Harbingers of a new false dawn?

Three newly-elected and sworn former political-emigré Latvian parliament or Saeima deputies met informally with other ex-diaspora (the new terminology) Latvians living in Riga on a Friday evening and spoke with general optimism about what they expected the new Saeima and government to achieve.

Rasma Kārkliņa of Vienotība/Unity (as were the others, Atis Lejiņš and Imants Lieģis) talked about her hopes for reforming and speeding up the system of justice and fighting corruption. The others (Lieģis, minister of defense in the previous government, arrived late because of another engagement) were also upbeat.

Atis Lejiņš took some mild flak for purporting to belong to two political movements at once – Vienotība and the Latvian Social Democratic Workers' Party (LSDSP in Latvian). Its glory days as an exile movement in Sweden under its then leader Bruno Kalniņš long gone, the LSDSP is a borderline crackpot (my personal view) party that ran and lost in the October 2 election as part of the Atbildība/Responsibility ticket. Atbildība plastered Riga trolley-busses with the image of a woman (one of their candidates) putting her head in a noose (because of mortgage debt). This prompted the observation – “ticket number 9 – for hanging yourself”.

Lejiņš said he hoped the LSDSP would elect new leaders in January and then be able to possibly join or align with the Sabiedrība Citai Politikai/Society for a New Politics, a “social democratic lite” member of the Vienotība alliance. We shall see if the younger members of the LSDSP succeed in unseating party leader Jānis Dinēvičs, featured in the election poster campaign dressed and made up as a homeless beggar.

Harking back to 2002

The whole scene reminds me of 2002, when the Vienotība member party (and the party of prime minister Valdis Dombrovskis), Jaunais Laiks/New Era got elected and off to a promising start, speaking of clean and efficient government. The new government's Minister of Health, “Mr. Golden Hands” (as an undeniably good spinal surgeon) Āris Auders was exposed as a double dipper who received state health insurance payments for operations while also soliciting gratuities from his patients.

The new government of Einārs Repše then went on to consolidate remuneration for government ministers in a way that looked like (unless carefully explained) granting a huge pay raise to all ministers without them having a,chieved anything to show that they merited this apparent raise. Things did not go well after that and the Jaunais Laiks-led government proved to be a false dawn for anyone hoping to see an end to corruption and incompetance in the governance of the country.

I bring this up because the euphoria surrounding the victory by Vienotība in the recent elections has been shattered (or should have been shattered) by revelations that Vienotība deputy Silva Bendrāte has been in the pay of Latvia's richest man, Ventspils mayor and oligarch Aivars Lembergs, who faces criminal charges for money laundering and other economic crimes. Among other things, Lembergs used Bendrāte as a straw man (lady?) to buy a radio station in western Latvia.

To be fair, Bendrāte got economically entangled with Lembergs in the the late 1990s, before it was glaringly obvious that he was probably accumulating/skimming/extorting millions from lucrative transit-related (oil, fertilizer) businesses in and around Ventspils. Lembergs is another long story, but as a millionaire mayor, he is anything but Latvia's Michael Bloomberg.

Economy still comatose?

The economy also got mentioned in the Friday night discussion, with discussion moderator and one of the editors of perhaps Latvia's last independent publication, Ir, Pauls Raudseps talking of many signs of recovery. Harvard graduate Raudseps basically quoted from his own column in Ir where he talks of a more than 40% rise in exports and a 10 % increase in retail sales as indicating that both the external and domestic segments of the economy were recovering.

I don't doubt Pauls' mastery of the figures, but it must be remembered that these figures come against a background of month from year-earlier-month declines in retail turnover of more than 30 % in September through December of 2009. So, at best, this is a bottoming out at a level well below that of 2008 (where, of course, we were experiencing consumer spending on crack). Nonetheless,  the Latvian central statistics agency website shows the curve significantly below 2006, which is before the party leading to the crash of the past few years was fully pumped-up. So it is nothing to get excited about, sort of like detecting slightly higher heartbeat, blood pressure and other vitals in a comatose patient. It doesn't really change the comatose state, does it?

Gray economy or anarchistic improvisation?

Another issue raised in the informal discussion with deputies Kārkliņa, Lejiņš and, later, Lieģis, was the problem of the “gray economy” and tax evasion. The very word “gray” defines the problem, because what we are talking about is economic activity that is non-criminal (not drug trading, laundering of stolen goods, fraud, counterfeiting) but fails to pay full taxes.

