Does Austerity Work? The Case of Latvia

By Shlomo Maital


  Europe’s austerity program (spending cuts to reduce public debt) has been a disaster.  In this blog, I protested that you cannot grow an economy by shrinking it, and austerity shrinks demand and raises unemployment, leading to the need for more austerity, causing more suffering..and so on.   James Estrin, writing in LENS (photography website), documents the suffering austerity is causing in Europe:

    After three years of grinding austerity, the Greek gross domestic product has shrunk by 25 percent. The unemployment rate among young people is now at 50 percent, and over all about one fourth of Greeks are out of work. Ireland has a debt burden of 117 percent of its annual G.D.P. Spain’s unemployment rate is more than 25 percent, and the Portuguese government is predicting a third consecutive year of recession in 2013, with unemployment reaching nearly 16 percent….

   ..and so on. Estrin says the numbers don’t begin to convey the suffering, and the photographs in the LENS website show why.    See:   

    Yet – along comes Latvia, to prove that austerity DOES work.  In today’s Global New York Times, Andrew Higgins reports the following:  “Latvia, feted by fans of austerity as the country-that-can and an example for countries like Greece that can’t, has provided a rare boost to champions of the proposition that pain pays.     Hardship has long been common here — and still is. But in just four years, the country has gone from the European Union’s worst economic disaster zone to a model of what the International Monetary Fund hails as the healing properties of deep budget cuts. Latvia’s economy, after shriveling by more than 20 percent from its peak, grew by about 5 percent last year, making it the best performer in the 27-nation European Union. Its budget deficit is down sharply and exports are soaring.

    Why has austerity worked in Latvia, yet failed in nearly every other European country?  The people of Latvia are simply used to severe hardship. They’ve been through austerity before. They know there is light at the tunnel’s end.  Higgins notes: “Latvia has [endured] Soviet, Nazi and then renewed Soviet rule…After Moscow relinquished control in 1991, decrepit Soviet-era plants shut down, gutting the industrial base. The economy contracted by nearly 50 percent. The collapse of Latvia’s largest bank in 1995 wiped out many people’s savings. Latvia then was hit by debris from Russia’s financial blowout in 1998. Then came a dizzying boom, fueled by a lending splurge by foreign, particularly Swedish, banks, followed by a catastrophic slump as credit froze when the global financial crisis swept into Europe in 2008.”

    Latvia’s currency, the lat, is now pegged to the euro, and Latvia desperately wants to join the euro in 2014. Why? Because having a relatively strong currency is a condition for attracting foreign money, and as weak as it is, the euro is far more reliable than the lat.  Latvia resisted the easy solution (devaluing the lat to spur exports and demand) and accepted short term pain for long term gain.  I wish them great success.

    Latvia is perhaps  the exception that proves the rule (austerity fails).  Morten Hansen, head of the economics department at the Stockholm School of Economics in Riga, says, “You can only do this [austerity] in a country that is willing to take serious pain for some time and has a dramatic flexibility in the labor market,” he said. “The lesson of what Latvia has done is that there is no lesson.”  

    There IS  a lesson, Prof. Hansen.  A condition for austerity should be the willingness of the people to endure severe pain. America lacks it. Greece lacks it.  Most of Europe lacks it.  If you lack this political resilience, better not to start down the austerity road in the first place.