What Ireland Can Learn From Latvia's Fate

I have spent the past week in Eastern Europe trying to learn something about the right way to impose fiscal austerity.

The region throws up some fascinating examples that Dublin might like to study as Ireland battles to keep its fiscal independence. The most illuminating of my destinations turned out to be Latvia.

Much has been written about the Baltic state that delivered the worst economic performance in the EU last year.

Gross domestic product fell by 18 percent in 2009 and employment decreased by roughly 20 percent from peak to trough.

Latvia’s boom was driven overwhelmingly by consumer spending, with 70 percent of its growth from 2000 to 2008 from this source.

In the wake of the collapse of Lehman Brothers foreign money fled the country and the consumer-driven boom and housing market were left in tatters.

The country took IMF and EU support which, as Prime Minister Valdis Dombrovskis told me last week, “came with strings”.

IMF-style cuts were imposed, resulting in fiscal tightening to the tune of 14 percent of GDP last year. The parallels with Ireland are striking.

Both countries experienced a consumer-driven boom and bust. Both have applied fiscal tightening measures that have been applauded by financial markets. And neither country was able to devalue its currency to export it out of trouble.

Latvia decided not to devalue the ‘Lat’ to boost exports as so many of its households were indebted in euros. Instead of forcing many families into bankruptcy, the country decided to protect its currency peg to the euro.

Ireland’s euro zone membership results in the same lack of currency flexibility. The differences are significant though in both timing and scale.

Ireland’s plansinvolve spending the equivalent of 50 percent of GDP on bailing out its banks. Latvia spent only 10 percent of its GDP in part-nationalizing Parex bank.

It created a good-bank and bad-bank, just as Ireland has done, but because much of the consumer boom in Latvia had been driven by Scandinavian banking giants (SEB and Nordea are still on every street corner in Riga), it fell to Swedish and Norwegian governments to deal with them.

Things are looking up now for Latvia as growth is returning, wages are bottoming out and unemployment has stopped rising. But the social costs of austerity have been great.

Hospitals and schools have been closed and local journalists told me many Latvians just left the country. Ireland may now have little say in its fiscal fate, but a little study of the Baltic beacon of budget-busting might be time well spent.