I think the reason why there is such a gray economy in Latvia goes to the core of my failed state thesis. As I have repeatedly written, Latvia is not a classic failed state, like Somalia where whacked-out gunmen careen through the streets in “technicals” randomly shooting automatic weapons at stray dogs and yelling the equivalent of “yee-haah” in the local dialect. Latvia is a failed state lite because the trust of the population in the state (not really there to begin with) has been irreparably broken by the behavior of those charged with governing the state and by the behavior of the socio-economic elite in general.

So what is the gray economy? Certainly, much of it, the big-money part of it is “grabbers” who simply are accumulating personal fortunes by breaking the law that says one has to pay taxes (I will spare you anarchist arguments on the legitimacy of taxation, because I don't believe these people are even aware of them). I think that another significant element of the gray economy is the spontaneous, chaotic formation of alternative structures to the state that has “failed” the population and lost its trust. In other words, many entrepreneurs evade taxes and pay their employees in envelopes because they know the money will be better used this way. It will not contribute to paying for the world's most expensive (per meter of span) bridge across the Daugava river or other boondoggles. It will not maintain largely useless and hostile bureaucracies, such as a State Revenue Service that (the example is a lady who spoke up Friday night) harass a small, tax-paying private child-care center over petty matters while millions in taxes are owed by the “grabbers”. To contnue paying taxes under such conditions is a form of law-abiding masochism.

In short, a good part of the gray economy is an anarchistic improvisation to make up for what the state cannot, will do, or is and will be incapable of doing for the foreseeable future.

I have previously brought up the concept of “return on taxation”, which, in Latvia, is negative and getting worse as public services are cut and underfunded. But this is a general case of everyone making economically-motivated decisions, even when it comes to obeying the law (at least in case of malum prohibitum – not doing forbidden things that are not evil in themselves). Thus, in breaking speed limits or jaywalking, we take a risk of a fine in exchange for getting somewhere a bit faster. We also pull out of poor investments to avoid economic loss. So it is also logical that we pull away from non-performing “assets” such as the Latvian state, even if there is some risk of penalty (against the strange background of – the larger the sum we rip off /or deny getting ripped off by the state, the less likely we are to suffer for it. The risk is greater being a day late with the pendanticly calculted social tax on four employees at a day care center).

At the end of the meeting with the three former exile Latvian deputies, it was agreed to give the new government 100 days to set its course before making a judgement. Fair enough. However, I have already drawn my own conclusions about the Latvian state and I will not be holding my breath for anything dramatic.  

Analysts see collapse of trust in government

The Strategic Analysis Commission (Stratēģiska analīzes komisija/SAK), a kind of think tank that has been operating under the office of the President since 2004, presented a report (Latvian language, downloads from the link page) saying that trust in government institutions was extremely low and that around half of the population would be ready to engage in violent protest.

Roberts Ķīlis, a political scientist who heads the SAK, presented its findings to an extraordinary meeting of the Cabinet of Ministers (the government) called by President Valdis Zatlers to ask for an accounting of the reform process. The meeting, broadcast live by Latvian Television, lasted more that six hours and included heated exchanges between ministers, between the President and ministers, as well as statements (and outbursts) by third parties (representatives of unions and NGOs).

The findings of the report stated, among other things:

Latvian society is dominated by unprecedentedly low trust in both the government, the parliament, and, as surveys from the summer of 2009 show, also in the entire political and party system. Even though Latvia's inhabitants have never shown significant trust in their democratic representative institutions, the spring and summer of 2009 are illustrative of a permanent crisis of confidence. In this context, it is unlikely that it is possible to regain even a part of the lost trust in a few months time, In order to renew trust in the political system, it is essential to achieve a positive dynamic in the crisis (breaking a negative vicious circle).

The report goes on to say that there will be an inevitable new wave of emigration (both for economic reasons, and to seek social and political stability). This addresses the point I have earlier made in this blog, that emigration is not only a choice in favor of higher salaries (offset by a higher cost of living and sometimes, higher taxes that emigrants don't anticipate), but also a choice of governance. Emigration is also seen as a kind of final break of any loyalty to the Latvian state and society.

