IMF Chief Praises Latvian "Success Story" - A Scary Speech for the Eurozone

from Mark Weisbrot

IMF Managing Director Christine Lagarde has made conflicting remarks in the last few months indicating that she might have doubts – shared by IMF economists — about the self-destructive economic policies that are pushing the eurozone deeper into recession and causing a financial crisis. This despite her comments that offended many Greeks two weeks ago, in which she appeared dismissive of the mass unemployment and suffering in Greece, saying that she worried more about poor children in Niger who “need even more help than the people in Athens.”

But this week she really flip-flopped over to the far-right side of the policy spectrum. In a June 5 speech in Latvia she praised the government’s economic policy as a “success story” that “could serve as an inspiration for European leaders grappling with the euro crisis.”

Latvia suffered the worst output losses in the world during the world financial crisis and recession of 2008-2009, sacrificing nearly a quarter of its national income at the altar of austerity. Even worse, unemployment rose from 5.3 percent to over 20 percent of the labor force. And if you count the people who dropped out of the labor force or were involuntarily working part time, unemployment/underemployment peaked at more than 30 percent.

But even that doesn’t measure the extent of the suffering that Latvians have endured. About 10 percent of the labor force left the country, many never to come back.

The Latvian economy grew by 5.5 percent last year but is projected to grow by just 2 percent this year – a sluggish recovery for a country that fell so far into a hole. Much worse, unemployment is still brutally high at 16.3 percent for the official rate, and 23.6 percent for the broader measure noted above. IMF projections show Latvia taking a full decade to reach its pre-crisis GDP.

If that is success, perhaps the eurozone governments should start thinking about what the Troika (the European Central Bank, European Commission, and IMF) considers failure.

But the worst part of Lagarde’s twisted message is the idea that eurozone countries could emulate or learn positive lessons from Latvia’s experience.

In fact, Latvia did not have a successful “internal devaluation,” even ignoring the social and human cost – as the Troika likes to do. An “internal devaluation” only works if the country can lower its labor costs enough to become more competitive in world markets, and thereby improve its trade balance. This is done, as was attempted in Latvia, through creating mass unemployment and driving down wages. (This is not a conspiracy theory – this is the actual economic reasoning behind a strategy of “internal devaluation,” and how it is supposed to work.)

Latvia succeeded in creating the mass unemployment, but it didn’t move its real exchange rate enough for this to cause its exports (or reduced imports) to pull it out of recession. In fact, the country’s trade balance contributed very little to the recovery.

So how did Latvia finally recover from its deep recession? The main thing was that in 2010 the government didn’t do what it promised the IMF and the European authorities. They had promised to tighten their budget by a huge amount but they didn’t do it. And they also got some help from unanticipated inflation, which gave them a more expansionary monetary policy than they had planned, and reduced the growth of their public debt. Latvia also got a lot of money from the European authorities, who wanted to make sure they didn’t devalue their currency, which would have left the Swedish banks with big losses.

So the lesson for the eurozone is the opposite of what Lagarde is preaching: if you do what the Troika is prescribing, you will have a devastating recession with vast unemployment – as witness Greece and Spain. “Internal devaluation” doesn’t work. And yes, if the eurozone countries were to ditch the budget austerity, their economies might begin to recover.

It is amazing to hear Lagarde, who almost certainly knows better, calling Latvia a “success.” It is like calling the Great Depression a success – after all, the U.S. economy did eventually recover from the Great Depression. And the U.S. lost a comparable amount of output from 1929-33 as Latvia lost in just two years (2008 and 2009). Spain, Greece, Portugal, Ireland, and the rest of the eurozone will also recover – eventually — and most likely they will do so after a change of macroeconomic policy. Then the IMF and their allies in Europe will ignore the years of lost output and employment, and all of the needless suffering and wasted lives, and announce that these countries have “successfully” restructured their economies — because they did what they were told to do.

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