Convergence ® divergence (40)
Autors: Mortens Hansens
Publicēts: 2009. gada 3. decembris 21:23
Atslēgvārdi: , , , , , .
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Prior to 2007 Latvia’s economy enjoyed several years of convergence i.e. catching up with the average income level per person of the European Union.  These calculations are made by Eurostat and describes a country’s income per capita via GDP per capita but evaluated at a common set of prices i.e. at so-called purchasing power standards.

In 2008 the level of income in Latvia per person was about 55% of the EU27 average. Due to higher growth in Latvia than in the EU as an average up to 2007 Latvia was closing the income gap.

It also created some rather hubristic visions here of how fast Latvia would indeed do a full catch-up, but they never had any realism attached to them.

Why not?

The annual development of GDP per capita is typically slow. Austria may grow two percent, the Netherlands three but it does not make much difference in one year – but if it accumulates, it will.

The case is, however, that the accumulated difference almost never happens.

The countries which were in the top some 5, 10 or 15 years ago are still there. The countries that were at the bottom of income per capita remain there.

Convergence just does not take place. Or, I should say,  full convergence does not take place.

The case which is often quoted is Portugal.

In the late 1990s Portugal was admitted to the eurozone. It lowered otherwise high Portuguese interest rates to the German level.  This created a credit boom in Portugal, which led to a property boom and a consumption binge. It was also inflationary and with time hurt competitiveness.

As the boom fizzled out Portugal was left somewhat uncompetitive and with overleveraged borrowers who could not help sustain growth. The result was a long period of slow growth (still going on) and did not lead to any convergence.

In 1997 Portugal’s income per capita was 76.1% of the EU27 average. In 2008 it was 75.5 and Portugal is firmly entrenched as the poorest of the “old” EU members.

The somewhat scary part of the “Portuguese scenario” is that it sounds very familiar. It was essentially what happened here, too – a demand-driven boom with scant attention to development of the supply side i.e. of the economy’s capacity to produce.

Will Latvia end up in the “Portuguese trap”?

Certainly, convergence has now turned into divergence (the numbers in the graph for 2009 and 2010 are my own calculations based on projections for Latvia and for the EU as a whole).

One may (and I think it is correct) view some of this downwards movement as a correction of a “convergence mirage”. Due to the massive overheating of the economy in the fat years Latvia created “too high” levels of GDP or, in other words, unsustainably high levels of GDP.

Having now fixed the budget for 2010 and created a bit of breathing space (but a 2011 budget is also looming…) there should be time to ponder the following question:  why is Latvia so relatively poor (now only ahead of Bulgaria and Romania in the EU) and can it escape from the “Portuguese trap”? Or is the country doomed forever to GDP per capita levels at the low end of the EU?

Some of the answers to these questions may be known but certainly not all the answers are so obvious.

Allow me to follow up on this in the next few blogs.

Morten Hansen is Head of Economics Department, Stockholm School of Economics in Riga

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Komentāri

Glad to see you here, Morten!

Great blog! I am really pleased to see You blogging here, keep it up! :)

As for “several Years of convergence” that Latvia enjoyed, I think this is one of those spots where GDP (or GDP/capita for that matter) tell much less than full story (I assume that in graph and article income/capita was meant GDP/capita)

It is of course true, that disposable income of people in Latvia went up rapidly (on avrage, more for some, less for others, but that’s another story), however, it is not really that hard to feel rich (and be rich in short run), if You, for example, borrow large sum of money in bank. You can spend more money (and other people can produce goods&services for You to spend money on, which to some level is a good thing) and You can feel like You have “converged” with those rich guys, who drive around in their Hammers and are upper class in general. However, when bank stops lending You and asks their loan back, it all turns around extremely rapidly.

This is to make a point, that much better measure for convergence would be something like net income (income-debt) per capita. And I guess a good arguement could be made to take both households and public (most of it) debt for this measure, as public debt in the essence is just future taxes due to houeshelds.

