Catching up or remaining behind?

  • 2002-11-07
  • Morten Hansen
Since regaining independence in 1991, Latvia has achieved remarkable results in its transformation process. According to the European Commission, the Europen Union's executive arm, Latvia fulfills the Copenhagen criteria, part of which means that Latvia is seen as a democracy with a functioning market economy, ready to take on the rights and obligations of EU membership.

Macroeconomic stabilization has been achieved, too. Inflation is at EU levels and budget deficits are well under control.

Nevertheless, when entering the EU, probably by January 2004, Latvia will be the poorest country in the enlarged EU-25. Reforms and stabilization are obviously not enough in themselves. The question is: Will economic growth continue at a sufficiently high pace for Latvia to catch up with existing EU countries?

As I shall argue, that this should just happen as time passes is at best naive.

The existing EU is rather heterogeneous with respect to economic performance. On Jan. 16, 1988, The Economist ran a piece titled: "Poorest of the Rich," a description of Ireland, then the poorest country in the EU. Ireland subsequently grew dramatically in the 1990s and is now at the top end of the EU in income per head.

Such shifts are remarkably rare, however. For instance, Greece, after more than 20 years of membership, is still poor, at least in an EU context. Obviously, EU membership does not guarantee income convergence, and it might therefore be instructive to look at the Irish experience and compare it to Latvia: What are the lessons to be learned? Can Latvia emulate the Irish model, or is Greece the more probable model?

During the 1990s, the Irish received huge amounts of structural funds from the EU budget. In itself this helped create economic activity, but it was in the way the money was spent that also suggests a clue to the Irish performance: massive investment into human resources and infrastructure.

The argument has also been put forward that the process created a greater deal of accountability on the part of the Irish. Ireland 10 years ago was certainly not completely transparent and corruption-free. But it has improved, ensuring a more efficient allocation of financial resources.

Latvia regularly scores badly on corruption measures. Might this be improved? And will the structural funds be spent wisely? On corruption there is certainly a long way still.

Ten years ago, Irish unemployment ranged from 15 percent to 20 percent, and the biggest export item was people. Today unemployment is very low, and there is in influx of labor. The Irish labor market is very flexible: it can draw on Irish people living abroad as well as on foreigners. The Irish labor force is in general very well-educated.

The Latvian labor force is less flexible. Many unemployed are, cruel as it may sound, in reality unemployable in today's context since transition means their skills are no longer in demand.

Immigration, the one solution to potential labor demand problems, is not an issue yet, and is likely to be a very hot one if it emerges. In other words, Latvia is likely to face bottlenecks in the labor market, which in turn may stifle growth.

The Irish also have a huge comparative advantage: the English language. This is an asset American firms, for instance, value highly. Witness the many U.S. computer firms in Ireland.

In comparison, Latvia's comparative advantage is the knowledge of Russian language and culture. A growing Russia is good for Latvia's economy – but will this also be perceived as such by politicians? As English becomes ever more important, the future successful professional here must be fluent in three languages.

The Irish have skillfully branded Irish culture: U2 and Guinness are known – and cherished - worldwide. The Irish also enjoy a huge market for tourism: over 40 million Irish-Americans. With all due respect for Marija N. and Aldaris, I find it hard to see Latvia come anywhere close.

Ireland created a huge financial center to lure in foreign businesses via low corporate taxes, and this proved hugely successful. There have been talks of something similar in Latvia. I cannot judge whether it is feasible, but tax competition will be harder as the EU moves towards Ever Closer Union.

I have tried to argue that Ireland had some exceptional advantages to foster its economic miracle of the 1990s. Latvia starts from farther behind than Ireland ever was and with fewer advantages.

Corruption must decrease, which is not easy; understanding of Russian must be seen as an advantage which is not always popular; and there must be much more investment in human resources, an issue which is not always recognized to full extent.

Will this be achieved and will Latvia catch up eventually and not follow the "Greek way?" Having been here for a long time I am far from certain – but I would like to see it, given the vast talent that has also emerged here and that deserves better.