Is Latvia an Example to Other States in Economic Crisis?

Latvian bank run.

Latvian bank run.

Latvia is the model economy that can teach the world how to survive the financial crisis. That, at least, is the opinion of renowned economics columnist Robert Samuelson, who published a Washington Post article praising the Latvian economy. In “What We Can Learn from Latvia’s Economic Recovery,” he argued that Latvia, which suffered an economic collapse in 2008-2009, turned around because Latvian authorities implemented “tax increases, layoffs, salary cuts and other spending reductions.” It also cut its budget by 16 percent of GDP, fired 29 percent of government workers, and reduced wages for the rest by 26 percent.

Latvian banks must maintain stability and public interest in order to avoid disrupting the Latvian economy. The KrÄjbanka and Swedbank crises call into question Samuelson’s previous arguments that the IMF’s fiscal austerity packages saved the Latvian economy. Despite positive improvements to unemployment statistics quoted by Samuelson, these banking crises suggest that Latvia is no model for other countries to follow.

Recent economic news out of Latvia seems to contradict Samuelson’s rosy assessment. On the weekend of December 9-11, 2011 Swedbank clients in Latvia withdrew nearly $30 million, or seven times more than usual, due to a false rumor spread via text message and social media. Swedbank boasted of $2.9 billion in deposits in Latvia and $82 billion internationally showing that the run was not a significant threat for the bank. Less than a month before, the Latvian government nationalized KrÄjbanka, a subsidiary of the Lithuanian Snoras bank, when the Lithuanian bank’s two owners stood accused of embezzlement. These recent crises exemplify the lack of faith Latvians have in their banking system.

But it’s not just the current Latvian banking news that undercuts Samuelson’s arguments. According to Jason Bush writing in Der Spiegel, “Latvia is suffering because it followed orthodox economic advice, liberalizing its financial sector and opening the economy to outside capital and investment.” When Bush asked lending institutions how this happened, Erik Berglof of the European Bank for Reconstruction and Development told him, “The model wasn’t the mistake. The mistake was the lack of architecture to support the model.” Berglof was speaking more specifically about the lack of credit monitoring, which had resulted in the bubble economy. Only three years previous, Parex, then the second-largest bank in Latvia, had also been nationalized. Latvia had to take $2.35 billion in aid from the IMF to bail out Parex.

These banking crises, as well as a long history of financial problems dating back to the Soviet period, have undercut consumer confidence in the Latvian banking system. The Parex banking crisis should have taught Latvian and international authorities to increase transparency, monitoring, and evaluation of the Latvian banking sector.

However, the KrÄjbanka and Swedbank crises illustrated that austerity packages and job cuts have not solved the lack of consumer confidence in the Latvian banking system or financial officials. According to the Wall Street Journal’s Gustav Sandstrom, “a poll from Latvian research institute SKDS last month [showed] that only 14% of the population trust what top-level officials say about issues relating to financial stability.”

Latvian banks must maintain stability and public interest in order to avoid disrupting the Latvian economy. The KrÄjbanka and Swedbank crises call into question Samuelson’s previous arguments that the IMF’s fiscal austerity packages saved the Latvian economy. Despite positive improvements to unemployment statistics quoted by Samuelson, these banking crises suggest that Latvia is no model for other countries to follow.

Julia A. Heath is an intern at Foreign Policy in Focus.