What type of economic recovery? (21)
Autors: Mortens Hansens
Publicēts: 2009. gada 23. decembris 10:12
Atslēgvārdi: , .

Nosūti raksta adresi draugam.

For there will be a recovery; there always is but that may be the last positive item of this entry.

The graph below tries to show economic development during the boom, during the current bust and presents three scenarios for the future.

Economic growth, in particular after 2005-06, was above the trajectory that was consistent with full employment in Latvia. This is shown by the line “Actual GDP” being above “Potential GDP” and this displays the overheating of the economy – that virtually any pair of hands could get a job but that this also was highly inflationary via an extremely overheated labour market. Potential GDP in the graph is rising, which is due to general productivity gains etc. and this is where at least the potential for increases still is considerable due to Latvia being quite a bit behind in the catch-up towards the average income level of the EU. Then came the world financial crisis, which hit the Latvian economy like a hammer and will have created some 25% or so loss of GDP level before recovery starts.

But the question is: What will the recovery look like? Will it be fast or slow i.e. will GDP start growing fast again or not?


Case A would see a quick return to the overheating trajectory – this is highly unlikely and even unattractive as it would re-engineer overheating. Case B suggests a return to the original path for potential GDP i.e. a return to the previous long-term development of the economy while Case C presents a lower-growth scenario where the original trajectory for potential GDP is flatter and thus where economic convergence will take considerably longer (a so-called structural break). Case C is obviously unattractive – the problem is that research shows that it is quite realistic, see e.g. http://www.bis.org/publ/work226.pdf (for economics aficionados only – it is quite technical).

In Case C the economy never returns or at least does not return to its pre-crisis potential performance until after a very long time. What makes this realistic – and what to suggest to try to avoid or at least mitigate such a scenario?

Three quick arguments in the Latvian case:

1) Far too much investment was put into real estate and some of this may never end up being productive and will thus be “lost” – I mean, what can the 17 floors of Panorama Plaza 3 be used for except serving as a monument over a spectacular investment folly?

2) Emigration means lost GDP, both actual and potential.

3) And unemployment means loss of skills. Lots of studies show that lasting unemployment deteriorates the skills of the unemployed and makes some of them unemployable. This destroys potential GDP and with it, of course, actual GDP.

It is close to Christmas so I am sorry for this rather bleak post but the way to look at it is of course to evaluate its likelihood (previous research, as mentioned, says it is quite likely to happen) and then be proactive and provide countermeasures.

2009 was not a great year for visionary economic policy in Latvia, and understandably so – 2009 was a firefighting exercise, plugging holes here, there and everywhere in the budget. Hopefully 2010 can be more forward-looking, including the issues raised here.

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


Nosūti raksta adresi draugam.

(9 balsotāji )

Rather realistic scenario C I must say, and unfortunately it paints the whole issue in rather bleak colours during this Season Holiday time.

Nevertheless, the scenario B requires already reformed education, police and health care systems that are undergoing reform simultaneously righ at this moment…In addition political system (mandatory and uniform property and tax declaration + election financing law in particular) MUST be reformed prior October 2010. Without those legal amendments and effective finalization of started reforms Latvian governors would lead the country into permanent state of Belgization… with real and visible consequences to bear:)

Merry Christmas!

I would think that the overheating is understated here. In 2006-2008 there was no productivity growth, even more so there was a depreciation of productivity while the economy grew in nominal GDP terms.

Nevertheless, I would opt for scenario B and here are my counter-arguments to support it:

1) “May never” is not “will not”. As for how and why these floors might be used – more office space for the right price. What is the point of Grindeks building its own Skyscraper near the old town if it can purchase a ready made scraper? There are other large organizations in Latvia, which are still doing fairly well and are at the same time placed in several places. Economic gains from centralizing HQ can be realized – for the right price.

