Adjustment in Latvia Post author By Philip Lane Post date May 26, 2009 The NYT provides an interesting profile of the Latvian economy here. Categories In Economic Performance, EMU Tags Latvian economy 4 Comments on Adjustment in Latvia ← Bank Debt Versus Sovereign Debt → A Critique of Irish Economic Policy 4 replies on “Adjustment in Latvia” The risks of social unrest in the Eastern European states is very serious. The European Union must be very wary that people in the East are starting to see the EU way as leading them into financial bondage and insecurity. The EU must further be wary that this is a correct perception. Modern economic systems and techniques require individuals and populations to be supremely adaptable. Where the economic system assumes a greater flexibility than people can or will provide then the economic system must adjust or fail. This problem is particularly acute in the EU which is a bureaucratic polity which has used economic gains to bind its members together while it travels the road to becoming a fully democratic political entity. If economics fail then economic become wholly secondary to politics and chaos ensues until another economic system can gain dominance. This is the alternative to adjustment by the EU. The EU must decide how it will adjust its economic system. The same decision faces other political entities. Protectionism appears inevitable but even protectionism may not save the EU. “Latvia is racing to halve an enormous government budget deficit, now estimated at 12 percent of gross domestic product, even as its economy is expected to contract by 16.5 percent this year” and we are struggling to make a dent in a similar sized mountain “The lat is still with Latvia, however, and so is a colossal problem of how to devalue the currency — the usual adjustment mechanism in a financial crisis — without creating a crushing debt burden. Rather than let the currency decline, the government has chosen what it calls an “internal devaluation,” in which wages are forced downward to restore the economy’s equilibrium.” How exactly is “internal devaluation” (aka deflation) supposed to avoid “creating a crushing debt burden”? More generally I think Zhou makes a great point – ultimately politics trumps economics, or in other words an economic system or theory or policy that “require[s] individuals and populations to be supremely adaptable” is doomed to possibly catastrophic failure. (cf Polanyi, Karl) The recently elected Lithuanian President Dalia Grybauskaite also clearly stated that the devaluation of the national currency is not the option because of at least three reasons: 1. the effects of devaluation are temporary; 2. the devaluation would double the public debt, and 3. it would triple the private debt. The first steps which should be implemented is the discipline of public finances and gradual downward adjustment of wages. There are hundreds of anecdotes about 100% and 200% wage decreases. Also, unemployment is growing at record pace! In these countries you are not going to see the strikes everyday as here in Ireland. Everybody is happy to stay at work even at the significantly lower salary. Comments are closed.