The new EU fiscal rules being finalised would still leave central- and eastern-European states such as Latvia in a bind.
It is no secret that the fiscal and monetary architecture of the European Union has been made in the image of Germany, with a little touch of France. The European Central Bank is basically a twin for the Bundesbank with its institutional emphasis on price stability, conceptualised as 2 per cent inflation in the medium term. This has been coupled with dedication to fiscal discipline, which supports Germany’s export-oriented growth model (France has historically been more lenient when it comes to public spending).
These broad outlines were reinforced during the Global Financial Crisis, which polarised the EU while forcing most member states to try to copy the German idea of development. There is nothing inherently wrong with the notion that one becomes rich through exports: many countries have shown that pursuing such an industrial strategy can bring rewards. Not everyone, however, can feasibly achieve that, since for every net exporter there must be a net importer. Yet the crux of the matter is more political.
One hurdle after another
Take Latvia as an example. The country does not have the political weight to counter the fiscal and monetary imperatives of the EU, so faute de mieux it embraces them. Unwittingly it tries to become like Germany but runs up against one hurdle after another which stymie its development.
Since regaining independence, exporting has always been seen as the strategic economic objective, since the population is small and the domestic market thus limited. Moreover, Latvia has consistently suffered net emigration, further restricting opportunities to grow the home market.
Yet Latvia is unable to answer a very simple question: what does it want to export? Goods or services? Which sectors in particular? And how does it support that? An embedded neoliberal mindset rejects even asking these questions, believing it to be up to the market, not politicians, to decide.
Extreme suspicion
The total victory of neoliberalism in eastern Europe more broadly is not surprising: after breaking out of the Soviet occupation, any whiff of the public sector becoming involved in decisions regarding industrial policy meets extreme suspicion. Yet the market philosophy of the EU also plays a significant role here—any ‘state aid’ to market participants is strictly regulated and the private sector is institutionalised as sole arbiter of potential growth areas.
For a small open economy such as Latvia’s, the result is dependence on the export of low- to medium-value goods and services. Every government in Riga touts its ambition to move up the value scale, but the political instruments to achieve that are few and far between and a sceptical eye is cast on politicians using them anyway. Latvia has achieved a positive trade balance only twice in the last 30 years—a sure sign of policy failure.
One obvious industrial opportunity is provided by the green transition. In fact, allocation of EU funds comprises the unwritten industrial policy of the country, allowing politicians further to evade these difficult questions by pointing to how public-investment goals are decided at EU level.
But the funds for the energy transition and climate adaptation do not address the strategic question of onshoring the production of components needed for renewable energy. As long as the approach of ‘de-risking’ private investments prevails over direct public investments to support domestic industry, Latvia is unlikely to change its export structure.
Export-led inequality
Overcoming these hurdles would not anyway mean a smooth road to prosperity. The policy dilemma then becomes: how to avoid export-led inequality? The rewards of exports do not trickle down evenly.
The social justification of export-led growth is that increasing state revenues allow government to invest in public services. But Germany demonstrates that the counterpart to supporting exports is suppressing domestic wages and consumption, to retain cost-competitiveness and limit imports.
Inequality in the labour market thus emerges between workers in the exporting industries and those employed mainly in the service and domestic sectors. Even if overall welfare might increase, the uneven distribution of rewards is always going to be a political problem.
The unresolved question haunts Latvia of the role of the domestic market in an export-led growth model. Local producers can rarely scale up as the local market suffers from low purchasing power and decreasing population. The result is a significant shadow economy and unsuccessful demands to lower taxes.
Yet the more substantial inequality exists between those in the labour market and those outside it, living on savings, pensions and benefits. The rate of senior-citizen poverty in Latvia is one of the highest among the members of the Organsation for Economic Co-operation and Development. For them, the rewards of exports will probably never be tangible.
Opportunity lost
If such income inequality is to be reduced, then becoming like Germany is simply not possible: it would require relaxing the imperative of fiscal discipline. Yet if the state were to spend more by increasing pensions and benefits, it would risk deficits on the budget and the current account.
Enhanced public spending would have to foster growth of the domestic market, rather than leaching out into imports. But the rules of the single market, alongside those of the monetary union, act as a brake on such potential instruments, whose utilisation would probably carry a political risk too.
Thus, becoming like Germany places Latvia in a bind: accept substantial income inequality or suffer the political costs of relaxing fiscal discipline. This dilemma illustrates the conundrum in which many eastern-European EU member states find themselves.
It is precisely why the new fiscal rules—while a step in the right direction—are such a disappointment. At a time when the EU also has to rethink its approach to industrial policy, a colossal opportunity has been lost to find a sustainable solution to the geographical divide defining Europe. As a result, countries such as Latvia will be marked by their attempts to emulate the hegemon of Europe, while grappling with the historical and structural hurdles that prevent them ever succeeding.
Andris Šuvajevs is a member of Latvia’s parliament, representing the Progressives, a green party of the left. His political work is focused on fiscal and tax policy as well as public spending. He has previously worked as a financial journalist, policy analyst and lecturer in social anthropology.