but, just for the record, here's what I actually did say.

First of all I would like to say thank you very much for thinking of me and inviting me to your conference....

....while I think a decision to accept the original IMF proposal of a 15% devaluation of the Lat, and pressure the EU Commission into euro entry was the best option last autumn, this is now no longer the situation. So while I was advocating devaluation back then, what I am saying now is that in my opinion devaluation is inevitable at some point, but that it will now be an unholy mess. Serious contagion problems will most likely ensue, and so in this sense I am no longer "advocating" Latvian devaluation. Ideally it needs to take place as part of a much more general solution to problems in the economies of the Eastern European countries who are members of the EU.

If Latvia is simply forced off the peg, then we should all watch out. I am in Spain, and I am expecting consequences here.

Thirdly, I am not in basic disagreement with the IMF, and would not wish to do anything which may make their work more difficult. Basically, from where I am sitting the issue is to put pressure on the EU institutional structure in an attempt to get them to recognise some of the basic ABCs of economics.

Lastly, I would emphasise that I am an economist, a mere technician of economic systems, and not a politician. I am explicitly non politicial, and am maintaining this stance both vigourously and adamantly.

Basically, as I said, I consider devaluation inevitable..... tomorrow, in August, after Christmas, in 2011, I don't know when. I also know that the longer it is in coming, the more serious the consequences will be, due to the continuous degradation in the credibility of the associated institutions (IMF, ECB, EU Commission, EBRD etc). This is all now quite likely to eventually become (via the other Baltic states, Bulgaria, Hungary, Romania and even Ukraine and Serbia) a very serious problem, with potentially major global implications.

So there will be a before and after. After devaluation there will need to be a major rethink about where Latvia is going. Devaluation is not an end in itself, it is simply a means to an end, a begininning. We also need to think about how Latvia will earn its living, pay off its debts, and find its way in the world.

Long term structural, and strategic economic thinking are needed.

Here I think I do have a part to play. As you may well have noticed, my view is that the ongoing demographic deterioration of your country lies at the heart of your macro economic problems.

I think this deterioration needs to be addressed as soon as possible, and I see three large issue.

i) Productive capacity needs to be increased substantially. This means increasing the labour force, and this means (as outlined in the World Bank Report, From Red To Grey) facilitating large scale inward migration. Given the serious political implications of encouraging ethnic Russian migration into your country, I see only two viable source regions, the Central Asian Republics in the CIS, and Sub. Saharan Africa. Possibly this solution will not be widely popular with Latvian voters. Well, they do have the right to choose. Your country can take the measures needed to become sustainable, or you can watch it die, as the economy shrinks, and the young people leave. That, I think, is your choice.

The other two measures you need to take are contingent on the first being implemented, since without the first measure you will simply not dispose of the economic resources for the other two.

ii) A serious policy to support those Latvian women who do wish to have children. But with major financial advantages, not half measures, and propaganda stunts. You need policies that can work, and I know plenty of demographers with ideas.But this needs money. Important quantities of money. And gender empowerment, right across the economy, at every level. We have formal legal equality in the labour market, but evident biological and reproductive inequality, in that only one of the parties gets to bear the children. The institutional resources of the state need to redress this imbalance.

iii) Major reforms in the health system to address the underlying male life expectancy problem. You can only seriously hope to raise the labour force participation rates at 65 and over if people arrive at these ages in a fundamentally healthy condition. In economic terms, simple investment theory shows why this is the case. A given society spends a given quantity of resources on producing a given number of children, those who have citizens who live and work longer evidently get a better return on their investment. If you want to raise Latvian living standards, you have to raise the life expectancy. And this apart from the evident human issues.

OK, I am saying no for the moment, but I would like to stress that when conditions change, I would be more than willing to come to your country to try to help. But not for a day, for a month, and not to give a talk, but to work with some serious people who are willing to roll their sleeves up and do the serious spadework that will be needed to find those solutions you so badly need.

Basically, my feeling is that the issues you face are so complex that public debate is unlikely to produce a very fruitful outcome at this point. You need a long term education process, and for the time being more or less technocratic solutions, but not the technocratic solutions you are being offered by the EU now (which basically won't work), technocratic solutions which get to the heart of the problem and set your country on a sustainable path.


Vitalijus said...

Yours is an admirable position, Edward. You have hit on the issue that is faced to a greater or lesser degree by all post-soviet east block states and you are suggesting broad solutions supported by a logical presentation of the issues. The residents of these states sought and continue to seek material well-being at the expense of a viable demographic - and they chose that option from the very beginning. The central solution is clear. To cut and paste one of your paragraphs –

The institutional resources of the state need to support those Latvian women who do wish to have children with major financial advantages and policies that can work.

