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Three governments, one prime minister

  • 2012-06-27
  • Interview by Steven G. Traylor and Dorian Ziedonis

Taking the reins of government on March 12, 2009, in the midst of the global crisis, Prime Minister Valdis Dombrovskis has led three successive governments through an environment marked by political turmoil amidst strong economic recovery, a feat many didn’t think possible considering the depth of Latvia’s collapse. Not easily excited, this young European leader has worked tirelessly to ensure stability as Latvia gets its house in order through governmental reform, backed by the support of the international financial community. Surrounded by what may be considered Latvia’s most competent Cabinet in its post-Soviet years, Dombrovskis and his government enjoy the confidence of the citizens, and respect from world leaders for what has been accomplished. With an upcoming visit by a U.S. business delegation set for early July, the prime minister sat down with The Baltic Times to talk about why Latvia is an attractive place for investment, and what work his administration still has on its plate.

Considering that European growth is slowing, unemployment is rising, wages are falling in some of the southern EU countries, with many locations in Europe now offering a lower cost wage workforce and a well-qualified work force, Latvia cannot rely on its being a low-cost status to attract investment. At this upcoming U.S.-Latvian business conference what will you say to potential U.S. investors and what would be your definition of a ‘measure of success’ at the upcoming conference?
 
First of all, as regards to the situation in the EU and the situartion in the eurozone, we see that it is quite complicated and we also see that there are different developments in different member states. And really, if you look regionally, it seems that the Baltic Sea region as a whole, not only the Baltics or the Nordics, but also Poland and Germany, is currently doing quite well and in fact is developing as one of the most dynamic, or the most dynamic, region in the EU. It’s worth noting that countries in the region were able to deal with the global financial and economic crisis and to restore financial stability, and in the case of Latvia and the other Baltic States, to also return to economic growth. Latvia is the country which has done most of the fiscal adjustment in the EU 27 and currently is also the fastest growing  EU economy. 

So, from that point of view, investors, when they are investing and looking for new business opportunities, there are two important factors: one is stability in the country, in the region, they want to invest [with] predictability of both the business environment and the financial situation, and second is, of course, cost. In terms of stability and predictability, I would say the Baltic Sea region, and Latvia, among those countries, is probably now the best region in the EU to invest. As regards costs, of course I would still say that we have a quite competitive cost structure, also as regards, let’s say, average wages and things like this. You may read lots about the crisis in Greece and so on, but the reality is that wages in Greece are still way above wages in Latvia. Just some time ago there was a survey, on EU capitals, on a costs vs. benefits ratio, and among 27 EU capitals Riga was ranked no. 1.

So, we are not the cheapest, we are not the best, but if you make this quality-to-cost ratio Riga is offering the best value for money. There are other important factors like, for example, as regards Internet connections. Our global upload and download speeds are somewhere near no. 5 or no. 6 in the world. We are well connected with many cities regarding air connections including flights to New Yorkand so on.

I forgot to answer exactly on this U.S. business meeting. We are very glad to have both this U.S. Congress and business delegation in Latvia. It’s in a sense a followup from my visit in the United States last July when we were visiting with a business delegation, and in fact visiting quite a few places in the U.S., from Washington, DC to California, and now really I am glad that we are able to organize this visit. The success of this visit, of course, would be more contacts between our companies, even though already we see that many of the companies which were in the business delegation for Latvia were able to find new partners, were able to increase trade turnover, find new partnerships with U.S. companies. We just went through the list of companies and quite a few, in fact, had tangible results, and I think that will be the best result also from this visit, that there are new contacts, there’s new trade and hopefully there is new investment in Latvia. That is the main goal.
 
Can you speak specifically about this delegation, on what you think Latvia can offer that would be of strong interest for the Americans coming over here? Do you have anything tangible with regards to something that you want to propose, such as tax incentives, or inducements that suggest, even in tough times in the U.S., that Latvia is the place to be?
 
Certainly there are a number of instruments; we also can come up with practical proposals, and in fact we are also negogiating with some of the companies about potential investments. But in any case if you look at the issues, there are two main elements which we can propose: one on taxation, of course [we have] a competitive overall tax environment with 15 percent flat corporate income tax, and a decision now being taken to gradually reduce our flat personal income tax from 25 to 20 percent. Then we have corporate income tax reduction for large investment projects in selected industries, so if you are coming with a large project you can get an additional corporate income tax reduction.
 
