We have a very special guest today, whom I’d like to welcome to the studio: Valdis Dombrovskis, Prime Minister of Latvia since March 2009, which was a particularly turbulent time for the Latvian economy. Mr. Dombrovskis, who was born in 1971, previously served as an MEP and also Finance Minister for his country. He is also an economist, physicist and author. Welcome to the studio Mr. Dombrovskis.
So what brings you to the Czech Republic? I understand that you were invited by Prime Minister Petr Nečas and that this is the first official visit by a Latvian prime minister for eleven years.
“In fact there are two reasons for the visit. The first is a meeting with Prime Minister Nečas, and I have also been addressing graduates of the American Institute on American and Political and Economic Systems [AIPES] and receiving a Pollack Award.”
Is this your first time in the Czech Republic?
“No, I’ve been here previously in different capacities, also as a Prime Minister during the Czech EU presidency.”
And what is your relationship to the country? Do you enjoy the Czech Republic?
“I certainly do. I think that Prague is one of the most beautiful European cities and I’m always glad to be in Prague and to be able to walk around here and so on...”
I’d like to ask you: Czechs often complain that some Western Europeans talk about ‘Czechoslovakia’ or that they don’t know certain things about the history of the country. Do you find that Latvia also has this problem - that people in Western Europe don’t know too much about Latvia?
“Well, of course we also complain about this but then again, even if we would ask in the Czech Republic to describe the difference between Lithuania and Latvia, quite often you would see confusion. So we are used to the fact that we are a small country and that there is quite often confusion between Baltic states.”
Could you perhaps tell us a little about Latvia? It’s obviously a Baltic country; it neighbours Estonia, Lithuania, Russia and Belarus and it has a population of 2.2 million people. And like the Czech Republic, it joined the European Union in 2004. So what are the key things a person should know about Latvia?
“Currently, Latvia is the EU’s fastest growing EU economy – in the first quarter we had 6.9% economic growth. During the crisis, we also managed to change the structure of the economy, putting more emphasis on industrial production and exports and what we are now trying to do is promote a business environment for both trade and investment. As regards tourism, Latvia is certainly a very beautiful country. A large part of its territory is covered by forests; we have hundreds of kilometres of sandy beaches, so summer is definitely a good time to visit. It is not too crowded and Riga is also a beautiful city, an old Hanseatic town and so on…”
And you mentioned the economic crisis, so I wanted to ask you a little bit about that. In 2008, Latvia suffered a major economic crisis. It was one of the hardest hit countries in terms of the global economic meltdown and it ultimately required a bailout of €7.5 billion; its unemployment went up to 23%; it had a double-digit GDP collapse of more than 25%. And this was around the time that you came into office, so you had a particular approach towards addressing this economic crisis, which is obviously relevant as we look at Spain and Greece today. So tell us how you dealt with Latvia’s problems.
“Of course, in order to address how we dealt with the problems, it is also important to know how we ran into this situation. Especially after Latvia joined the EU, we had rapid double digit economic growth; there was inflow of foreign capital into the country. But the problem was that those capital inflows were not put to productive use. So instead what happened was that we developed a real estate bubble, a construction boom. We had double digit economic growth but not a balanced budget and our current account deficit was reaching more than 20% of GDP. So Latvia’s economy was really overheated; inflation hit double digits. When the global financial crisis stared, all those capital inflows into Latvia suddenly stopped and that is when the country’s economy collapsed. Just in 2009, we had an 18% contraction. Budget revenues were decreasing by some 30%, so what we had to do was more or less three main directions of policy: one was fiscal adjustment to get our finances under control, second was measures to stimulate the economy – given the state of the economy the scope for that was limited and also we created an additional social safety net to deal with the social consequences of the crisis.”
“Between late 2008 and the adoption of the 2012 budget, all in all we undertook a 17% of GDP fiscal consolidation. Roughly one third came from tax increases and two-thirds coming from expenditure cuts. So far, this is the biggest fiscal adjustment that has taken place among the EU27.”
I located a quote from the BBC in which you emphasise the principal of financial certainty as being the most important factor. This, as opposed to ongoing fears about whether taxes will go up or spending will be cut – that the main point, you argue, is that the markets simply know what the government is doing. Is this something you still believe is of the utmost importance?