Of course, this should be clear to You and people with some economic knowledge, but it annoys me quite a bit when I see economic articles (mostly in past years here in Latvia) about convergence, basing conclusions (like “We are converging! We will reach EU average in 5 years! We are Rich! Buy, Buy, Buy!”) on gdp per capita graphs. Maybe I am misunderstanding it, and gdp/capita is really better convergence measure than some other, which would take debt (at least purely debt for consumption reasons, especially the part spent on imports) into the account…I don’t know :)

Your former student,
Art

Are you talking about European Union? Then it might be the case, although I would definitely disagree about the world on the whole.
However, let’s introduce an extreme example. Say, vast reserves of oil are found in Latvia, just like it happened in Norway. Can we still say convergence would not happen? Of course, not. Then, why would we change our minds? Just because – we have found a very good source of income.
Therefore we can assume – a good source of income may cancel the regularity. It does not necessarily have to be oil, it can be anything you can sell in large amounts. Anything, including a great business idea.

By looking at numbers, one should not forget the logic.

So basicly your saying there is 20 years of economic stagnation ahead of Latvia ?

Archy – that’s not what he’s saying. Morten gives no final conclusion on what’s going to happen, but he’s inferring that progress may be take a while, and will require a lot of small steps and hard work.

Reinis – true, but oil is an extreme example. A great business idea would require far more effort and result in a much smaller boom in the economy, than would a sudden discovery of oil. We can’t be negative though, and we really need to find that great business idea so that Latvia has its unique selling point internationally.

Hard work may well be the key. In the boom years, the model was buy a field or apartment, wait a year, sell it, make a big profit. This worked for a lot of people, and they got rich. Suddenly half the population thought they were real estate specialists. Let’s be honest though, the business model was not terribly sophisticated, and it created a “money for nothing mentality”. When Morten mentions western European countries having annual GDP growth rates of 2% for example, that 2% growth is the result of an enormous amount of hard work across all sectors of the economy. There’s no short cut, there’s no quick fix. The same will be true for Latvia.

Cmon, Morten,

why is Latvia so relatively poor? Because the country basically does not produce anything, and when it does, it is on the whole crap. You don’t need another blog to figure it out.

The scary thing is that Portugal is very similar to Latvia in many other ways as well. Both are boring provincial countries that are interesting only for some “niche connoisseurs” – port and sun in the former, and beer and sex in the latter. Both do not produce much (or at least much of anything that matters), do not do research, and to not influence the world affairs. It is up to us _Latvians_ to decide what we want to be in the future.
A decent opera and few football/hockey teams is not enought in the modern Europe.

..and to follow up, why does Latvia produces crap? because of its low-quality human capital (i.e. an average persone is quite stupid). You simply can’t produce hi-tech here, if only because people will most likely steal all the equipment before long…

Dear oh dear, everyone seems a bit negative today. Cheer up, it’s almost Christmas!

Latvians aren’t stupid (although they got really really lazy due to the credit boom and the effects of mass emigration) and there’s certainly more to Latvia beer, sex, ice hockey and the opera (although that would be enough for the average person!).

In my view, there are two key issues which need to be fixed in order for Latvia to move forward in any long term sustainable sense.

1/ Russia & Russians – 34% or so of the people in Latvia are Russian and the 76% or so of others (mainly Latvians) struggle to live along side them. This is the fault of both sides, but the snail paced speed of accepting most of these Russians as Latvian citizens is a huge mental block for them. If 34% of your population are pulling in another direction to the 76% then how on earth can the country act as a single unit in any effective way? Also on the subject of Russia, despite the fact that following independence Latvia understandably looked to the west as a role model, Latvia should use and take pride in the fact that the Russian language skills here are first rate. You speak their language (including all nuances, swear words, jokes, expressions etc), you know their mentality and their music and films etc. It is a massive asset, so use it, even if you find it distasteful. Russia, the biggest country in the world and with masses of natural resources, will always be next door to you. The Russian language will always be as important in Latvia as English. Get use to the fact and nurture you relationship. I know this is really difficulty. Russia is a bully and has a tendency of kicking off with every country it has a border with. But this will not be for ever.