Will some of the U.S. companies coming be in those industries?
 
Yes. It’s mainly in industrial production, but then it’s many sectors of industrial production, and a number of services. Basically, we used to have those kinds of tax incentives, in the late ‘90s early 2000s, but then it was scrapped. One of the reasons was it was not sector-specific. We were starting to see applications for casinos and shopping malls, [who wanted] to receive these incentives... we know that somebody will build a shopping mall without any incentives. It’s for those in the priority industries. The second important incentive we have is EU funds financing. If you are coming as an investor in a...

In a JV (Joint Venture) relationship?

No, you don’t need any JV; you can come with your own project. If you develop this project in Latvia then there are different possible programs, like a ‘high value added’ products program, a new products program, [there are] some grounds for training employees, and so on. You can look at different programs, what are the instruments. Not all of them are open all the time, so you need to look at what is available at this specific moment. Those are especially grant scheme openings, companies are applying, money is used, and then you will see whether there are new programs opening. But in any case, EU funds assistance is available, so businesses also can look around at what they can get in those EU funds incentives. Right now we are working on new programs that may be for the next EU financial perspective - industrial infrustructure. Programs that actually allow for more flexibility, again when a business is coming in, especially large investments to support industrial connections, like electricity connections, roads, or whatever is needed in pipelines... some infrastructure support.
 
 While you were in California, you visited the Google headquarters. Tell us a little about what happened and what the goals were there, and maybe what has transpired since then?
 
As regards Google, currently it seems that it’s our company DEAC which has some close cooperation with Google as a result of this meeting, but they’re still working on a joint project. There are other companies that have found some contacts, in different fields; we’re working with IBM about a facility for an IBM research center in Latvia.

The U.S. ambassador in a recent meeting with Saeima mentioned that corruption is a big problem holding back U.S. investment. Others have said that Latvia’s justice system shows favoritism, non-transparency. These are not new problems; we’ve heard them for 20 years. What would you say are the causes and what is your administration doing to combat corruption?

I think those issues may be sometimes inter-linked. As regards corruption, you know that we have, first, a quite active anti-corruption bureau which is dealing with high-profile cases. We are currently implementing a plan to fight the shadow economy, which is often linked with corruption. It includes issues such as the zero declaration, making it easier to track savings and legal incomes of physical persons and to compare this to their spending patterns and identify possible illegal sources of income. Quite a few amendments in taxation preventing tax avoidance and a number of other initiatives on the gray economy. On judicial [issues] there again are two aspects we are concentrating on. One is to speed up court procedures and make them more predictable. We also tend to have a backlog of cases… in some small claims simplifying procedures.

[As was] already done with the land-register judges for the purpose of general legislation to deal with some simpler cases, we are letting some simpler issues be resolved by notaries. We are introducing wider use of written procedures to make sure those court procedures are speeded up. There is a saying that justice delayed is justice denied. Then, we discuss, with the court system (of course the court system is independent), some complaints we’ve received, say, from the Foreign Investors’ Council, on specific court decisions, what we see from the European Court of Justice judgments; again, there is a whole category of cases which is attributed to our judicial system’s mistakes, which then we have to pay for. There are quite a few activities ongoing as regards the judiciary right now.

In terms of the shadow economy, part of the reason is high taxes. Wouldn’t lowering social taxes, which seem to be an extremely high burden in Latvia. Wouldn’t that be a place to cut, rather than only marginal VAT, income tax. Taxes for business are very high.

First of all, as regards the overall tax burden, in fact Latvia’s tax burden is one of the lowest in the EU. Where we have identified some issues, and that seems to be in line with the European Commission’s recommendations to lower the tax burden for labor, that is exactly what we’re doing, lowering by 5 percentage points during the next 3 years, and I wouldn’t call it marginal by any extent.

I agree on that. I was referring to the VAT, from 22 to 21 percent.