No kids – no nation – end of story. They need to do it now. It’s not rocket science, and it applies not just to Latvians – but also to the Baltic states in general. The time to begin was independence, but it is never too late to make the commitment. The inbred political class, which remains predominant in these states, has virtually guaranteed the economic flight of the very individuals necessary to sustain these nations. It’s something akin to an autoimmune disorder. If they ultimately survive as something other than a grab bag of unrelated economic migrants just passing through to the states of old Europe and North America depends on the ability and success of the citizenry in castrating oligarchic politics. One hopes they are up to the task, but the view from here on the ground is rather ominous.

Anonymous said...

How inward migration is going to increase productivity ?
Young latvians are leaving because there are no jobs, and with inward migration there will be even less available jobs. Incompentence of local business "leaders", low investments per capita, is source of problem, and influx of imigrant labor are only going to make it worse, decreasing per capita investment, depressing wages and allowing "businessman" to continue use labor inefficiently.
Only imigrants that Latvia needs, are people knowing how to run bussiness, increase productivity.

Edward Hugh said...

"How inward migration is going to increase productivity ?"

Hello Anonymous,

I think you are presenting a widely held argument which is based on a misunderstanding.

The key question is who is going to clean the public toilets in Latvia, wash the elderly who are unable to care for themselves, and dig the holes in the road.

As I understand your view you want educated Africans, Moroccans and Indians to come to your country and oversee Latvians while they carry out such tasks.

I think this is a mistake, and will only foment xenopohbia.

I think the way to raise productivity in Latvia is to better leverage your few young people by educating them, and putting them to oversee unskilled Africans, Indians, Moroccans etc while they do these jobs, or assemble TV sets and mobile phones in factories.

Basically, beggars can't be choosers. Your country is bankrupt, and probably going to need to default on its debt. Also, with so many people working outside the formal system, or declaring only part of their income, your pension system is going to be totally unsustainable.

And with citizens who don't want to pay tax, your pensions will have to be low, which means your prices and wages will have to be low too, and you will never close the income gap.

Maybe you would not like your country to become as prosperous as the UK or the United States, where despite the fact they are just as able to get into a housing market mess as you are, can eventually get out of it, since they have societies based on inward migration where the migrants and the children will eventually buy up all those extra houses.

Without migrants your housing market will never recover, as your talented young people are steadily forced to leave.

Without an open attitude to migrants and an effective diversity policy the United States would never have had Barak Obama as president, or Sonia Sotomayor as a judge on the Supreme Court, and Arun Sarin would never have become CEO of Vodaphone in the UK.

Basically, this whole issue is about economic growth, about whether you want it or not. If you don't grow your economy, even by having some relatively lower value activities like in the UK and Germany, then you will never be able to pay for the dependent elderly, and you simply don't have enough people to get economic growth without migrants.

So come on, let's be honest. If you have a bankrupt country, where migrants are mnot welcome, and most people don't want to pay income tax, isn't it better to be honest about this, start shutting up shop now, and advise your young people to leave now, for a better life elsewhere. If this is going to be the attitude, and my son were in Latvia, I think I know what I would be telling him.

Fortunately, I am not convinced the views you express really represent the aspirations of the Latvian people once all the issues are adequately explained to them. This is why I am still fighting.

Anonymous said...

Considering low numbers, due to global demand, of skilled people coming, filing upper managament position with them is not problem.
What are latvians leaving doing ?
Exaclty that, working in low skill jobs, while being overseen by foreigner.
So it is match better to bring 1 manager here, to oversee 100ds of locals, than cause them leaving, as local management is unable to use their labor. Then taxes are paid here.
I know, im working in such job for last 4 years, where lots of locals are managed by one foreigner, in this crisis only layoffs we had so far, were in support functions.
As for eldery, every state pension system is big ponzi scheme, that will collapse anyway, as they all are built on assumption of ongoing exponetial economic growth, that is impossible, as carrying capacity of any territory is limited.
As nobody is willing to pay taxes to support other people's parents an state middleman, state should announce, that eldery is reposibility of their children, with gradual elimination of pensions and related taxes.
This will also provide incentives for demographic growth, as people will know, that children are in fact long term investment, as noone else will support them later.

Mary Stokes said...

Hi Edward,

I agree with your opinion that a Latvian devaluation is almost inevitable at this point. Where I differ with you is on the fallout from contagion effects.

I think it's generally agreed that a Latvian devaluation would have very serious consequences for Estonia and Lithuania and would lead to a concentrated spike in non-performing loans, which would weigh on Swedish banks.

However, I think that the longer Latvia can avoid devaluation, the more likely that the contagion effects on other CEE countries will be minimized. For example, Poland's economic health looks like it has stabilized, and the FCL it signed with the IMF will help insulate the region's biggest economy from contagion.