2/ Corruption – the state is institutionally corrupt at every level, and as a result this mentality has infected the hearts of most of the citizens on Latvia. Corruption keeps people poor –always! Russia has enormous amounts of oil and gas and has a relatively tiny population. It should be the richest country on earth for the average inhabitant, but because it is shockingly corrupt (far worse than Latvia), it is a hole to live in for the average person. Sweden on the other hand is about as good as it gets in terms of transparency, and the average standard of living is very high. The vast majority of people there have a good life. To change this mentality in Latvia is not easy. It will take a rewiring of the country’s genetic code, and at the moment the movement is backwards, not forwards.

On the subject of “High-Tech”, that’s just some BS that sounds nice, and it’s good PR for a politician to talk about it. Why on earth should Latvia be good in high tech industries? As far as I can see, the vast majority of Latvians are very comfortable with the land for example. So why doesn’t Latvia (with a small population and lots of available land) make more of its agricultural possibilities? There are various reasons, but I’m sure that one is that it doesn’t sound quite as sexy as “high tech”! Agricultural expertise is a cause for pride not shame. America is a massive agricultural producer and it is the wealthiest country in the world. German & Japan are first rate manufacturers.

Concentrate on what you are good at guys!

Just came back from an interesting event where bright minds were discussing the worth of GDP as development measurement indicator. Despite the economic trouble in Iceland, it has yet again ended in the top 10 happiest nations list. Well-being only partially relates to economic development (Bhutanese have featured on the same list for several years). Developed nations face ever increasing nature risks and societal problems. Maybe we should rather use HDI indexes for convergence measurement? I think Spain has done measurements using both and judged by GDP the convergence had not been happening but the HDI indicator revealed a totally different picture.

I personally think that the faith of Portugal is looming onto Estonia, since it will be the first of the BC. to euronize, and therefore bum and bust

This from the CIA factbook: share of agriculture in GDP, USA 1.2%, Latvia 3.1%. However, the share of agriculture in employment: USA 0.6%, Latvia 12% (in 2005). OK it has come down to 8% in 2008, but still ridiculously large. So much for America being a massive agricultural producer, Eddy!

13.

To Sleepwalker: Economists are the first to admit to the inadequacies of GDP as a measure of happiness (after which we use it anyway…) – but a) I think that some more GDP to increase salaries, pensions and what have you would not be bad and b) Latvia does not score well on HDI either (eg due to low life expectancy)

14.

To Archy:

The ranking is relative – so if all countries should enjoy a boom of, say, 5% growth Latvia would still hold its rather low ranking but would be better off. It is thus not doomed to xx years of stagnation. But I am still interested in whether further convergence is realistic/possible.

15.

To Reinis:

No offence, but oil is actually not a good example. While Norway is indeed oil-wealthy and a (very) rich country, most oil producers have fared very poorly (Venezuela, Nigeria, Iran – and I would include both Russia and Saudi Arabia here too). The story is that oil wealth often leads to a crowding out of other industries and is often tackled with poor governance and too much corruption. Norway is as such an outlier.

Fair enough MB, you’ve read something which I haven’t. But then doesn’t the drop from 12% to 8% between 2005 to 2008 make the same point that I made? (i.e. a drop in the number of people employed in what is a core Latvian economic activity).

Presumably they’re all involved in nanotechnology now.

17.

MB and Eddy:

Can’t help join your virtual fist fight: The US is actually a big agricultural producer (in terms of volume) but it has a small share in US GDP because the US economy produces so much else and is so very productive. Look at the numbers provided for agriculture in LV GDP and for LV agricultural employment in GDP. The latter is a quite a bit bigger than the former, indicating that Latvian agriculture is less productive than the economy on average. This is a problem for Latvia although it is not as big a problem as it used to be. For the US it is the other way around.

Will take many years to get into Portugese trap. Wouldn’t be so bad after all. Imagine having Siemens, Wolkswagen, Nestlé and other subsidiaries here and Latvian being spoken in Brazil. And if everything else goes down, tourists streaming in to enjoy half a year summer anyways. The figures and comparisons matter of course, but don’t forget that’s an old country with rich cultural heritage and a neighbour not by any measure interested to undermine your economy.

