Despite a 19.6 % drop in second quarter GDP, Latvia's prime minister Valdis Dombrovskis does not believe the country is heading into a so-called L shaped recession, the portal Delfi reports (in Latvian). In an L-shaped recession, there is a sharp drop followed by prolonged stagnation.
Unfortunately, this is unwarranted optimism. The problem is not the presence or lack of stimulus (although mechanical and largely chaotic budget cuts of over LVL 1 billion are a considerable "anti-stimulus"), but one of trust in the Latvian government as an institution. This, I believe, has completely and irrevocably failed. The past governments have allowed the country to spin into a recession and crisis that is far more severe than had some preventive measures been taken over the past two or three years. The present government has irreparably broken the compulsory social contract by effectively shutting down health care and education and cutting pensions (by 70 % for working pensioners). It has raised and plans to additionally raise taxes as the tax base contracts, thereby stimulating only the gray economy.
Don't get me wrong -- there is a lot of waste in the way Latvia is governed and in the way medical and educational services are delivered, but to chop them off and toss this into the "care"of society with little warning is not a solution. The right thing to do would have been to carefully analyze (by independent third parties) the gross inefficiencies of Latvia's government and public services and to start a gradual downscaling (privatizing hospitals, but setting up a credible private/cooperative health insurance network, cutting taxes and allowing broader use of private pensions, setting up private/cooperative schools with tax reductions and deductions). I suppose it would take some 10 years to move Latvia toward a night-watchman state with minimal taxes and a core of police, judiciary and defense services. Instead, the government has announced no plan, it has broken implied social promises and it has demoralized the able, working parts of the population ensuring that, as soon as the rest of the EU starts to recover, tens of thousands of Latvians will emigrate. This will ensure the stagnation of the economy as labor skills and entrepreneurial talent go elsewhere.
I am afraid that L is where we are going.