The report also points out that the municipal elections did not decrease what they called "social tension" and that voters, in effect, voted for politicians and parties they deeply mistrust. This is likely to continue or worsen as the national parliamentary elections of 2010 approach

On a positive note, the report concludes that Latvians are not yet ready to trade democratic freedoms for economic security. But on the economy, the SAK forecasts that recovery will not bring wages and living standards back to 2007 levels for at least five or six years -- by 2014 or 2015. This conforms my view, and that of blogger Edward Hugh, that what Latvia faces is essentially an "L" shaped recession. While Latvia stagnates, other European economies will recover and grow, drawing away skilled labor and professionals that would be needed even to make the slow and feeble recovery forecast by the SAK. After all, what kind of a recovery is it when you catch up with 2007 in 2014. Ironically, the "seven fat years" now look like seven pounds of flesh and seven years irretrievably cut from Latvia's development.

I would say the SAK report is more evidence of the main thesis of this blog -- that Latvia is a failed state lite.

The 4.8 % solution and fish with socks?

Pauls Raudseps, a senior commentator specializing in economic matters with Latvia’s leading daily Diena and I got into a discussion about whether Latvia could recover from its present economic crash. It started on a new Latvian television talk show and continued afterwards. Both on air and later, Pauls pointed to a 4.8 % rise in Latvia’s industrial production in April from March. His argument was that this was the beginning of a turnaround in the Latvian economy that would lead to the real start of an export-led economic recovery in six months.

Pauls also said that he believed Swedish economist Anders Åslund’ s prediction that East European economies (including Latvia?) would recover faster than the West, thereby precluding a scenario where recovery in the West leads to mass labor emigration (based on widespread and rational “no future” expectations) and permanent stagnation in Latvia.

I have looked at what I believe are the same statistics that Pauls uses. The April month-on-month rise seems mainly to have come from increased production of clothing (+14.6 %) pharmaceuticals (+ 11.6 %), and chemicals (+9.7 %). These are seasonally adjusted figures. In laymen’s terms, a mathematical formula has been applied to even out surges of certain kinds of production related to the seasons – wood is easier to harvest and process when the forests are dry and the access roads are clear, etc. The other statistical comparison is adjusted for working days (holidays on workdays, etc.) on a year-to-year (April 2009 compared to April 2008) basis, which showed production plummeting by 16.9 % from April 2008, and by 18.7 % when manufacturing alone is measured. So no glimmers of hope there.

The April statistics are not broken down proportionately, but there is a proportional breakdown of exports, which Pauls and others think should be the motor re-igniting the Latvia economy. I don't disagree-- in theory. These figures are disastrous. Exports are down 30.9 % from April, 2008 and have plummeted in all of the largest export groups. Food products, comprising 18.8 % of total exports, fell 6.8 %, forest industry exports (15.7 % of total) plunged 40.7 % and textiles (including clothing) at 5.5 % of the total were dowm 31.1 %. Only knitted goods, which include socks, I suppose, were up 0.9 %, while a fast rising export (except for re-exported fuels) was fish, up 16 % and just behind pharmaceuticals, up 19%.

The thing is that fresh, frozen and smoked fish comprise only 1.7 % of Latvia’ s exports, about the same as “socks”, at 1.8 %. Even the seemingly rising rocket of pharmaceuticals makes up 5.6 % of total exports. I also suspect that a large percentage of pharmaceutical exports are contract-manufactured pills made by Grindex and other companies for a market with relatively steady demand. Finally, in the month of April alone, on a working days adjusted basis, the production of textiles as a whole (a larger category than knitted goods), was down 59.8 % from the year before.

I find it hard to see how the 4.8 % uptick in industrial production and seeming higher exports of fish and socks (and pills) are serious indicators of an upturn and the green shoots of recovery. It still looks to me like the Latvian economy is crashing. The accelerants of the crash, such as rapidly diminishing domestic purchasing power, a total lack of affordable financing for new businesses (or any business), deflation and an uncertain tax environment (several contradictory plans in one day and tax hikes still looming on the horizon) and the certainty of increased workforce emigration at first opportunity, are all there. The massive cuts in public spending and the even harsher cuts we can expect i 2010 and 2011 will increase unemployment and further cut or "export" the purchasing power of Latvians (with only some showing up in national accounts as expatriate labor remittances).

At some point things will “bottom out” in a kind of prolonged stagnation for the better part of the next decade. It doesn’t look like there is more to hope for than that. Any hopes should be placed on how the flows of repatriated earnings from up to 500 000 Latvians working abroad by 2015 (my wild guess) will be spread in the local economy.