Edward Hugh said...

Hello Mary,

I hope you are having a good holiday. Yes, I think the thing about local contagion and the Swedish banks is more or less common ground among everyone at this point.

And I also agree that Poland is - at this point - stable, and doesn't seem to be headed for imminent trouble. The thing is, the Polish economy is the only one (including Slovakia and Slovenia) in this comfortable position. The next strongest economy - the Czech Republic (and incidentally both these countries are where they are in part because they retained some semblance of independent monetary policy) - is totally export dependent, and will therefore need to wait for recovery in Germany to come off the sick list.

Unfortuantely, I think recovery in the key German economy (which again is completely export dependent) is still some considerable way off, and difficult days lie ahead.

I also think that ex Poland and the CR the crisis in the CEE (including all the rest of the region, Ukraine, Russia, SE Europe etc) is still very severe, and as unemployment rises the NPLs will simply continue to pile up.

Then we have the South of Europe, and I am expecting major issues in at least Spain and Greece in 2010/2011. So really I can't go along with you. When Latvia devalues it will be devaluing into a greatly weakened European economic panorama, with the credibility of the European Commission and the ECB seriously undermined by all the silly policy decisions taken so far.

sidney sloth said...

Hello Edward,

Thanks for your comments, I really like the blog. I find your analyses wonderfully transparent and sincere. You are one of the very few economists who tries to write clearly, rather than trying to impress folks with big, unnecessary words.

I am a corporate tax lawyer living in Switzerland, so I know absolutely nothing about economics, but I am married to a Lithuanian, and I go to the baltic states every few months.

I have extensive conversation with local government leaders, which is to say that I listen to their ideas. There is not much point in me talking to them, because they do not understand what I say. Conceptually, my understanding of business is heresy to them.

If you are interested, this is what I have seen (insofar as it relates to your advice to Latvians):

1. The need to import cheap labour from Central Asia, Africa or Russia.

My eyes nearly popped out of my head!! You may be economically correct about the need for increased labour, but you could never have proposed a more impossible scenario if you tried! Of course, I am aware that you understand this, from your comments, but let us be clear, this is just never going to happen.

I cannot imagine being a negro in the baltic states, nor a brown skinned muslim. It would be risking violent death just to venture outside at night. Or in broad daylight. I know Lithuanians who hate negros with a violent passion, and they have never even seen one!!

Anyway, what language are these people going to speak? Latvian???? OK. So you are proposing that a bunch of folks come to Latvia and work in a massively intolerant and violent racist culture, and learn a language that is of ABSOLUTELY ZERO ECONOMIC BENEFIT to them.

Even if they are willing to do it to themselves, good luck finding anyone who will destroy the future of their child by forcing them to learn Latvian.

I think, if I were african, that I would rather pick up a rifle or a stick and fight for power as a revolutionary than go to latvia as you suggest. There are worse things than death, and being a negro in latvia is clearly one of them.

sidney sloth said...

part 2

Next, you say that Russian immigration is politically bad for Latvia.

I think you need to seriously rephrase that. It would be politically a godsend for LATVIA, but it would be the stone cold end of the private fortunes built up by utterly corrupt hyper nationalistic Latvian politicians.

Let us be real. Latvia has been economically raped by criminals dressed up as patriots. Politicians in the baltic states have played the "blame russia" game for all it is worth, and it has made them rich, and their countries poor. Right now, Latvia and Lithuania are pretending that they have good relations with Russia.

Now I know some Russian diplomats in Zurich, and they smile in a very evil way when I ask about the future of the baltic states. Their view is that Russia is big enough to withstand childish provocation from tiny little neighbours, and then they ask me, "But do you think Russian voters will tolerate politicians who do not strike back economically?"

In short, Latvian politicians have made an enemy of Russian people, in order to stir up patriotic feeling and the votes that brings. In doing so, they have given Russian politicians a massive stick with which to beat their economy. Every time a Russian politician is in trouble at the poles, all he has to do is blame the Latvian "fascists", and propose an economically harmful strategy to restore Russian pride.

And anyone who thinks other states like the USA or Germany are going to harm their own economic relations with Russia by sticking up for poor little Latvia is an absolute fool. Even the hyper nationalistic lithuanians I know (my mother in law was sent to the siberian gulags by Stalin, so I've met a few) are beginning to understand that picking a fight with the Russian bear was a very, very stupid thing to have done.

Latvia has done this to such a very great extent that it is likely Russia will be beating them up economically for decades to come, partly for the fun of it, and partly to set an example to other small neighbours. Latvia is now the economic punching bag for Russians who are upset with the world.

THAT is the result of "Latvian politics", which you so casually suggest might be harmed if Russians are encouraged to emigrate.