Resources — whether oil or forests should be used in a sustainable way. There should be a long-range plan of reforestation for Latvia and I hope that is in place. Oil will run out sooner or later so oil profits should be spent on things that will still be useful 50 – 100 years from now, in other words, infrastructure. I have been traveling in Norway in the sixties and again in the nineties. The difference in infrastructure was huge. After driving through the 50th tunnel I stopped counting. So that’s where the oil money went, I thought.

20.
Reinis > Morten Hansen
2009. gada 5. decembris, 19:16

Sure, Norwegian case of using oil resources is an exception. But, what is important – that under certain circumstances it is possible. Now we only have to analyze which direction is more plausible for Latvia, Portuguese or Norwegian (or Finnish/Japanese). I would say, somewhere in between.

1. Geography (actually a periphery)
2. History (serfdom and affiliation with the relatively backward Russia)
Those factors will never go away… However!
The current level and gap with the “EU average” is definitely not equlibrium, because it is overshooted in the negative direction, because of two factors:
a) cyclical (a lot features of the economy are temporary, like, for example, no credit to even sound business, uncertainty and unemployment)
b) there are huge productivity gap to close. I am not talking about some fancy thing requiring human capital etc. I am talking about simple things like copying technologies and marketing/branding. Enterprises like Madara cosmetics, Stenders are examples of the Latvian future. There is plenty of room for copying patterns and “ways of doing”. It also requires some human capital but it is hardly a rocket science. All this side of the economy was largely surpressed by huge returns from the real estate sector. Now the real estate is gone and naturally exports and branded sectors will receive more finance and talents compared to 2006.
Therefore, I am optimistic. Because of the two factors mentioned in the beggining we will NEVER be as rich as Sweden, but I am sure that our equilibrium level is roughly around 80 percent of EU average. So, flags up! Plenty of growth in the future :)

Not quite sure about the US productivity. You know, Latvia’s prime productivity industry in the past few years were real estate. And, sure, the “value added” was huge! :) The US is the same story. Thanks to the money printing, the service sector is highly productive (receive a lot of money for a lousy-quality job). Sustainability of this “productivity” is highly questionable.

And by the way. The “Portugal trap” is a bit racist concept. What do we do there: we look at the statistics and conclude: “terrible, low growth, it must be very depressive to live there!”. But I have been there some years ago, and also had all those ideas… And was surprised about the high level of their universities (which was sure higher than the Latvian) and the fact that they have quite a few European-strong industries. I am not quite sure, but I guess, the “horror story” of Portugal is largely what we here hope to see: growth of a sound export industry together with a decay in the “old sectors” (and naturally, high unemployment because of the structural change). A structural change, which in statistics appears as low growth. So maybe “the trap” is actually not such a bad thing (I have to admit, that I have not loked into statistics, those are only my “tourist impressions”, maybe completely wrong)…oh, sory for some English mistakes, was not particulary careful.

24.
visu vaiku surelis
2009. gada 6. decembris, 17:31

exactly the point, spot-on, very well – one of the most stupid ideas of catching up with someone. You know Ahilles will never catch up with the turtle.

Why? Because the right ingredients are not there. It’ s not about speed. It about grasping how can one catch up and go past the turtle. And the element is not of a realm of phisycality. When we isolate economy alone, when do not take into consideration a wider context we are doomed to make a miscalculation. With such a political set-up we will always lag behind, by the way, we will anyway…

its a funny world,Norway invest most of their oil money in to US&UK govermnt bonds and those Chinese…they do the same.
The point is-if you cant get rich by working hard or pumpig a lot of oil try marketing, it works too:)

26.

to G.D.:

Madara, Stenders – fully agree – but more is needed, right?

And,again, these rankings show that Prtugal is relatively poor among a series of rich countries which does not make it poor in an absolute sense, of course. The weather is fine, red wine is cheap – but it has some serious pockets of poverty in e.g. the countryside that some catching up would help.

2 Morten

“Madara, Stenders – fully agree – but more is needed, right?”

