PPIGS: EU's Internal Periphery, Left Forum 2010

Are the Germans going to drive the continent into recession to maintain their own fiscal health?

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Jeffery Sommers

Latvian economy gone from celebrated as Baltic tiger, to the poorest performing economy in Europe.

Burning up of its currency reserves to rescue its banks—those are not available, anymore, for rescuing its economy.

A serious demographic crisis that verges on the euthanizing of the population (the young generation is streaming out of the country). The 'exit' option—some 10,000 people on the streets in January, but this didn't go anywhere.

As early as the 1980s, there was great interest in Latvia—the crisis of the 70's had given rise to a desire to acquire raw materials located in the old Soviet Union. Latvia had warm water ports to facilitate this. An entrepreneurial class was well-positioned to take advantage of this; moreover, offshore banking/etc. saw an opportunity in this trade, as well (the money that was being used to purchase this raw materials was eventually being returned to the West, of course).

We see the beginnings, in short, of a highly corrupt offshore infrastructure.

With the fall of the Soviet Union, there was a need/desire to cement this arrangement—attract FDI, etc. (turned out to be largely speculative)

Simultaneous to this, the EU was launching its currency project (Maastricht) – one way to mitigate the unemployment in W. Europe was to dump goods in the old Soviet bloc (we see a reversal of trade flows, which served the interests of Germany and France; strong currencies in this regions served the interests of exporters in those W. Countries).

Despite political changes, there has been great consistency in the country's finance policies for the past 20 years. They have been resolute in their defence of the policies that have led to today's crisis.

25 banks for 2.3 million people, most of which are serving these offshore interests.

Latvia has reached a point where the legitimacy of the neoliberal paradigm is finally under question. We do see the possibility of some of the political parties in the country demanding some change in economic policy. Not enough mobilization from below, of course.

Biggest steps that need to be taken.

1. Introduce industrial policy.
2. Tax policy revision (high on labor, low on capital thus far) – this has made Latvia uncompetitive, when coupled with its high currency
3. Development of the agricultural sector (Lativa historically a major producer of grains, but neglected in the neoliberal era, completely)

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Mark Weisbrot

Latvian Central Banker pursuing a 'pro-cylical' policy – i.e., making the recession worse until wages fall enough to 'fix' the economy.

This will be a record loss of output for a cyclical downturn (slated to be greater than US depression in 1929-1933; comparable to destruction of Argentinian economy, where they tried to adjust the economy without adjusting the exchange rate. Defaulted, their currency collapsed—retracted for three months, and then grew 63% in the ensuing years)

The IMF has a fair bit of money, again. Alas. (In Latvia, the main thing that enforces these policies is the European Commission—a very powerful material interest, since European banks have loaned in excess of $1.4 trillion dollars to central and E. Europe. They stand to lose tremendously. A lot of money has been given to the IMF by major countries to 'save' Europe, in effect)

The economics of this crisis, then: when you have a situation like Latvia's (or the PIIGS), there are three macro policies

1. fiscal policy (as has been used, a little bit, in the US)
2. monetary policy (interest rate policy; 'quantitative easing')
3. exchange rate policy (let your currency fall in order to stimulate your exports and cut down your imports)

Latvia and Greece are in a situation where all of these policies are basically off-limits. If Greece, or Spain, could devalue their currencies, they may be on the road to recovery. Part of this would be the trade impact, but not all. When you have a fixed, overvalued exchange rate, you are in a situation where you can't use the other two policies, either—you can't use monetary policy, because you are afraid that when you do that, you will get a run on the currency (and then you've lost your precious peg, which they're holding so they can get the Euro).

The other problem with a fixed currency, like this, is the great loss in investor confidence (they're borrowing at 6.5 percent due to the fear that the economy might collapse; Greece is facing a similar problem).

To generalize to Europe, at large, is that they're all start with an overvalued currency, which prohibits them from pursuing expansionary policies that would be used to get out of their crisis.

So what is the ultimate lesson? Neo-liberalism has failed, yes. Economic integration is not a bad notion, but it took place under a neoliberal framework. They are not going to be able to take commonsense measures to escape the recession.