Latvia's Successful Recovery Not Easy to Replicate

Latvia's economic recovery shows importance of ownership, commitment

Euro adoption will be next big challenge

More reforms needed to ensure sustainable, inclusive growth

In the Baltics, Latvia was hit particularly hard by the global economic crisis, suffering a combined GDP decline of almost 25 percent and unemployment surging from 6 percent to 21 percent. Today, Latvia’s just over 2 million people have seen their economy grow at 6.8 percent in the first quarter of 2012, the fastest pace in the European Union. Unemployment, while still unacceptably high, is declining, and now stands at 16 percent. How did Latvia do it? And does its experience hold lessons for the crisis-stricken economies on the eurozone periphery?

“Latvia decided to bite the bullet. Instead of spreading the pain over many years, you decided to go hard, and to go quickly. The achievements were incredibly impressive,” IMF Managing Director Christine Lagarde told the Latvian authorities and more than 400 participants at a June 5 conference titled “Against the Odds—Lessons from the Recovery in the Baltics,” jointly organized by the IMF and the central bank of Latvia.

While Latvia’s “tour de force” sets an example for other European governments struggling to reduce national debt and get out of recession, Lagarde said the country—as well as neighboring Lithuania and Estonia—still need to make structural changes.

“Regardless of whether or not they join the euro, all three Baltic countries need to continue to implement the reforms necessary to make sure they can thrive under a fixed exchange rate. These reforms include raising labor productivity and boosting competitiveness to put them on a permanent path of higher growth and more inclusive growth.”

Keeping the peg

When Latvia first sought financial assistance from the IMF and its partners in the European Union, many economists were skeptical about the government’s decision to keep the peg to the euro. The level of fiscal consolidation that would be needed would almost inevitably plunge the economy into a severe recession, and it seemed as if devaluation would be a less painful way of engineering a recovery.

IMF chief economist Olivier Blanchard told the conference he was among those who had been skeptical that adjustment could succeed without a devaluation, and he had to recognize he had been wrong. He also explained why the IMF went along with the peg: “Programs are a partnership. When we saw that there was a very...