Postindependence Economic Difficulties

Postindependence Economic Difficulties

The Latvian economy began to falter in 1991 and took a nosedive in 1992. Industrial production declined by 31 percent in 1993, a relative improvement compared with the previous year's decline of 35 percent. Especially hard hit was the engineering industry, which was not able to sell most of its production. By January 1994, the official unemployment rate had reached a high of 5.9 percent. (The actual rate of unemployment, including the long-term unemployed, approached 14 percent.)

International trade also plummeted. Most of the trade with the former Soviet republics is conducted using world prices. One of the key areas of change is in the price of energy, which increased seventy-five times between 1990 and 1992. The average prices of imports in these two years increased forty-five times, whereas prices of exports increased only about thirty-three times. With such price hikes and the general economic chaos prevailing in the whole post-Soviet region, exports in the 1990-92 period decreased by 44 percent, imports by 59 percent, and energy imports by 52 percent. Despite moderate improvement in 1993, Latvia continued to face the challenge of modernizing its production equipment and improving the quality and qualifications of its work force. To do that, it needed international credit and investment. Foreign investment, estimated to be about US$130 million in November 1993, was still small, mainly because of political uncertainty. The greatest influx of foreign investment was from Germany (US$31 million), followed by the United States, Sweden, Russia, Switzerland, and Austria.

There is, nonetheless, evidence of considerable progress in economic reform. In 1991 most, or 88.2 percent, of Latvian exports went to the former Soviet Union, and 3.2 percent went to Western countries. One year later, more than 20 percent of exports went to the West. In 1993 West European countries accounted for about 25 percent of Latvia's exports and 17 percent of its imports. Moreover, there has been a positive shift in the distribution of economic sectors, away from industry and toward services. By 1994 the services sector accounted for more than 50 percent of Latvia's GDP; industry, about 22 percent; and agriculture, 15 percent. Another major achievement has been in the stabilization of the Latvian currency. Latvia used the Russian ruble as legal tender until May 7, 1992, when it introduced the Latvian ruble as a coequal currency. On July 20, it made the Latvian ruble the sole official mode of payment. On March 5, 1993, the new Latvian currency, the lats, was introduced to be used with the Latvian ruble. The lats became the sole legal tender in October 1993. The Bank of Latvia has scrupulously followed the directions of the International Monetary Fund (IMF--see Glossary) by restricting the printing of money and credits. By strictly controlling the money supply, it was able to wrestle inflation down to 2.6 percent in December 1992 and to keep it at an average of less than 3 percent a month through December 1993. The annual inflation rate was reduced from more than 958 percent in 1992 to 35 percent in 1993 and 28 percent in 1994.

In Latvia, as in Russia, managers of state-owned production plants pressed the government through early 1992 to increase credits, but failed. The strength of the Latvian currency has contributed to price increases, making it difficult to export Latvian products to the former Soviet Union. Exporters called for a devaluation of the currency and a lowering of interest rates. Despite low inflation and a strong currency, annual interest rates exceeded 100 percent, making it difficult for enterprises to obtain loans.

It is indicative of the struggles waged by different sectors of the economy, state structures, and other institutions that the 1993 state budget was introduced and accepted only in February 1993. At almost 29 percent, the biggest item in the projected budget was pensions. Unpaid taxes and unanticipated expenditures on pensions and other social benefits that year contributed to a deficit of LVL54 to LVL55 million (3.2 percent of GDP). To raise additional revenue, the value-added tax (VAT--see Glossary) was increased from 12 percent to 18 percent in November. In December the government also began to issue short-term promissory notes. The budget crisis abated in 1994, with an estimated deficit of LVL36.7 million (1.6 percent of estimated GDP). According to the Economist Intelligence Unit, with a projected revenue of LVL476 million and expenditures of LVL516 million the 1995 budget would run a deficit of about LVL40 million (1.5 percent of estimated GDP).

Privatization

One of the most difficult aspects of economic reform in Latvia is the process of privatization. By the end of 1992, only six out of the more than 2,000 state-run enterprises had been privatized. Of the 703 enterprises slated for privatization in 1993, only nineteen had been privatized by mid-October. An agency charged with the privatization of enterprises was not established until November 1993. By January 1994, about thirty state-owned firms had been sold. It had been widely assumed that Latvia would be one of the leaders in privatization because of its experience with a market economy as an independent state from 1920 to 1940 and because of a latent antipathy to communism. Many factors have hindered the privatization process, however.