2) Emigration does not always mean lost GDP. It does so only under certain conditions, i.e. workers leaving with everything permenently. More often it is just the labor active person that leaves for a prolonged period of time, yet transfers profits back to Latvia. While Latvia is not capable of providing work opportunities, these are found in other EU states and the income transfered back. The amount is considerable even this year. This money is then used by those family members who were left behind in consumption, thus actually contributing to GDP more than the same person stayong on unemployment benefits. The kind of emmigration that free labor markets procure is a problem only under full employment, because it limits potential GDP at full capacity.

3) Loss of skills is an issue. Luckily we have free labor markets that allow those willing to work find work outside the country (see 2), gain new qualification and experience and return with the ability to utilize that. Examples of learned skills include among others Emihls Gustavs chocolate factory, which is among exporting companies today.

Ex-student of Prof. Morten Hansen

Are you still a student? I can’t agree with ‘Luckily we have free labor markets that allow those willing to work find work outside the country’!
Do you have any figures how many of the emigrants got a job in their occupation?
Secondly, the age plays the important role in possibility to find out a job outside the country successfully. What about 45 +?

Some are always students, even if they graduated more than 5 years ago.

Getting a job in an occupation is not necesserily relevant, as Latvia has a proprotionally high output of lawyers, language skilled, historians and business administrators.

For them acquiring new skill-set in an industry (be it understanding how fish are canned) can be useful, just as much as “life-long learning”.

Those studying engineering easily find jobs in any country in their field – even those countries limiting access to their labor markets are open for engineers.

45+ depends on the 45+. There are some that have moved and found jobs. There are proportionally some that stay long-term unemployed. But these are not the masses of unemployment. Age proportions for unemployment show that the majority of workers made redundant are under 45.

Here is the statistic from http://www.csb.gov.lv for percentage of unemployed in age group.

Age group/ Q1 / Q2 / Q3
15-24 23.5 21.2 25.0 –
25-34 24.0 22.8 22.2 –
35-44 19.8 23.3 19.1 –
45-54 22.1 21.3 23.5 –
55-74 10.6 11.4 10.2

Only 33% are in the 45+ range.

to editor: why this (today’s!) article doesn’t show up if frontpage???

MH, not that bleak

LVs economy did not run at full potential nor was the best place for FDIs. Therefore, we have a great chance to get back productive capital by improving the environment (and getting down that damn overvalued lvl). Veiko mentioned some of the goals – I agree with him. We have to get in WB Doing Business #10. Definitely, it will require fast, radical and politically lethal decisions. Guess if one is able to make them…and who from the current clerk horde is able to implement… Luckily, Castle has showed some interesting moves and I hope for them.
Radical funding/organizational improvements in education can (must!) be implemented by Sept.2010 and the outcomes can be expected in 6 years… not before :( Faster results can be expected in reducing red tape, corruption, getting banks back. Investing EU funds in productive ‘infrastructure’ (meaning of ‘infrastructure’ as in http://tinyurl.com/yb9j9ts) Meanwhile, WB suggests, that education IS NOT the key factor for FDI decisions.
So, scenario B _IS_ achievable, but with damn hard, focused, unpopular and devoting work by highest trio+.

Moreover, as e/i/risks will get back to equilibrium, speculative capital should return – our i still will be high. Yes, we have shits on balance sheets, but swedish model shows how to solve it with minimum moral hazard and econ growth afterwards, or Japanese – how to bleed for years…. have to decide…

Otherwise… there is no chances for growth with contracting fiscal, fixed rate and limited flexibility of monetary… and flight due to risks….

