Christine Lagarde's perverse praise for Latvia's economic 'success'

baltic region | economy | non-anarchist press Friday June 08, 2012 16:50 by Mark Weisbrot - The Guardian

The IMF chief surely knows better than to believe Latvia's disastrous internal devaluation is a good plan for the eurozone.

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 last week, 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 flipped to the far-right end of the policy spectrum. In a 5 June speech in Latvia, she praised that country's 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% to over 20% 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%.

But even that doesn't measure the extent of the suffering that Latvians have endured. About 10% of the labor force left the country, many never to come back. The Latvian economy grew by 5.5% last year, but is projected to grow by just 2% 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% for the official rate, and 23.6% 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 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 even have a successful "internal devaluation", even ignoring the social and human cost – as the Troika (ECB, European Commission, and IMF) 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 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 they didn't do what they 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, which wanted to make sure they didn't devalue their currency, as that would have left the Swedish banks with big losses.

So, the lesson for the eurozone is the very opposite of what Lagarde is preaching: if you do what the Troika is prescribing, you will have a devastating recession with vast unemployment – witness Greece and Spain. "Internal devaluation" does not 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 US economy did eventually recover in the 1940s. And the US lost a comparable amount of output during 1929-33 to what 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.