Latvia Moves Forward on Euro

Latvia’s application for Eurozone membership is now with the European Commission.  The latter will announce its decision on July 6.  If, as expected, the Commission says yes, Latvia will introduce the common currency on January 1.

Riga has garnered widespread support within Europe, which is desperate to shore up the besieged currency.  Even France, which previously indicated that it did not want to expand the Euro, has indicated its backing.  Foreign businesses also favor Latvia’s entry; 91 percent of German businessmen in the Baltic States say they approve.

However, Riga’s entry looks like rats running onto a sinking ship to many Latvians.  The majority opposes membership and activists are pressing for a referendum.  The latter would delay entry and has been rejected by the government.

Finance Minister Andris Vilks defended his government’s decision:  “The debt crisis in Eurozone member states and the market reaction to them have prompted a long-overdue policy action to strengthen the coordination of fiscal policy and accelerate reforms.”  Moreover, he added, “The decision of the European Central Bank to emerge as lender of last resort has greatly reduced the risk of potential break-ups.”

Riga also points to the fact that Estonia already is a member and Lithuania plans to join in 2015.

However, Latvia could assuage popular concerns by accelerating economic reforms.  The Baltic State enjoys Europe’s fastest growth rate and IMF Managing Director Christine Lagarde praised Riga last year:  “You have lowered budget deficits and kept government debt ratios to some of the lowest in the EU.  You have become more competitive in world markets through wage and price cuts.”

Nevertheless, the country has paid a high price for its recent economic success, argued economic analyst Zsolt Darvas, with the Belgian think tank Bruegel.  Moreover, Latvia still faces significant economic challenges.  Unemployment dropped marginally in March, but remains high, 10.8 percent, and above December levels.  Industrial production dropped in February.

One problem is Latvia’s high “tax wedge” on labor, that is, the share of workers’ earnings taken by government.  The SEB Baltic Household Outlook reported that the 44.2 percent taken from the average single wage-earner is the highest of the Baltic States and higher than the EU average.  Reducing the wedge would help promote continued growth.

Latvia’s entry into the Euro will not fix the economic zone’s continuing problems.  However, the Euro will benefit from the entry of Latvia’s strong and growing economy.  Riga must continue economic reforms to ensure that Latvia prospers irrespective of what happens elsewhere in Europe.