Until the early 1990s, no major initiatives in this realm could be made because of unclear jurisdiction. As early as 1990, Moscow had prepared a privatization plan for Latvia, which assigned 51 percent of the shares of industries to their workers, with the remainder to be divided between Latvia and the rest of the Soviet Union. Such a move was vetoed by Latvia. One of the primary reasons for the slow pace of privatization was the attempt to honor the claims of previous owners or their descendants. The right to make such claims was extended to the end of 1993. By January 1, 1993, there had been 14,958 requests for buildings, of which only 2,614 had been reviewed. In addition, more than 10,000 apartments had been denationalized, and more than 50,000 claims to city land had been received. A number of owners have been reluctant to make early claims because they would be liable for large costs, especially in buildings with high tax, heating, lighting, and repair bills. Meanwhile, rents have been strictly controlled, and tenants cannot be evicted for seven years unless an equivalent apartment is provided elsewhere.

Potential private owners reclaiming their rightful properties face other obstacles as well. There are legal confrontations between previous owners and a variety of squatters or other claimants. Before independence, many properties were leased or sold to cooperatives. Property law in Latvia has a curious clause that allows so-called "jurisdictional persons" to keep their contracts or properties if the acquisitions were made out of ignorance or "goodwill." In most of these cases, the former owner is then granted compensation by the state, which is usually a small fraction of the worth of a property.

An important psychological aspect of privatization is that many Latvian citizens are afraid of selling off Latvia for a pittance. On the one hand, a belief widely held by leftists--former communists--is that the IMF is trying to wreck the Latvian economy in order to lower purchase prices for foreign firms. On the other hand, rightists charge that the old managers are sabotaging production to lower the value of firms and allow themselves and their Moscow-based mafia allies to once again dominate the Latvian economy. Of particular note is the widespread belief among ethnic Latvians that the main beneficiaries of privatization will be non-Latvians. There is a common perception that about 80 percent of private economic activity is in the hands of other ethnic groups. In private interviews, many reasons are given for this economic breakdown: other groups are more active and willing to take risks; they have better contacts in the old party nomenklatura (see Glossary); they have more links with organized crime; they live mostly in cities where the economic action is; and business has not traditionally been highly regarded in Latvian culture. The predominantly Latvian state bureaucracy, which can affect the rate of privatization, is afraid of losing its power and the concomitant benefits involved in the control of industries.

As in other formerly socialist states, there has been an innate difficulty in estimating the value of industries or buildings. An auction could help overcome this problem, but other considerations, such as job retention and the ability of different bidders to compete in future markets, have become important. In effect, only 9.5 percent of the 295 privatization sales held in Latvia by January 1, 1993, had been accomplished through auction. Most of the privatization undertakings were bids to lease commercial sales establishments for up to five years. In most cases, the leasing of commercial sales establishments requires that the newly private entrepreneurs continue the same line of business as before. Even this kind of relatively mundane transaction was plagued by jurisdictional squabbles. For example, in the lease of the Minsk, one of the largest department stores in Riga, it was discovered after the contract had been signed that the city district that organized the lease had no right to do so because the Minsk is actually under the jurisdiction of the city of Riga. This case illustrates just one problem such initiatives can engender. There were also public charges about favoritism, the involvement of family members of the Cabinet of Ministers, the undervaluation of existing stock, and so on.

A few foreign investors had started up new firms or enterprises, but initial investments were cautiously small--in most cases well below US$1 million. In 1992, for example, total capital investments involving United States enterprises amounted to less than US$13 million. The many problems slowing down foreign investment include the limited title to land (at best a ninety-nine-year lease); the unreliability of contracts with government representatives or ministries, which can be broken; the expectation in some instances of favors or bribes by government contracting or signing parties; the presence of organized crime and, in some localities, its demands for protection money; the widely reported stealing and pillaging of private property; and the variable quality of workers. Other problems involve communications difficulties, a dearth of adequate housing for Western staff, the deficit in knowledge of foreign business language, the lack of Western-trained management, and even the question of safety in the streets. These problems are also reflected in other former Soviet republics. Latvia appears to be tackling them with vigor and determination, however, and major improvements in the investment climate have already been achieved.

Until 1993 one of the key variables blocking a resurgence in economic activity was the erratic and unstable local banking and financing system. More than forty banks in Latvia had an average capitalization of less than US$1 million. Interest rates varied considerably, and services had yet to meet Western standards. The Bank of Latvia, which is the country's central bank, operated forty-eight branches and a specialized foreign branch.

Although much remains to be done, some progress has been made in reforming the financial sector, particularly in privatizing commercial operations. Twenty-one former branches of the Bank of Latvia were merged in 1993 to establish the Universal Bank of Latvia, the privatization of which was to be completed in 1995. The Latvian Savings Bank also was to be restructured and privatized by the end of 1995. As the central bank, the Bank of Latvia assumed a supervisory role, guiding and monitoring the country's banks. To facilitate payments, many banks have joined the Society of Worldwide Interbank Telecommunication (SWIFT), the international fund transfer system, and some have begun to offer credit cards, cash advances, and other services.

