The positive side of inflation

  • 2006-01-25
  • By Martin Kleinemas
RIGA - It follows axiomatic business logic: Foreign companies in Latvia suffer from high inflation, which in turn increases fees. These fees are passed onto consumers, who in return demand higher wages and salaries both in the public and private sector.

Latvia's accession to the European Union in 2004 was followed by a boom in foreign investment. Inflation, however, has become a serious problem. Starting in 2004, prices in Latvia have climbed approximately 6 percent every year. Naturally, this macroeconomic aberration was observed by all foreign companies starting up a base in the Baltic state.

"From my point of view, one could have predicted this development years before. It was a sure bet that inflation would increase after entrance to the EU," says Roberts Stafeckis, head of the German-Baltic Chamber of Commerce's Riga office.

The GBCC looks after some 600 companies in Latvia that include German capital. According to Stafeckis, inflation is not a big issue for foreign companies so far, but he foresees a problem. "If the Latvian government does not intervene, the inflation rate could even rise," he says.

For foreign companies like those represented by Stafeckis, a high inflation rate decreases the country's business attraction, because wages rise in step, if not faster than inflation.

However, alongside some other factors, the cheaper labor is one of the most important reasons foreign companies come to Latvia.

"There are stronger incentives, but low wages are an important motive for German investors," Stafeckis explains.

In 2005, the wages for workers officially rose 17 percent. This development is responsible for a new competitive situation between the companies: Because there is often an absence of workers, companies start poaching workers with higher fees.

Nevertheless, German companies currently are not discouraged by the rising payments. In 2005, Germany was again the most important trade partner of Latvia, in import as well as in export. With 14.8 percent of all foreign direct investments, Germany leads in this field, too.

An optimistic example is Germany's AKG factory in Jelgava, which produces car production parts like fans for Porsche, Ferrari and several other brands. The factory was opened in November 2005. Covering a total of 7,000 square meters, it has generated 50 new jobs so far, and this is only the beginning: in 2007, there will be 300 employees.

Why did AKG choose Latvia? Roberts Stafeckis explains: "They were searching for a location with low wages, but with a reliable legal system. Additionally, they wanted to produce near Russia, which is seen as a future market for them."

According to the expert, many prejudices have been abolished by Latvia's entrance to the EU, as Latvia is no longer seen just as a small spin-off of Russia. Furthermore, there have been no tariff barriers since 2004, which makes trading back to companies' home countries more profitable. The most promising answer comes in the form EU-funds, which support companies in areas with a weak economy. Until 2004, those funds were not accessible for private companies.

However, the positive effects of EU-participation still dominate.

"To be honest, it does not matter if the wage level is adapted to EU standards within 15 or 25 years, because we all know that it will be adapted sometime," says Stafeckis.