I am not quite sure about that. For imitating one does not need much brains. And in this area we have huge gap to close. Simply they should start teaching it in schools and universities. You know, Helly Hansen, H2O (hope they are not broke), Chinese goods in Jysk and Danish Design… :) What I am saying is that the women, which started Madara was hardly a rocket scientist/human capital type… The same applies to Stenders. Growth, at least up to 80% of EU average will come around more or less automatically. If not, then we should assume that we are particulary stupid somehow. And, while being a masohistic Latvian myself, I decline to agree to that! PISA and other international tests are on my side.
Of course, it is difficult (ok, impossible) to quantify the negative effect from the two factors I mentioned above (sorry, forgot the third one: “small nation” ir another evil curse), maybe our eq. level is somewhat lower. But why exactly should we be below Portugal? I see no reason at all. And if one talks about corruption and political system, or education system, I dont buy it. As far as I see, those things are endogenous. For example, now there will be a considerable change in education system and political system and traditions, I hope – improvement. And that would be the result of failure of the previous concept of development… A natural dynamic.

to G.D.

Nice recipe to copy, but doesn’t help neither us nor Portugal. Somehow we are still at a much lover level than Portugal (GDP 55% over 75,5% of EU27 in 2008). Taking into account previous dynamics (average growth since 1997) it is more than 20 years difference. And now this massive emigration comes as a new age. But for Portugal my best wishes to get out of trap.

Income difference does not matter. What matters is growth. Also emigration does not matter. If the myths about “the best and the brightest leaving” were right Ireland and Germany or any European small country (including Danmark) would be quite miserable place to leave. Sorry for spamming a bit but this is the subject I enjoy and have some knowledge about.

“place to live” of course :)

31.

It’s advice like yours, from westerners that live here a couple of years and then leave, (but think they are god’s gift to the ignorant eastern folk) that help keep this country down. “Concentrate on what you are good at guys! ” which in your view seems to mean „focus on Russia”. Well I’ve got news for you, that is what Latvians have been doing for the past 20 years and where has it gotten them? The economy is primarily service based (like Portugal’s incidentally) and oriented towards Russia, but despite that, the major ports have seen a decrease in cargo turnover lately, oil does not flow through the pipelines in Ventspils, and there are massive queues on the Russian-Latvian border. And anyway, only a fool would think that cargo transit and laundering Russian mafia money will help develop an affluent middle class over here. Real convergence could only occur if Latvia did increase its manufacturing base. It seems to be working for China isn’t it? Given Latvia’s size, manufacturing on the same level as China is not realistic, but high tech (such as in Finland) would be viable. And incidentally, why, in your view, has Finland not needed to speak their eastern neighbours language (including all nuances, swear words, jokes, expressions etc) to prosper?

So keep your condescending cheery BS to yourself. Enjoy you beautiful local wife and stop pretending you are smarter that you actually are.

FFS Chill out.

Finland – no idea. Presumably they got good at something and were professional about it.

I suppose you are just one more person who thinks only criticism from a Latvian is valid or acceptable. All foreigners here should zip up their mouths and just be grateful for their residence permits. And the taxes we pay obviously do not give us the right to voice an opinion on how the state is run.

Presumably you think that 20 years of corruption and poor governance have left the country in a good state? And that it wasn’t Kalvitis who spent eveything the state earned? And it wasn’t Latvian bankers who lent too much money to real estate buyers?

Yep – blame the foreigners for everthing and keep repeating your mistakes for the next 20 years. Pathetic.

33.

I did not blame foreigners for all Latvia’s ills but merely pointed out that through poor advice they often contributed to them. It really irks me when a foreigner suggests Latvians should embrace everything Russian, or that Russia will be the source of Latvia’s prosperity. Look at how contradictory your own comment is – your first piece of advice is for Latvians to build on their closeness with Russians. Then you point out corruption as Latvia’s biggest problem and use Russia as an example of how not to be. So which is it? Should Latvia strive to reunite with the East or move to the West? And don’t start up about this bridge between the two! Nobody needs an extra layer of bureaucracy. Western companies do quite well on their own dealing with Russia, they do not need middlemen. To achieve M. Hansen’s „convergence”, the best piece of advice anyone can offer post-soviet countries, is to do exactly what the wealthier (in terms of living standard) countries do and try to implement that here. That will inevitably mean a western and not eastern orientation. (Or do you think these savages are not capable of behaving like Swedes?)