Yes, in any case, after we have dealt with our crisis and finished the fiscal consolidation it was also clear that we ended up with the highest, both VAT and personal income tax rates in the Baltics. From the point of view of regional competitiveness, of course, it is important for us to have a tax system which is competitive within the Baltics, but it is also not in our interest to undercut it and try to create some kind of race to the bottom. So in this sense, yes, we are reducing VAT from 22 to 21 [percent] which should bring us to the level of Lithuania; Estonia has 1 percentage point lower, but we feel that with 21 we are Ok. And on personal income tax, of course, there are different structures in different countries, but again, with this reduction, we’ll be quite competitive within the Baltic framework. That was the main idea for why those taxes, and those amounts [were agreed on]. On social security contributions, given the problems of population aging, with the social system’s long-term stability, I wouldn’t be very optimistic to promise any major reductions in social security contributions. There is some debate on restoring the social security contribution’s payment ceiling, above which one is not obliged to pay, which also means some ceiling for the benefits received. Those are linked to the payments you put into the system. This is one of the possibilities we are now exploring and probably will be implemented. But I wouldn’t promise in the near future some social security contribution tax cuts.

I’d like to speak a little about what transpired at the NATO conference in Chicago. I know you don’t want to involve yourself in domestic politics in the U.S., but candidate Mitt Romney spoke about Russia being a ‘Revanchist Russia.’ I’d like to know your position with regards to how you see Russia today in relationship to Latvia.

As regards relations with Russia, it is in our best interest to have good relations, to develop economic cooperation, and to the extent that it’s developing successfully, trade volumes are increasing, we are able to agree on important issues on, say this northern distribution network, which is transit of goods for [the] mission in Afghanistan, where Latvia is a lead nation. There are quite a few positive developments. At the same time, one can see that there are things that are not developing as they should. For example, we signed a treaty of avoidance of double taxation already in December 2010. There are big delays in ratification in Russia, so we’re not able to have this treaty implemented. Also, if we want general rhetoric, we see that during the last months, half a year, we see this Russian rhetoric is getting more aggressive, more negative about Latvia, but also about the EU, and the U.S.

Is that tied with the Russian elections?

It is difficult to say. The Russian elections are over, at least presidential elections. Probably it was tied to the elections. There is a new government in place, so it remains to be seen what are the developments; currently there are mixed signals, in some things we see that there is development, moving forward Ok, in some others we see that there are [still] some issues.

What are the issues that are the most important with our Nordic, Scandinavian neighbors?

As regards Nordic-Baltic cooperation, I would say it’s in good shape. We just recently had this Baltic Sea countries’ council, in Stralsund, in Germany, and discussed different projects as regards Baltic Sea strategy, as regards some regional cooperation projects. Relations are good, they’re developing, and I think we should really be jointly exploring this opportunity which we feel being the most dynamic region in the EU.

You’ve led Latvia through a very difficult economic time, have received high praise the other day over at the IMF meeting here. There is some talk that you may have some interest in being in Brussels.

Well, there was some talk a couple of months ago. And there is different talk at different times, and I think I was quite clear that I am ready to work in this office. We claimed the intention to work for the whole parliamentary term, and that’s still the intention. But, from time to time, we see different talks and attempts to destabilize the government from whatever angle you may try.

You have taken Latvia through these tough years. What more do you have to do?

I think one of the short-term issues we are currently dealing with is, we’re working on Latvia joining the eurozone, as of January 1, 2014. Of course there is no more difficult [issue] to convince the public [on], as it was a couple of years ago, that it’s a good idea to join the eurozone, because all you hear about the eurozone is crisis, crisis and crisis. But we still think that it is a good idea to join the eurozone. We’re studying Estonia’s experience, which also joined during this eurozone crisis, and it still served as a positive signal about financial and economic stability in Estonia, and we would expect a similar effect in Latvia. It would reduce transaction costs for business, more convenient for travelers within the eurozone. What is important, we see, [it is] more a financial and economic crisis in certain eurozone countries, and not so much as a euro-as-currency crisis, and from that point of view, the lats is anyway pegged to the euro, so whatever is happening to the euro, is happening to the lats. That’s a short-term perspective. On a more medium-term perspective there are two main challenges: ensuring sustainable economic development, maintaining the competitiveness of the country, creating growth and jobs, which is an issue everywhere in Europe. The second, where we need to concentrate our resources, is in improving our demographic situation. We have huge issues with the population aging, with emigration, and this is one of the fields where we have to react quickly and work for improvement.