I vote for B (of course, provided that the Western Europe also returns to B). Anyway, our growth rate should be higher than the Western. Even without human capital etc. growth in Europe has usually larger impact on low cost countries. Usually all non-sophisticated part of the production process is shifted to the East. And we, with our nice 20% unemployment, now are the best place in the region.
I do not see emigration as problem and agree to the Jaanis arguments. I also think that most of the “skills” the current unemployed have, are not worth a dime – the faster they forget how to trade with real estate – the better. Of other professions (e.g. in chemistry or IT industry) I have not heard of any tragic stories, – usually the least productive workers are fired. Which is also good. However, there is a negative effect from emigration, namely
1) deleveraging and disinvestment will limit growth in the next 3 years.
2) that will increase emigration.
3) public debt remains the same – therefore that increases the burden on others… And that decreases growth -> return to 1). A vicious cycle. But there is nothing much we can do about it, except I would advise a temporary de-regulation everywhere (like the decision for direct trading for farmers – that was one of the best decisions lately, respect!).
However, there are also some arguments for A:
1) extreme, and as far as I see, not very rational, uncertainty, when firms cannot insure their deals etc., will not last forever. That will result in explosive growth at some point (I would say 2012) when the tide turns.
2) the same applies for FDI – there are no rational reasons for 10% positive CA. Not at this stage of development. Again, all the projects on “hold” will be switched on “move” at some point…
So, on balance – B, with perhaps lower growth in 2010 and first 3 quarters of the 2011, but much higher growth in 2012 – 2014. Of course, provided that all goes according to the current plan.
Merry Christmas everyone!

Probably C. Manufacturing industry has been in decline for many years, though the share of higher value added products in manufacturing has increased a bit, but that does not change the picture. Apperantly, there are no conditions for masive expansion of manufacturing. Lat is still overvalued.
Is there a hope for another real estate bubble with those projects on “hold”? why?

I think C is normal and good for Latvia, since overheating was exactly in the wrong place-consumption and real estate. C anyway lands on around 5-6% yearly growth (?), which means reaching todays EU average in 10 years, and being at about 75% level of EU average then. Not bad at all.

More so, we need truly conservative fiscaly prudent government that is able to reduce government spending even more than SVF requires, again against too high basis.

I think, every postsoviet country after the 15-20 year post totalitarian oligarh period needs fiscal conservatives to develop nation that takes responsibility for own deeds. Latvia does not have such nation, yet. But its coming with rocket speed with the help of deep crisis.

That is a political issue, not economic. Tighten the belt until people start to fight for their rights, really, everywhere, everyday.

Defintely C given the current bunch of politcians. They’re not really politicans and the crisis has shown up their shortcomings in embarrasing and humiliating style. They have no idea what to do, and while they stay, Latvia will not recover.

I disagree with Morten’s quote…”For there will be a recovery”…. There were specific factors that drove Latvia into crisis, and there has to be specific factors present to drive Latvia out of the crisis. At the moment those factors don’t exist, and the politicians don’t know what they are or how to find them. A recovery won’t happen just becasue it’s natural for a recovery to follow a slump.

Latvians are not daft and will not tolerate the current set of useless politicians indefintiely. They will do something sooner or later. I don’t know what, but it will happen. Until it happens, C is a certaintly. When it happens, B is a possibility.

Easy – I totally agree, the root problem is political, not economic.

Lala – you’re right, unpopular decisions and total focus will definitely be necessary.


Crisis will end because its a psychological phenomena, not economic ( what is economy anyway??).

But where will we steer politically when it ends means a lot. I would prefer , at the same time, get rid of Russian soft interests, Swedish bank greed, local oligarchs, SVF dictate…

In one go, coming out of crisis as an almost mature nation, with a mettle, ready to test it.

Perhaps too early.


It is indeed too early to say.One of the most distressing things about this whole mess is the total lack of clarity about what the futue might hold. If the government can’t announce its 2010 budget till one month before the new year (and the recent constitutional court judgement re:pensions won’t help much!), then foreign investors have probably written off Latvia as a place to invest in 2010, as their investment budgets for 2010 were probably decided several months ago.

We will see….


I would stay out if I were a foreign investor during 2010 except to acquire position, assets that might be needed in future.

Or, to establish export oriented production, its right time ( minus the mess with unclear taxes). More and more foreign companies restart export oriented production in Latvia , especially ones that involve timber based raw materials and related knowledge.

But now the deals-land, labour, premises- are realistic.

After some time (few years) this capacity can be also turned to serve local e.g. building market.