Hi Soviet,

As far as I know, I’ haven’t insulted Latvians in my posts, and I certainly haven’t called them (or ever thought of them as) savages.

Sorry if I didn’t explain myself properly in my original post. My point was that given the proximity of Latvia to Russia, and the obvious ease of communication between the two, eventually (and this may mean decades) the relationship and ties with Russian have to be good. It’s not a case of orienting either to the East or West. That’s not a good long term strategy. You shouldn’t have to chose, nor would it be beneficial for Latvia to do so. Yes, Russia is an appalling bully, and it is dreadfully corrupt. Yes, it is currently impossible for Latvia to maintain a good relationship with Russia, while Russia uses the issue of ethnic Russians in Latvia as a tool for manipulating popular nationalist sentiment. Therefore, I was not suggesting that the way out of Latvia’s current mess was to look to Moscow for salvation. I think my original post made it clear that I consider it a long term necessity to eventually live alongside Russia in relative harmony. Not a quick fix, or even a current priority.

You are absolutely right that emulating the best practice of wealthier countries with a high standard of living is the right direction to go in. I also fully agree that foreign advice is often poor and has contributed partly to Latvia’s problems. My country is one of the main culprits guilty of dragging the world into its current financial mess. However, I comment as an individual not as my country.

I don’t think I’m particularly smart, but I do think I have as much right as anyone to comment in a public forum such as Citadiena, even if you or anyone else doesn’t like what I’m saying. That’s the whole idea of the article. On the other hand, I appreciate you compliment about my beautiful girlfriend (we are not married yet).

Anyway, I’m not an economist or politician, and I’m quite willing to be proven wrong about the above. Out of interest, do you think it is a non-starter to use Latvia’s agricultural capabilities to greater effect?

35.

Sorry if I came across a bit strong, I didn’t mean to imply you have no right to comment in a public forum. Constructive discussion is important if we are to find a solution to the current political and economic state of affairs. The problem with the ethnic issue is that it occupies far too much energy, when all interested parties should be prioritizing economic growth. Too often the issues are linked and that in my view is not productive. Russia all too often uses tries to use trade to leverage its language and other specific cultural demands. This is why Latvia should look more to integrating economically with the west. I doubt Sweden will demand greater “swedenization” (I know that’s not a word) as a prerequisite for reduced trade tariffs. That is why I have always though Finland is a good role model for Latvia. It has a very high level of trade with Russia, but has done so without having had to link itself culturally and linguistically with Russia. There may be many Latvians of Russian origin in Latvia, but that is not a justification for making this a Russian pseudo-province.

With respect to your question on agriculture, I don’t disagree. Latvia needs to diversify, there seems to be a tendency to want put all one’s eggs in one basket. There is a lot of fertile land and no lack of water here, naturally agriculture will always have its place. But this doesn’t preclude research in the IT sector like Estonia is doing or trying to revive scientific research potential in other fields (there were a lot of research institutes here in the Soviet days).

No worries.

Of course Latvia shouldn’t become a Russian pseudo-province, but Latvia will always be partially linked culturally and linguistically, as long at there is a relatively high proportion of ethnic Russian living here (or rather as long as those ethnic Russian still identify with “mother-Russia”). In the meanwhile Latvia may as well leverage off that fact if it is possible do so, whilst of course following the Swedish/Finnish lead.

Regarding agriculture and IT etc, I totally agree. What concerns me is that the author of the article and the readers adding their comments, have a better grasp of these issues than many or most of the politicians entrusted with the country’s governance.

As you say, constructive dialogue is the key. Let’s hope the real decision makers engage in the conversation.

By the way, by “leveraging” off the RU angle in Latvia, I don’t mean money laundering or anything dodgy like that. Just legit business, if in fact Russia is capable of such a thing.

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