September 23, 2011 / 1:32 PM / 6 years ago

Latvia teaches austerity pain and gain to Greece

RIGA (Reuters) - Latvia’s lesson for Greece is that harsh austerity is unavoidable to remedy years of over-indulgence but the vast social differences between the two countries suggest it may be lost on ordinary Greeks.

Latvians, having suffered two years of a strict diet under IMF/EU orders, can attest to plenty of pain which was largely accepted with stoicism. With people starting to see the economy being brought back to health, they can now see the gain too.

In Greece, outrage among a public more used to the good life is already at fever pitch, testing the government’s ability to push through the stringent measures it needs to cut a mountainous debt and avoid default.

Although a party backing more social spending was the biggest winner in Latvia’s general election on September 17, the country is unlikely to stray far off the path of austerity as the two center-right parties with which it aims to work will have more seats in parliament and say in the coalition.

“Currently, it seems that all parties have agreed to the principle that Latvia’s economic stabilization programme should be continued and the international loan programme should be finished,” current Prime Minister Valdis Dombrovskis told Reuters during coalition talks after the election.

Latvia suffered the deepest recession in the European Union in 2009, when the economy nose-dived 18 percent. The government had to take a hatchet to the budget in return for a 7.5 billion euro bailout from the International Monetary Fund and EU.

Political haggling to form a new government will continue but the budget job still be done, finding about 100 million Latvian lats ($190 million) of further savings, is small compared to the work already completed.

Over two years of austerity under Dombrovskis, Latvia lopped more than $2 billion off the budget deficit in public sector pay cuts, spending reductions and tax hikes equal to more than 10 percent of gross domestic product (GDP).

The way the IMF and EU see it, Greek leaders have tried to evade such harsh austerity cuts, which include reducing a bloated civil service by 150,000 by 2015 and selling 50 billion euros of state assets.

Dombrovskis said the hard work paid off.

”It took us more or less a year to regain confidence in financial markets,“ he said. ”With the adoption of the 2010 budget, it was clear the confidence of the financial markets was returning and we immediately returned to economic growth.

“I think it’s really in Greece’s interest to actually go ahead with this package ... The point is that financial stability is a precondition for economic growth,” he said.

VERY DIFFERENT PLACES

Though Latvia is a poster child of austerity for Greece, the two countries are very different places, in terms of history and political culture.

Despite some of the harshest public sector pay cuts enacted in Europe, Latvia had one riot, in January 2009, and some peaceful demonstrations.

In Greece, unions have fought the austerity measures tooth and nail, politicians have been assaulted and it has seen near daily demonstrations. Protesters were camped in a square outside the shuttered parliament building for months.

The relatively passive public reaction in Latvia could be partly attributable to the memory of the bleak years of Soviet rule and the massive post-Soviet dislocation and, possibly, a more stoic northern European attitude.

Greece has been used to a steadily rising standard of living since World War Two, although the country remains one of the euro zone’s poorest.

Until the mid-1970s Greece posted healthy growth on its own. After 1981, when the country joined the then-European Community, growth was supported by billions of euros of EU aid, compounded by a credit-fueled boom since it joined the euro zone.

Greeks are going through their longest post-war recession, with GDP expected to shrink for a fourth consecutive year in 2012, which is hard for people to stomach given that the cutting back has only just begun.

Latvia on the other hand is still a developing economy.

“Latvians have lived through much worse, 1000 percent inflation in 1991, ‘92, ‘93, the early years of transition,” Said Daunis Auers, a political science professor at the University of Latvia.

“Then in ‘95-‘96 people lost their savings and there was the ‘98 rouble collapse. The 1990s were a pretty tough time and people remember that. That’s why people haven’t taken to the streets.”

FELL OFF A CLIFF

A drop in wages and prices after the 2008 crash led to Latvia becoming more competitive and provided the foundation for the export growth taken as evidence of an economic recovery.

Gross domestic product expanded 5.6 percent in the second quarter of 2011, much better than the EU’s total 1.7 percent growth. Unemployment has fallen to 16.2 percent from 20.5 percent in the first quarter of 2010.

But would it work the same way in Greece, given the differences in the two countries’ economies?

“Latvia is a very open economy, 50 to 55 percent is geared toward exports, in Greece it is only 20 percent. Our government debt is 45 percent of GDP versus 140 percent for Greece,” said Swedbank economist Lija Strasuna.

The public sector pay cuts and recession led to falling Latvian wages and domestic prices, which economists called an “internal devaluation” as opposed to a devaluation of the lat currency, which policy makers wanted to avoid.

According to IMF data, real gross wages fell 6.9 percent in 2009 and by 7.9 percent in 2010.

This is the trick which Greece will find most difficult to achieve, said Morten Hansen, economics professor at the Stockholm School of Economics in Riga.

“Greece should do internal devaluation, but they cannot do that (because of the public protests). In Greece they are between rock and a hard place,” he said.

The plunge into greater poverty in Latvia was all the harsher as it came from the peak of a boom after the country entered the European Union in 2004.

Swedish banks pumped cheap credit into the economy, nearly everyone had a job and wages were rocketing.

“In mid-2000 it was like it was midnight at a party where everyone is boozing freely,” said Auers.

“Then the building work stopped, the lawyers had no more deals to work on and investments froze ... Now we have to deal with the hangover -- the mess,” he said.

“Latvia had the biggest credit boom in Europe, possibly even the biggest in the world,” added Hansen. “With a lot of people employed, the government had a huge windfall of tax revenues, but they still managed to have budget deficits. Then, the tax revenue fell off the cliff.”

PEOPLE FEEL THE BLOW

Even if Greece can achieve the same cutbacks as Latvia, the Baltic state’s experience demonstrates the downside in terms of people’s suffering.

Former nurse Rita Lalina, who had to take food handouts, was such a person. The first visit to a soup kitchen was difficult, she said.

“There were so many alcoholics and homeless. The smell was hardly bearable. But now they moved the kitchen to ... a new place and there are other people like me coming,” said Lalina, 34, a nurse who is on maternity leave.

Lalina said she had her nurse’s salary cut in 2009 by almost 30 percent to 160 lats ($308) a month.

Her husband kept his job despite 20 percent unemployment, but the family survives on 220 lats a month after housing costs, hence the soup kitchen visits.

The kitchen that Lalina frequents opened only in March and is lined with wooden tables and benches. People take ladles of rice and meat stew, borscht soup and cabbage salad and eat their portions on the spot or fill plastic containers to take away.

“We have opened more soup kitchens in Riga this year, because we saw rising demand,” said Riga city council welfare department official Aldis Strapcans.

Many Latvians are voting with their feet by emigrating, something which began after EU countries like Britain opened up their labor markets to workers from eastern Europe and has remained.

The population has fallen from 2.7 million after independence was regained from the former Soviet Union in 1991 to 2.2 million in the first half of 2011.

Irita Abola, 38, who worked as a saleswomen in a Riga store that was shut in the downturn, went to Britain in search of work and stayed. She was back just for a visit.

“I work now in a greenhouse, and earn much more,” she said. “In Latvia, I used to earn 120 lats per month, now I am getting 340 pounds per week.”

A recent Estonian Human Development report, which dealt with issues in the whole Baltic, was bleak: “Latvia will be one of the most quickly shrinking populations in Europe.” ($1 = 0.527 Latvian Lats)

Additional reporting by Harry Papachristou in Athens and Patrick Lannin in Stockholm, editing by Mike Peacock

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