Go to the Globe and Mail homepage

Jump to main navigationJump to main content

A Latvian Central Bank employee counts banknotes in Riga. (INTS KALNINS/REUTERS)
A Latvian Central Bank employee counts banknotes in Riga. (INTS KALNINS/REUTERS)

Chrystia Freeland

Latvia shows how Europe can save itself Add to ...

Spending time with top European policy makers at the moment is scary and slightly nauseating, like the final, slow-motion moments of a car accident, when you can see precisely both how you will probably crash and what it would take, if only you could force your paralyzed muscles into action, to swerve into safety.

More Related to this Story

That’s why Christine Lagarde, the formidable French chief of the International Monetary Fund, told me this week that she wants to lock Europe’s dithering leaders in a room and leave them there until they figure things out.

“If I was able to do one thing, I would lock them in a room, take the key and let them come up with a comprehensive plan,” Ms. Lagarde said, when I asked what her fantasy scenario was for Europe. “I’m sure they can make it. I know the fundamentals are solid. The numbers on an aggregate basis are good. And, as I said, we have to take the key because they cannot escape unless and until they’ve firmed up the plan. But they can do it.”

Ms. Lagarde’s dream is frustrating and encouraging in equal measure because she is right: There is a clear, credible and widely accepted path to safety for Europe. But that car crash may still happen, because no one has the power to lock Europe’s leaders in a room and, absent that forcing mechanism, they may not muster the will or the sense of urgency to act in time.

The sticking point is not policy. Speaking on a panel with Ms. Lagarde, Jorg Asmussen, a member of the European Central Bank’s executive board and a former official at the German ministry of finance, outlined what Europe needs to do.

“It’s very simple,” Mr. Asmussen said. “We need a more integrated monetary union, because the monetary area that we have now is incomplete. And we have to complement it in a way to make it more stable. One point is a fiscal union. The second one is a financial market union with three key elements: a resolution regime; second element, a deposit guarantee insurance; and third, we need a centralized supervision for the large 25 banks in Europe.”

“We need a democratically legitimized political union,” he added. “We need to start this speedily.”

That’s a plan the overwhelming majority of European leaders would agree to in principle. The problem is putting it into practice.

As Olli Rehn, the European commissioner for economic and monetary affairs, jokingly explained on the same panel: “Prime Minister Jean-Claude Juncker” of Luxembourg, the chairman of euro zone finance ministers, “put it quite well some years ago by saying that we all know what needs to be done, but we do not know how to get re-elected after that.”

Mr. Rehn’s wry comment is a reminder of the real tragedy at the heart of Europe’s troubles today: An idealistic political experiment, founded above all on the principles of democracy, peace and social inclusion, is failing because elites are unable to sell their vision to the public it was meant to serve.

Part of the problem is that the European idea, which really is a gauzy, high-concept confection, long ago devolved into a profoundly uninspiring affair of EU directives, painstakingly translated into 23 languages, and the Brussels apparatchiks, remote from the everyday life of their nations, doing the translating.

That’s where Riga, the venue for the conversation between Ms. Lagarde, Mr. Asmussen and Mr. Rehn, comes into play. The 2008 financial crisis was devastating for this country of just over 2 million. Like some of the euro zone states that today teeter on the brink, Latvia gorged itself on easy money during the credit boom of the first decade of this century. When capital abruptly flew to the world’s havens – a category that most certainly did not include the Latvian currency – Riga was pushed to the brink.

One option – which many contemporary observers thought was inevitable – was devaluation. Latvia, after all, enjoys a freedom that Greece, Ireland, Italy, Portugal and Spain do not. It controls its own currency, and printing money would have been an expedient way of both reducing its debt and instantly bolstering the country’s global competitiveness.

But Latvia chose the tougher route of internal devaluation. The country stuck with its currency peg to the euro, and instead rebuilt the confidence of the international capital markets by slashing government spending and domestic wages and prices. Over the course of the program, the Latvian government’s combination of spending cuts and tax increases amounted to 15 per cent of gross domestic product.

That hurt. In the first year, unemployment jumped to more than 20 per cent, and the economy shrank 18 per cent. Nearly four years later, Latvia, whose overhauls were supported by funding from the IMF and the European Union, is harvesting the payoff. The economy grew 5.5 per cent in 2011, the currency is stable and unemployment has subsided, to 13 per cent.

“I want to congratulate Latvia for the recent successful completion of their balance of payments program which has been conducted together with the EU and the IMF and also for the successful return to the markets and the rather positive data on growth,” Mr. Rehn said. “And Latvia has shown that this kind of economic assessment is possible without currency devaluation.”

The harsh Latvian plan worked because the whole country was committed to it. And that commitment, including the painful peg to the euro, is rooted in the overarching national mission that has driven and united this small Baltic state since the collapse of the Soviet Union – to escape the legacy of communism and Russian rule and to build a modern, democratic, capitalist nation. Latvians believe they can achieve that goal by joining the European Union and eventually the euro zone.

The people on Europe’s periphery still believe in the union’s great historical purpose. Unless the Europeans at the continent’s centre regain that faith, their leaders will be unable to summon the political will to swerve out of that slow-motion car crash.

Follow us on Twitter: @GlobeBusiness

 

In the know

Most popular videos »

Highlights

More from The Globe and Mail

Most popular