“I don’t remember that particular quote, but certainly I would agree with that idea today: financial stability really is a precondition for economic growth. I think that there is no contradiction between the fact that Latvia is a country that has done most of the fiscal adjustment of the EU27 and is currently also the fastest growing economy among the EU27.”
Would you prescribe what you did to countries such as Greece or Spain? The unemployment rate in Latvia is currently around 16%, which is obviously better than a country like Spain (24.6%). But you’ve also had some side-effects, such as as many as 200,000 people may have left Latvia as a result of the crisis, which is around 10% of the total population.
“Certainly unemployment is still a cause for concern in Latvia, although it is now steadily decreasing. But still we need to do more in terms of job creation and in terms of facilitating and promoting foreign investment. As regards emigration, it is definitely a big issue for Latvia, and again, it fundamentally depends on the economy. If you have economic growth and if you have good job opportunities in Latvia, then you are less inclined to leave. We saw this in 2004-2005, just after Latvia joined the EU, that already then tens of thousands of people were leaving for other EU member states. At that time, probably the biggest driver was the large wage differences; during the economic crisis, the biggest driver was unemployment. But what we saw, say between 2006-2007, was that economic growth and job opportunities stopped the process of emigration and people even started to return to Latvia.”
“And I think that there are aspects of Latvia’s experience that could be used. First of all, when we undertook our adjustment, it was controversial because many economists were saying that it was not possible to do it and that the currency should be devalued instead. Our rate is fixed to the euro, so we chose not to devaluate for many reasons, and instead we went for real structural reforms and for a so-called ‘internal devaluation’. This helped to restore financial stability quite quickly, and what can be used from the Latvian experience is that if you are in a situation where financial markets do not trust you, you need to act quickly to restore financial stability. What I think is important in the case of the current eurozone crisis, is to not try to delay this necessary fiscal adjustment, but to do it and to restore financial stability.”
And is it politically easier for a smaller country to undertake such measures than it is for a larger country?
“Well, I don’t think it is so much an issue of small countries or big countries. In the case of Latvia, of course what was helpful was that we had a social dialogue. This meant that we were negotiating with trade unions, with the employers’ confederation, with the chamber of commerce, with local governments in order to agree what the measures should be in order to overcome the crisis. And not that there weren’t complaints – of course there were along with disagreeing with many of the measures. But at least these groups were partly on board in the decision making and they were not calling people out onto the streets.”
“If you look, for example, at Germany, they have been undertaking very comprehensive structural reforms for the last ten years without running into a crisis. They did the necessary adjustments in order to stay competitive and this is a big country – the biggest in the EU.”
And one major difference between the Czech Republic and Latvia is that the ongoing economic crisis here has pretty much put eurozone membership off into the distant horizon never to be discussed again, at least for a number of years, whereas Latvia is still on target and insistent that it will join the eurozone in 2014. So why that decision?
“First, it is worth noting that Latvia’s currency, the lats, is pegged to the euro. So whatever is happening to the euro is happening to the lats. From that point of view, it certainly makes sense to join. We also studied Estonia’s experience. They joined during the eurozone crisis in 2011 and yet it still served as a positive signal about financial and economic stability in Estonia and we would expect a similar effect in Latvia. So weighing all the pros and cons, we see that there are more pros in favour of joining than cons. Of course, the public in now less convinced than it was a couple of years ago, so it is also a task of the government to explain all the economic reasoning why we still think that it is a good idea to join.”
And the last question I wanted to ask: as Prime Minister you are dealing with economic matters but you also have a background in physics. So I’m wondering whether you are still interested in that field and whether, for example, you have been following stories like the discovery of the Higgs boson.
“Yes, of course. I still try to follow general developments including the Higgs boson discovery. But my main work in physics was more to do with the physics of lasers.”
“[Laughter] Well, that might take quite a substantial amount of time. I did my Master’s thesis on measuring the exact wavelengths of broadband impulse lasers!”
Valdis Dombrovskis, Prime Minister of Latvia, thank you very much for joining us.