Monday, June 15, 2009

About the Latvian experiments

The government just announced that pensions and maternity benefits in Latvia will be reduced from July 2009 until 2012. That means that active pensioners' wages will be slashed by 70% and all other pensioners' revenues will decrease by 10%. Maternity and child care benefits will also be cut by 10%.

The aim is to force active pensioners to leave their jobs so that younger workers can remplace them. The other goal of these measures is to bring prices down.
How can a country which is "dying" because of a low birth rate be actually cutting child allowances? Everything is possible in Latvia...except devaluation!

In the meantime, Latvia Economy Watch is having very interesting thoughts about the consequences of the current ""social and economic experiment" in Latvia".
Here are a few samples:

As the European Commision and the IMF conduct their latest post-Keynesian "social and economic experiment" in Latvia to see whether it is possible to revive an economy which is contracting at an annual rate of 18% under the weight of debt deflation relying almost exclusively on a process of drastic fiscal cuts - a process which today is glorified with the name of "internal devaluation" but which in the 1930s was simply called what it is: wage and price deflation - a new problem looms its head.
What, we might like to ask ourselves will be the long run consequence for Latvia's already fragile demographic dynamic if we don't get a most-optimistic-scenario-best-case outcome here? That is, if instead of a devaluation-driven "V" shaped recovery, we get not a "U" shaped one (the optimistic scenario), but rather "L" shaped stagnation (a distinct possibility on my view, if wages and prices simply take too long correcting to competitive rates) what will be the implications for the longer term future of the country?

The question I want ask here is simply whether or not short term decision making on the part of the Latvian government (the crisis "exit strategy") may not produce knock-on effects on the short term decision process of potential Latvian parents leading them to postpone decisions on parenthood, such that the impact of the crisis is a further deterioration in long run population dynamics, and hence, ironically, in potential economic performance? What I am asking is whether or not there may be a kind of "vicious circularity", whereby one negative feedback process influences another in a way which produces a very unfortunate outcome. Not for nothing do we say that social systems are complex ones!

But before we go into the nitty gritty of all this, I would like to just take a quick look at two charts:

Structurally, they look quite similar don't they? They are both output charts, showing year-on-year changes in production. The second is a chart for industrial products, and the first is a chart for birth rate. Strange they should look so similar, isn't it? Or is it? Below I will go into some recent work by economists and demographers which providing a theoretical background within which we may be better able to understand the sort of complex processes we can see operating in Latvia. At the end of the post we will then breifly take a brief look at some of the conclusions it might be possible to draw from what is happening... read more

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