Progress toward privatization has been made in agriculture as well. By January 1, 1993, some 50,200 farmsteads encompassing 21 percent of farmland had been given over to individual ownership. By late 1993, the number of private farms had grown to 57,510, compared with 3,931 at the end of 1989 (see table 26, Appendix). At the same time, another 99,400 families were assigned private plots averaging 4.4 hectares, which provided a significant buttress to their economic survival. The major thrust for this privatization came from the program of denationalization, which returned farms and land to former owners or their relatives. Aspects of this privatization could cause problems in the future, however. Although imbued with idealistic expectations, the new farmers have little equipment and inadequate housing for themselves and their animals. Also, many of them have never farmed before. Their farms are usually small, averaging seventeen hectares each. Not all collective farms were dismembered, but where they did split up, the leadership of these farms was able in many instances to buy out equipment and animals at preinflation prices. This apparent unfairness has left a legacy of bitterness.

In November 1992, a law providing vouchers for privatization was passed. The law came into effect on May 1, 1993, and the distribution of vouchers began in September. The law provides for the distribution of vouchers according to one's length of residence in Latvia, with one year worth one voucher, or about US$42. Other factors are also taken into account. For example, those who can lay claim to Latvian citizenship prior to the Soviet occupation in June 1940 and their progeny are entitled to an additional fifteen vouchers as compensation for so-called "ancestral investments." Refugees who left Latvia because of World War II may also obtain one voucher for each year lived in Latvia before December 31, 1944. Those forcibly deported from Latvia in the past receive a differentiated number for each year of confinement in prison camps or in exile. Finally, people are allotted vouchers on those occasions where private claims on property cannot be realized because of conflicts with squatters or because compensation is chosen in lieu of property. An estimated 87 percent of vouchers are to be granted to Latvian citizens. Of the total of 113 million vouchers in circulation, an estimated 2 million are expected to be used for purchasing farmland, 40 million for city land, 43 million for apartments, and 28 million for state enterprises.

Public opinion is an important consideration in policy making. Popular attitudes toward privatization differ somewhat between Latvians and others but not between men and women or between urban and rural areas. A random poll revealed the greatest split between individuals thirty-four years and younger and those thirty-five and older, and this difference may portend increased support for privatization.

Consumption Patterns

One of the main effects of the 1991-92 economic changes and dislocations has been a change in the pattern of consumption. According to family budget studies, food claimed only 29.4 percent of expenditures in 1990 but rose to 37.8 percent in 1991 and to 48.8 percent in 1992 (January-September). (In the United States, an average of 15 percent of income goes to food purchases.) The share of other commodities in the budget decreased from 37.6 percent in 1990 to 24.1 percent in 1992. Services, taxes, and other expenses declined only marginally as a proportion of total spending.

In the third quarter of 1992, the average monthly wage was 5,054 Latvian rubles, and the minimum wage was set at 1,500. According to the calculations of the Ministry of Welfare, the minimum "crisis survival basket" was determined to cost 3,010 Latvian rubles, and a minimum noncrisis basket of food and services cost 4,120 Latvian rubles. To purchase one kilogram of beef in September 1992, a person employed in the state sector had to work 180 minutes; for one kilogram of pork, 309 minutes; one liter of milk, thirty-six minutes; ten eggs, 110 minutes; one kilogram of sugar, 159 minutes; a man's suit, ninety-four hours; a man's shirt, 520 minutes; one pair of men's socks, fifty-two minutes; one pair of pantyhose, 110 minutes; and a pair of women's shoes, twenty-four hours. The price of one kilogram of bread was equivalent to 15 percent of a day's wages.

The decrease in real wages and the increase in the cost of goods resulted in a decrease of 45 percent in retail sales between January and September 1991. The volume of purchases of many items decreased by well over 50 percent.

However, retail sales do not reflect total consumption. Many individuals started their own garden patches; relatives availed themselves of their farm connections; and farmers, of course, grew their own food and exchanged it for other goods and services. A survey of family budgets found that in comparing the first nine months of 1991 and 1992, meat consumption de-creased by 13 percent, milk and milk products by 18 percent, fish and fish products by 24 percent, and sugar by 19 percent. Bread products consumption increased by more than 10 percent, however. Total calorie intake decreased by 5.9 percent, and fat intake fell by 11 percent.

Although the purchase of new manufactured goods de-creased significantly, there is still a considerable availability of household goods likely to last well into the 1990s. In 1991, for example, for every 100 families there were 143 radios, 110 televisions, ninety-nine refrigerators, eighty-nine washing ma-chines, seventy vacuum cleaners, and thirty-seven automobiles.

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