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A Not-So-Surprising Accession

9. January 2014, von Alexandre Abreu, Comments (0)

On January 1st, 2014, the day on which the euro had its 15th birthday, Latvia became the 18th member of the eurozone. This accession was prepared over many years and Lithuania is scheduled to follow in 2015, but still this will have come as a surprise to many. Given the predicaments to which eurozone members, and especially the more peripheral and economically-fragile ones, have been subjected to in the last few years, one would imagine eurozone exits to be more likely than eurozone accessions. And yet here we have Latvia proving just the opposite. So what are we to make of all this?

Let us begin by rewinding the tape a few years. Latvia was hit by a severe financial crisis in 2008, as a consequence of the bursting of a credit bubble. In its core, the mechanism was not dissimilar from those which affected most crisis-ridden countries of the eurozone periphery: an inadequate exchange rate (in the case of the Latvian lats, due to its peg to the euro since 2005) giving rise to a mismatch between external economic competitiveness and financial-market inflows and a gradually inflating bubble leading to an inevitable bust triggered by the Global Financial Crisis.

Like the crisis-ridden countries of the eurozone periphery, Latvia requested, and was given, a bailout package (worth €7.5Bn) by the EC-ECB-IMF troika. Quite unlike the peripheral eurozone countries, however, Latvia did have a significant margin to choose between two alternative courses of action when it came to responding to the crisis: given that it had not actually adopted the euro, but merely pegged its currency to it, the choice between internal and external devaluation was a real one. Thus, the Latvian government of the time could perfectly well have abandoned the ERM II mechanism, devalued the lats, undertaken external stabilisation in a way which ensured that the cost of adjustment was borne by the whole of society, and subsequently pursued counter-cyclical fiscal policies. Instead, it chose internal devaluation: keeping the peg and having the overwhelming cost of adjustment be borne by workers through the reduction of ‘labour costs’. The class dimension of this choice is not difficult to see: between having everyone pay (through devaluation-induced inflation) and having workers and the popular classes pay (through wage cuts and austerity measures such as school and hospital closures), the Latvian government chose the latter. And it did so with more than a little cynicism, by attempting to suggest that this choice was made out of social considerations.

Now, we cannot say for sure what would have happened had Latvia made the alternative choice. What we do know, however, is what the selected course of action brought about: a 24% drop in GDP, including a drop by 17.7% in 2009 alone; an increase in unemployment from 8% to 18% in 2008-2009; and the emigration of about one-tenth of the labour force. What the ‘austeritarian’ camp hails as one of its greatest success stories (because of the subsequent recovery: 5.5% in 2011, 5.6% in 2012) is arguably anything but: six years into the crisis, Latvian output remains below the pre-crisis level, unemployment remains at 11% despite mass emigration, poverty and inequality have increased, social services have been slashed, and the demographic fallout of mass emigration will only be felt in earnest further down the road.

What is most interesting to note, then, is that the Latvian government was in a much better position to avoid the social pains of austerity than the countries of the eurozone periphery but nevertheless chose not to do so – and it chose not to do so because what seems like a dysfunctional choice from the point of view of society as a whole, is in fact a perfectly rational course of action from the point of view of particular vested interests. From the standpoint of the financial elite and of the politicians that represent it, joining the euro and abandoning the lats has little to do with the pursuit of noble continental ideals, and a lot to do with further reinforcing of class power. Little wonder then that not more than 22% of Latvians favour joining the euro. And so the tragedy continues.

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Adriaan SchoutAdriaan Schout

Dr Adriaan Schout is Deputy Director Research/Europe at Clingendael, Netherlands Institute of International relations. (read more...)

Alexandre AbreuAlexandre Abreu

Dr Alexandre Abreu is a 33-year-old Portuguese economist with a PhD from the University of London. Currently he is a lecturer in Development Economics at the Institute of Economics and Business Administration, Technical University of Lisbon, and a Researcher at the Centre for African and Development Studies of the same University.

Almut MöllerAlmut Möller

Almut Möller is a political analyst in European integration and European foreign policy. She is currently the head of the Alfred von Oppenheim Centre for European Policy Studies at the German Council on Foreign Relations (DGAP) in Berlin. (read more...)

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