IR

On June 5 the Bank of Latvia and the International Monetary Fund hosted arguably the biggest economics conference ever in Latvia ("Against the Odds: Lessons from the Recovery in the Baltics"). The aim was to discuss Latvia's internal devaluation experience - crisis management, remaining challenges and lessons (if any) for other countries, in particular the Southern European countries of the Eurozone.

Although international attention was almost hijacked by Estonian president Ilves and his tweets about Nobel Laureate Paul Krugman a lot of focus was still directed at Riga and I think we should be very happy with that.

If someone just cannot get enough of that conference and the ensuing debate in the blogosphere, here is my take on it:

1) Latvia has come a long way in solving its problems since the IMF-EU programme was initiated at the end of 2008 - public finances have been stabilized, the banking system has been saved, the current account has been substantially reversed and the economy is growing, even briskly - at least for now. Substantial achievements indeed and I fully laud them but is it enough to say, as Jorg Asmussen, member of the Executive Board of the ECB that "First, it [Latvia] disproved the frequently made claim that an internal devaluation strategy cannot work". Is the internal devaluation battle really won and, by the way, how does one assess when an internal devaluation is over? Or, Christine Lagarde, Managing Director of the IMF: "We are here today to celebrate your [Latvia's] achievements". May it be too early to celebrate?

2) It certainly made some of the usual suspects in the blogosphere react and in various ways e.g. Paul Krugman, Simon Wren-Lewis and Mark Weisbrot rejected the claim that internal devaluation has worked. Weisbrot, who seems to have a part-time job denouncing Latvia's economic performance (see e.g. here, here, here) claims that "They [the Latvian government] had promised to tighten their budget [in 2010] by a huge amount, but they didn't do it". Ehhh... The data does in no way indicate that fiscal policy wasn't tight in 2010, see Figures 1 and 2, so where does this assertion come from? That (poor economics in my view) and the title of his piece "Christine Lagarde's perverse praise for Latvia's economic ‘success'" (biased, biased, biased...) is enough for vertical archiving of his article.

Figure 1: Government spending, quarterly, seasonally adjusted, 2002 Q1 = 100

Source: Central Statistical Bureau of Latvia and own calculations

Figure 2: Government expenditure as a share of GDP

Source: Central Statistical Bureau of Latvia and own calculations

Krugman's intervention is much better and should certainly not be dismissed: The current account may have improved considerably but it is now (mildly) negative again even when the economy is still far away from full employment. In Figure 3 I choose to look at exports and imports and a truly successful internal devaluation would have shown a picture where the blue export line had moved above the red import line. What we have is more of a massive import compression due to the credit bust and subsequently to the decline in GDP and thus income and an impressive export comeback but still with less ‘oomph' than hoped for.

Figure 3: Exports of goods and services from Latvia, quarterly, seasonally adjusted, 2002 Q1 = 100 for exports

Source: Central Statistical Bureau of Latvia and own calculations

That said, exports are as seen in Figure 3, above their peak before the financial crisis started; in fact exports are higher than ever before in Latvia. Not just that - exports as a share of GDP have never - never! - been higher, see Figure 4*. Alas, my question: Where is the competitiveness problem???

Figure 4: Exports of goods and services as a share of GDP

Source: Central Statistical Bureau of Latvia and own calculations

There is no definition of when an internal devaluation is successfully completed but besides the stabilization we have seen in Latvia it should include, in my book, a better export performance/better current account performance. But to completely dismiss what has been accomplished as e.g. Weisbrot does is utter crap. Latvia has come a long way and arguably longer than most thought possible but victory cannot yet be declared. Lessons for policy makers (as always...): No time for complacency - and keep remembering the issue of competitiveness!

For me the best article of the past week was written by Olivier Blanchard, IMF Chief Economist. It is not divisive, it is perhaps a bit bland, it suffers a bit from the profession's ‘on the one hand, on the other hand' type of argumentation but - and perhaps therefore - it is the one that offers the most insightful analysis.

* And, no, exports as a share of GDP are not (just) higher because consumption and investment are lower than before the crisis - private and public consumption, investment and exports sum to more than 100% when imports are higher than exports. As Figure 3 shows, exports are at record levels.

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