High-level European Union and International Monetary Fund officials have called on Greece and other eurozone periphery countries facing a debt crisis to follow the example of Latvia in dealing with their economic problems. They are the same officials who have approved tax hikes and focused on tax revenues to close the Greek budget gap, running counter to Latvia?s deep budget spending cuts. The lesson from Latvia for both Greece and its creditors is that upfront spending cuts and a downsized public sector are key to a successful adjustment program.
Amid growing criticism for prescribing excessive austerity in the bailout programs imposed on eurozone periphery countries, the EU and the IMF have turned to Latvia in their search for a successful model. Their purpose is to show that internal devaluation policies can work in countries where currency devaluation is not an option.
Speaking to an IMF conference in Latvia?s capital Riga earlier this month, the fund?s head, Christine Lagarde, praised the small Baltic state, which sought international help at the end of 2008, for biting the bullet and tackling its economic problems fast and hard by taking some brave decisions. She also had warm words for Latvian politicians for internalizing the reform program.
It is true the Greek Socialist government under George Papandreou, which sought a bailout in May 2010, did not really endorse structural reforms. After a strong start in the summer of 2010 with the overhaul of the social security system, the administration?s priority seemed to be to protect the interests of its main voter base, namely the employees in the public sector, and meet the budget deficit target set out in the economic adjustment program.
The Socialist government tried to reconcile both goals by relying on tax hikes to reduce the budget deficit and limit expenditure cuts to minimize the impact on civil servants. As a result Greek civil servants avoided the tough luck of their Latvian colleagues, who saw almost 30 percent of their peers being laid off at the start of the program.
Moreover, the remaining employees experienced wage cuts of 26 percent on average compared to similar progressive cuts in Greece. Accustomed to job tenure and sensing the extent of the economic calamity, it is understandable that the vast majority of Greek civil servants have flocked to the Coalition of the Radical Left (SYRIZA) on promises it will not fire anyone in the civil service and will even swell its ranks with new hires.
In contrast to Latvia, the Greek tax raid spread the pain of fiscal consolidation to the whole economy from the beginning, mostly hurting the private sector. The latter had also to endure continued delays in payments to suppliers and others as the government chose to fully pay wages and pensions at the expense of building arrears to the private sector in excess of 6 billion euros. This technically decreased government spending as well.
Numbers do not lie. The tax revenues of the Greek general government went up to about 41 percent of GDP in 2011 from 38.2 percent in 2009 and are projected to rise further to 42.4 percent this year despite the longest and deepest recession in decades.
On the other hand, total spending has stabilized around 50 percent of GDP from an all-time high of 53.8 percent in 2009. This is way above the average of 45-46 percent during the 2001-08 period.
In Latvia, the general government spent 44.5 percent of output in 2009 but this figure declined to 39 percent in 2011 and is projected to fall to 38 percent in 2012. Tax revenues increased from 34.5 percent in 2009 to 35.6 percent in 2011, when the Latvian economy returned to growth, and is seen rising to 36 percent in 2012.
Nevertheless, despite all the praise for Latvia by EU and IMF officials, Greece?s fiscal consolidation has been bigger than the small Baltic country?s. The Greek primary budget deficit, which does not take into account interest payments on public debt, fell to 2.2 percent of GDP last year from 10.4 percent in 2009, an improvement of 8.2 percentage points. Latvia?s primary budget deficit fell to 2 percent of GDP in 2011 from 8.3 percent in 2009, a decrease of 6.3 percentage points in terms of output.
The improvement in the overall general government budget deficit has been similar in both countries, or 6.5 to 6.3 percentage points, but this is explained by their huge public debt burdens.
Of course, the Greek unemployment rate continues to climb, approaching 22 percent in March as the economy continues to weaken, while Latvia?s jobless rate appears to be heading south as its economy recovers, although it remains high above 15 percent.
All in all, the figures show Greece?s fiscal consolidation has been greater than Latvia?s so far. However, Greece?s heavy reliance on taxes to close the huge budget gap along with the former Socialist government?s half-hearted endorsement of structural reforms have undermined the private sector, dragging out the downturn and resulting in reform fatigue.
Although the country?s creditors cannot be blamed for the slow pace of structural reforms here, it is fair to say they are also accountable for stressing tax revenues as a means of filling the budget gap. It is therefore paradoxical to praise Latvia, which focused on spending cuts, as a success story while doing quite the opposite in Greece by approving tax raids. Unless they mistakenly believe it would have sufficed for the Greek economy to grow if local politicians and bureaucrats implemented reforms which usually bear fruit in the medium to long term with the public debt-to-GDP ratio above 150 percent.