So don't drink the kool aid, Edward. The hard reality is that Latvia cannot recover unless it repairs relations with Russia. You know it, I know it, and Russia knows it.

This talk about importing Africans is childish nonsense.

Furthermore, if and when Latvia decides to make peace with Russia, they are going to have to solve the other fundamental economic restraint on their nation: the language.

We all would like to make benefit glorious nation of Latvia, but be honest: Do you want YOUR children to learn a language that is spoken by so few people in such a hamstrung economy?

No, and neither does anyone else.

Even my wife, who loves the Lithuanian language dearly, has made the decision that our children will not be learning lithuanian. They will speak to their relatives in Russian, if at all.

That sounds harsh, but for us, living in the modern world of Switzerland, we are faced with a stark choice: Do we do what is right for our children, what is right for make benefit glorious nation of Lithuania?

We want our children to have the best chances in life. We want them to speak English, and to learn mathematics. We know our children will need to understand chemistry, and physics. We just can't justify forcing them to learn a language that nobody speaks. It is simply too much of the available school curriculum thrown away for the sake of mindless patriotism.

And if you think this is all a bit hard on Lithuania, you are right.

But i would rather be hard on Lithuania than on my children.

So in my view these baltic economies are simply unsustainable if their governments insist on forcing parents to compromise if they want the best chances for their children.

sidney sloth said...

part 3

Lastly, there is the issue of corruption, and hyper nationalism, and how these things affect business growth.

For the first few months of my relationship with my wife, before I went to the baltic states, I had visions of going to these grand new capitalist societies and starting a business there, free of the high taxes and stupid regulations of western Europe.

One day. One day was all it took to make me understand that a foreigner doing honest business in the baltic states is a fool and a sucker who will be robbed blind by everyone, most especially the government.

Until the corruption is addressed, the baltic states are a killing zone for foreign investment. That is a fact, and right now the western media refuse to admit it. Maybe they don't know.

Well, the Swedish banks are about to take a massive bath in the east, unless the EU bails them out. And if that happens, the result will be the same.

The word is out, in the financial circles of Europe: Go invest money in the baltic states if you can think of no other way to lose it.

Anyway,I have probably offended everyone from Talin to Warsaw, and beyond, so I will stop right there.

I know it doesn't sound like it, but I like the baltic folks, and wish them all the best.

But their governments...... these people are poison for the rest. Absolute poison. If they people are serious about change, they need to publicly name every registered member of the political parties that have overseen the policies so far, and investigate each and every one for fraud, racketeering and theft.

I have never met a more brazen criminal class of people than the politicians I know from the baltic states.

Edward Hugh said...

Hello Sidney Sloth,

Well, as the saying goes, I may not agree with your arguments, but I'll fight to the death for your right to advance them.

Although I would put none of the points in the strong way you do, there are some things I agree with, and somes I don't

a) Corruption is obviously a problem. I also think whenever you find a patriot, you need to ask whether there lies a knave below the flag they are wrapped in.

And I say this as a self-adopted Catalan, and someone who is proud of my new identity and language.

Basically, when I meet a frenchman I am inclined to say (in French), Monsieur, I speak two languages, one which is apparently too large for your taste, and one which is evidently too small.

Obviously, as we can see in Portugal, or Sweden, Norway and Denmark, having a small country with a small language is not an impediment to using English, and not an impediment to success with exports. Basically I personally prefer small countries, and tend to feel that the ones who have the real problem in Europe are Germany, France and Italy, since they now have little global reach in terms of their own language, yet there is a large resisitance to the use of English, Spanish or Chinese for a variety of reasons.

In Spain very little English is spoken by the local population, but they do have Latin America to sell to.

On racism, I am sure you have a strong point. I am simply pointing out the changes people need to make if they want to have a country 30 years from now. It may be very heartwarming everyone meeting in a field and singing their hearts out - especially if you have no money for heating in winter - but some of the facts of this life need to be faced up to.

I have nothing whatever against Russophone migrants, in the Baltics, in Spain, or in Ireland wherever. But I am aware that here in Catalonia, the reception to new migrants from Morocco, Senegal or Ecuador tends to be more positive to migrants coming from greater Spain, and this for historic reasons.

What I am really trying to get at is that all this argument about only wanting skilled migrants is silly, since someone has to do the menial work, and it is sort of shooting yourself in the foot to offer your own children for that while trying to attract migrants for the well paid jobs.

On Russia itself, I am nothing like as optimistic as you are. You will have noticed that a lot of my argument is posited on demographic dynamics, and these in Russia are horrible.

Thus I see it hard for Russia to escape from the "Rogue State" stereotype, I don't see democracy any time soon, and I do see problems coming in the future both for those in the Baltics and for us in more westerly parts of Europe.

But then again, maybe some Baltic citizens have views they would like to express on all the above.