LATVIA: LOOKING AHEAD –

THE REMAINING CHALLENGES

Agnese Bukovska, Mark Griffiths, and Bertrand Gruss

International Monetary Fund

Riga - June 5, 2012

Fiscal adjustment

Recovery

Low interest rates

Current account deficit shrinks

Low inflation

A. Many Successes (Session I)

2

A. Joining the Euro

B. Ensuring sustainable growth

C. Making growth inclusive

Three Challenges

3

A. Joining the Euro

B. Ensuring sustainable growth

C. Making growth inclusive

Three Challenges

4

B. Sustainable Growth – Why Important?

(1) Income Levels Low 5

0

20

40

60

80

100

120

140

BG

R

O

Latv

ia

LT

PL

EE

HU

SK

C

Z

PT

MT

SI

GR

C

Y

ES

EU

IT

Eu

ro

FR

U

K

FI

DE

BE

SE

AT

IE

DK

N

L

GDP per capita (2010, PPS, percent of EU27)

Sources: Eurostat

B. Sustainable Growth – Why Important?

(2) Current Account and Competitiveness 6

1997

1998

1999

2000

2001 2002

2003

2004 2005

2006 2007

2008

2009

2010

2011

y = -0.7598x - 4.8226

-25

-20

-15

-10

-5

0

5

10

15

-20 -15 -10 -5 0 5 10 15 Cu

rren

t acco

un

t b

ala

nce (

% o

f G

DP

)

Real GDP growth (%)

Latvia - Growth and Current Account Balance (1997-2011)

B. Sustainable Growth – What is Needed?

(1) More Investment in Tradable Sector 7

0

5

10

15

20

25

30

35

40

45

50

RS SI Latvia RO LT PL BA MK AL SK CZ HR HU EE BG

FDI in the Tradable Sectors FDI in the Nontradable Sectors

Foreign Direct Investment (Stock/GDP, 2007)

Sources: Kinoshita (2011), IMF WP/11/123

B. Sustainable Growth – What is Needed?

(2) Structural Reforms to Boost Competitiveness 8

Areas of structural reforms:

Rule of Law / Business Environment

Stronger Product Market Competition

Improving Tax Administration

B. Structural Reforms

Weak Rule of Law Deters Investment 9

1

2

3

4

5

6

7

Property rights

Efficiency of legal framework in

settling disputes

Transparency of government policy

making

Ethics and Corruption

Favoritism in decisions of government

officials

Institutional Framework(GCI scores 1 to 7=best)

Latvia EU27

OECD Nordic

Sources: Global Competitiveness Report, WEF

B. Structural Reforms

Weak Product Market Competition… 10

3.0

3.5

4.0

4.5

5.0

5.5

CEE LT Latvia EU27 OECD EE US Nordic Japan Asian

Tigers

Goods market efficiency (GCI 6th pillar, 1 to 7=best)

Sources: Global Competitiveness Report, WEF

B. Structural Reforms

…Worsens Price Competitiveness 11

BG

RO

Latvia

Lithuania

PL

Estonia

HU SK

CZ

PT

MT SI

GR

CY

ES EU

IT Euro FR

UK

FI

DE

BE

SE

AT

IE

DK

NL

y = 0.4889x + 48.546 R² = 0.945

40

60

80

100

120

140

160

20 40 60 80 100 120 140 160 180

Pri

ce level

(EU

-27=

100)

GDP per capita (EU-27=100)

Income and Price Level (2010)

Sources: Eurostat

Three Challenges

12

A. Joining the Euro

B. Achieving sustainable growth

C. Making growth inclusive

C. Why Inclusive Growth?

High Rates of Poverty and High Inequality 13

AT

BE

BG

CY

CZ

DE DK Estonia

ES EU

Euro

FI FR

GR

HU IE

IT

Latvia

Lithuania

LU

MT

NL

PL

PT

RO

SE

SI SK

UK

10

20

30

40

50

3 4 5 6 7 8

Sh

are

of

po

pu

lati

on

at

risk

of

po

vert

y o

r so

c. e

xclu

sio

n

Income inequality (the S20/S80 decile ratio)

Latvia - Poverty and Inequality Levels Are High (2010)

Sources: Eurostat

C. Why Inclusive Growth?

High Unemployment Rates 14

EU27

0

5

10

15

20

25

Q1 2002 Q1 2004 Q1 2006 Q1 2008 Q1 2010

Latvia Estonia Lithuania

Unemployment

(in percent of active population, seasonally adjusted)

Sources: Haver Analytics

C. Why Inclusive Growth?

Employment Still Well Below Pre-Crisis Level 15

-200 -150 -100 -50 0 50

Total

Construction

Manufacturing

Other

Public administration and defence

Agriculture

Financial intermediation

Latvia - Change in Employment 2007Q4-2011Q4(Thousand of people)

Sources: CBS

C. Why Inclusive Growth?

Middle-Aged Unemployment High in Baltics 16

0

2

4

6

8

10

12

14

Latvia EE LT EU27

15-24 25-49 50-59

Unemployment-Population Ratio(Percent by age group, Q4 2011)

Sources: Haver Analytics

C. Policies for Inclusive Growth:

(1) Reduce Labour Tax Wedge (Low Income) 17

0

5

10

15

20

25

30

35

40

45

50

MT

IE

LU

UK

B

G

PT

PL

NL

GR

SK

FI

ES

DK

SI

EE

LT

CZ

EU

SE

Eu

ro

RO

A

T

Latv

ia

IT

HU

D

E

FR

B

E

Sw

itze

rla…

U

S

Jap

an

Tax wedge, single person without children (67% of average wage, 2010)

Sources: Eurostat

C. Policies for Inclusive Growth:

(2) Enhance Active Labour Market Policies 18

0

1,000

2,000

3,000

4,000

5,000

6,000

RO

MT

UK EE

Latv

ia LT SK

BG

CZ

HU SI

GR PL IT CY

ES

EU

Eu

ro PT IE DE

SE

AT FI

FR

LU NL

DK

BE

Spending on Active Labor Market Policies (AMLP) (PPS per person wanting to work, 2009)

Sources: Eurostat

C. Policies for Inclusive Growth:

(3) Increase Spending on Social Protection 19

10

15

20

25

30

35

10

15

20

25

30

35

Latv

iaB

GR

O SK EE

PL

MT

CZ

CY LT LU HU SI

ES

PT IE

GR

UK

EU IT BE

Eu

ro FI

NL

AT

DE

SE

FR

DK

Sources: Eurostat

Spending on Social Protection Benefits(Percent of GDP, 2009)

EU-27

C. Policies for Inclusive Growth:

(4) Improve Education 20

460

470

480

490

500

510

520

530

540

550

560

FI

NL

EE

DE

BE SI

UK PL IE

DK

OEC

D a

ve

HU

CZ

FR

EU

ave

SE

AT

SK

PT

Latv

ia IT LT

ESP

LU GR

Average scale scores, PISA(Average science, mathematics, reading; 2009)

Sources: OECD

Conclusion

21

Latvia’s “Mission Impossible” is over: well done!

Challenges remain:

Responsible macro / joining the Euro

Structural reforms for competitiveness and

sustainable growth

Reducing unemployment and inequality to

make growth more inclusive