Jobs is what it’s all about. Do you see that more in the private sector, or do you have some programs that the government offers in worker compensation, to put people back to work.

Of course, first and foremost, it’s in the private sector. It’s more about the developing of industrial production, attracting new investment, which we have been doing during the last years. So far the progress has been quite good; we managed to have on average some 10 percent growth in industrial production for each year for the last 2 years, and on average some 30 percent growth in exports for each year of the last 2 years. From that point of view we see this development of industrial production and attracting investment as important parts of job creation.

With regards to Europe, given the worst-case scenario with the euro, where some countries extract themselves from the eurozone, do you have some idea of what Latvia would do, or what position there would be for a Plan B, so to speak, if the euro would be a currency that wouldn’t be accepted much more.

I would say that first we should concentrate on Plan A. I think that the eurozone is making important steps, in re-introducing, or introducing in another form, sanctions and control mechanisms within the eurozone which were not in place [before] and which led to the problems - the initiates of Sixpack, Euro-plus pact and the fiscal compact. So there is a range of initiatives that the eurozone follows, [as well as] other countries that are joining these initiatives Latvia has also joined both the Euro-plus pact and recently finished ratification of the fiscal compact, [which shows] that there is a willingness to regain the confidence of the financial markets and shows that the eurozone is able to ensure sustainable fiscal and macroeconomic policy. From that point of view I think that the eurozone is working quite intensively; of course it’s clear that the next couple of months will be critical, the situation in Greece, in Spain, probably Cyprus, so we have to see how this will develop. Again, we are talking about the financial and economic crisis in those specific member states; we are not talking so much about a crisis of the euro as a currency.

We have economic stability now, strong export growth, but some would consider that it’s not spread evenly across the economy. After stability, what do we have in the way of a development plan?

As regards a development plan, we are now working on a national development plan, from 2014 to 2020.

That’s two years away; are people willing to wait?

In fact, if you want, we have a development plan from 2007 to 2013, though we had to amend it quite substantially with the medium term plan from 2010 to 2013 because the crisis hit and many of the [items] were no longer valid. For some sort of mid-term perspective, [from] 2014 to 2020, we set some main priorities for this, on economic development, growth supporting the regions, human capital development. So overall the main strategy, as regards economic development, is, first of all, to not repeat the mistakes we made, to make sure when we have economic development it is sustainable. [This means] gradually moving up the value-added chain in our traditional industries, like wood processing, food processing; develop those industries where we already have value-added, like in chemicals and pharmaceuticals, in machinery, ICT, transit and logistics. In a sense, use those strengths we already have and move up the value-added chain.

Christine Lagarde at the June 5 IMF meeting said that there is too much inequality in Latvian society, and it creates a problem for social cohesion. It’s clear that wealth in Latvia is concentrated in too few hands. Can you say what is being done to make Latvia a fairer society for everyone?

As regards income, this is one of the issues that are identified in our national development plan.

Beginning with 2014?

Of course there are some short term issues, which are being addressed, but in any case yes, the plan we are working on is 2014, but that doesn’t mean that nothing will happen in 2013! There is still quite a lot that is happening in 2013. As regards to inequality, of course, during the crisis we had to do quite a few things on the social side. That’s understandable. We created this additional social safety network to help those which were most affected by the crisis, first and foremost the unemployed, with this large temporary works program, improving stability of healthcare and medicine to poor people, with helping local governments with co-financing of guaranteed minimum income benefits and housing benefits, and also increasing guaranteed minimum income benefits. There were quite a few measures that were specific crisis measures to help the most vulnerable parts of society. In the longer term, we cannot just rely on social policy; we need to see this through economic development, through job creation, through reforms in the educational system, to make sure that the education system is preparing those that are in demand by the labor market. In this sense there are quite a few structural reforms that we need to do to improve this situation in the medium term.

How will you be remembered with your administration?

Let me finish this administration and then I can begin to think about this question.