Dear Sirs,

Ok then, holidays are over, Christmas miracles and all that have been performed, so fingers crossed…or no, hold on, there aren’t no miracles, at least in the economy…

I reckon it is going to be Scenario D…as, from what sporadic news coverage I am willing to read on Latvia, there isn’t a single potential growth area…

I recall from basic economics that GDP = Consumption + Investment + Government Spending + Ex-Im…let’s take these in turn
Consumption – emm, no…all these cuts in salaries (teachers, state apparatus, except for the MPs, of course, etc.)
Investment – …of what? Can one invest home-grown cabbage or carrots into smth? There are no money.
Government spending – emm, provision of capital for Parex to write-off bad loans does not exactly qualify here…
Ex-Im…possibly, but we did not devalue, so our products are (i) pricey in other currencies, (ii) pricey in local currency, as Latvian productivity is stuff of dreams, (iii) we are doing an internal devaluation (OH, THE PAIN!!!).

All in all…hope you got a good fix of holiday mood…get ready for more of the same…


I vote for C but not because it’s good or bad for Latvia or it should be a kind of punishment for us. The growth now can only be export driven, and since exports makes only small part of Latvian economy, it means that economy will need VERY VERY hard (and – unfortunately – long) restructuring, and it will take time. Actually I’m afraid to make any forecasts… Obviously, Latvian exports will regain markets lost in 2007-2008, but further expansion will not be so easy anymore.

P.S. to PPP. You forgot to count exports into consumption :)

Piedod, neizlasīju tavu postu līdz galam un ieliku atbildi. Kā teica poručiks Rževskis, “oi, naveroje, hu*ņu smorozil” :)

I wonder about Mr Hansen’s comments about this conference. TinyURL.com/RBS-conf

Garry, my kindest regards to Поручик Ржевский.

Tommy, I have a feeling that this is not going to be the most valuable spend of Ls 30 you can undertake…with all due respect freelance consultants are not going to help Latvia out of crisis – so please, spend this money on something for yourself…


ppp -who are you? Why do you address me as Tommy? Did I somewhere say that I would spend 30 LVL on this conference.

Unless I misunderstand, you feel this is useless. It seems that the European Commission disagrees as they are sponsoring.


Apologies if I ofended you. Absolutely none was intended.

Got to go now, will finish tomorrow. Have a strong opinion re relevance and European Commission.

Vēl šajā sadaļā
Viesi raksta » Mortens Hansens
Meanwhile, 26,1% later… (40)
Mortens Hansens

Since GDP reached its zenith here, in Q4 2007, the cumulative decline has been 26.1%. It is a huge decline by any standards. GDP is back [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
The eurozone is too big… (24)
Mortens Hansens

I have used the graph below in another context but I thought some might find it interesting and at least it made me think. A [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
Can’t pay? Can pay! (97)
Mortens Hansens

That is the beauty of Latvia. You think you’ve seen it all and, nevertheless, something crops up and surprises you. Thus Inguna Sudraba, Head of the [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
Spending like the Nordics, taxing like Americans (68)
Mortens Hansens

I know I have used this sentence before but it is a good one. It was used in despair about the Latvian economy by a [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
What to look out for in 2010 (22)
Mortens Hansens

Even by the yardstick of recession-induced diminished expectations it may sound preposterous to suggest that 2009 was not such a bad year after all. It [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
Irish vs Latvian lessons (52)
Mortens Hansens

A small, relatively poor country on the periphery of the European Union. Unemployment close to 20%, soaring public deficits and debt. Main export article: People. Yep, [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
Convergence ® divergence (40)
Mortens Hansens

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 [..]

Lasi visu »»
Viesi raksta » Mortens Hansens
The price of uncertainty (63)
Mortens Hansens

One of the main questions in the economic-political debate right now is how to jump start the economy. Unfortunately, it is a question with preciously [..]

Lasi visu »»

Mūsu draugi:

BNS LETA Lielie.lv Lursoft Robert's Books