Can Latvia be a role model for reform in Europe?

Latvia will join the eurozone on January 1, 2014. In 2009, Latvia almost went bankrupt, but recovered surprisingly quickly. Can its path to recovery serve as a blueprint for other European countries?


Latvia's premier Valdis Dombrovskis believes he has found the best way out of an economic crisis. He is against borrowing too much to boost growth and he advocates comprehensive structural reforms even if they are painful.


Many leading Latvian politicians agree that his path could be a role model for other countries. They see Latvia as the model student of Europe, pointing to the country's high growth rate and balanced budgets.


"The euro is not an end in itself, it's a way for the government to sustain growth," says Inese Vaidere, a member of the European Parliament and economics lecturer. Latvians are convinced, she says, that a big and largely closed currency union like the eurozone can attract more investment than just a national currency area.


"Being part of the eurozone reduces risks for investors," Former Economy Minister Krisjanis Karins, who is also a member of the European Parliament, says. He points to its neighbor Estonia, which has seen foreign direct investment almost double in the past two years.


Shock treatment


The road to recovery and the euro has been hard work for Latvia. Five years ago the country was on its knees, sustained only through emergency loans from the EU and the International Monetary Fund (IMF).


In return for the substantial international aid, Latvia had to make stringent cuts - in 2009 alone, wages were reduced by 30 percent and government spending was cut by 20 percent. Unemployment shot up.


But the government under premier Dombrovskis stuck to its guns and can now reap the rewards - Latvia's growth for this year is expected to reach 5 percent, which Karins believes is a sustainable rate.


"We can't live beyond our means for long, that's a fact all European countries have to face," he says. Latvia had to balance its budget sooner rather than later as no one was granting it more credit, Karins said.


During the boom times of the early 2000s, when the economy was fuelled by cheap credit, the rate of inflation was already reaching double figures.


For fear of hyperinflation, Latvia refused to devalue its own currency to boost its competitiveness. Instead, the government decided to choose the much more painful option of a so-called internal devaluation, which calls for cutting wages, in Latvia's case especially in the public sector.


 Latvia's Prime Minister Valdis Dombrovskis addresses a news conference on the adoption of the euro by Latvia at the European Union council building in Brussels July 9, 2013. The euro zone embraced tiny Latvia as its newest member on Tuesday, eager to show that the bloc is not disintegrating while doubts remain about southern Europe's ability to overcome more than three years of crisis.


No panacea


So, can this model work for crisis-ridden southern European countries too? "The difference between us and other countries in Europe is that we have a small, but very open economy, which means we can focus on boosting exports to achieve growth," Karins says, adding that there isn't an approach that fits everybody's bill.


He believes that a big country with a weak export sector and strong domestic demand would not necessarily benefit from internal devaluation.


Expert opinion notwithstanding, many Latvians are eyeing the euro with suspicion. But the government and others in favor of euro entry point to polls showing that support is rising, compared with just a few months ago. They are confident that Latvians will learn to appreciate the single currency.


Cross-party consensus key


Economist Vaidere says the most important factor in joining the euro is that all parties were agreed on the move. She concedes that there were protests against the government's austerity measures, but because all political parties, as well as the unions, supported the government's course, it worked out in the end. She believes southern European countries should follow that lead.


"If I may offer some advice to Greece," Vaidere tells DW, "the people there should not just take to the streets, they should also think about what can be done to reduce government spending."


Latvia, she points out, has already lowered government and public sector spending to 36 percent of gross domestic product (GDP). In Greece, the equivalent rate is still around 50 percent, which means there is more potential for savings, says Vaidere.


But Latvia's future economic course is by no means clear. Latvia recently passed several laws Brussels is keeping a beady eye on. They involve lowering capital gains tax, which could lead to an inflated banking sector, especially given that a lot of equity is expected to flood in from the former Soviet countries.