In fact, this Latvia doom and gloom story has feeble legs. Personally, I’d sooner believe we are threatened by an invasion from… eh, Mars. Here is why it may be sensible to let go of the Latvia obsession.

First and foremost, size. Latvia’s economy is 0.2 percent (and shrinking) of total EU GDP. Its population is 2.2 million. Poland, the biggest new EU member Latvia is supposed to drag down with it, is 38 million people and its balanced, still growing economy is 20 times bigger. This is as if people believed that the near collapse of Iceland a few months back would turn, say, France upside down. Well, it did not.

Second, contrary to what you may read all over the place, Latvia’s economic woes are not at all emblematic of the alleged vulnerability of entire central Europe. No other country in the region managed to build such a bubble in the economy, based exclusively on foreign capital inflows and a real estate boom. Economic contraction and macroeconomic imbalances in Latvia are extreme even among other poorly managed economies in the region such as Hungary, Lithuania or Bulgaria. They certainly have little in common with the economic picture in Poland and Czech Republic, which together represent nearly 60 percent of the GDP in new EU members from the east.

Third, there is no real transmission mechanism apart from often irrational investor sentiment, or panic. Latvia’s trade with central Europe and the wider EU is negligible (from the point of view of the latter two) and the same applies to capital flows. Yes, the Swedish banks are overexposed but their recent stress tests confirmed that they would withstand even a total bankruptcy of Latvia. What’s more, the only trigger that could potentially release this particular transmission mechanism comes straight from the book written by the Latvia obsessionists themselves as they lambast the EU and IMF for supporting the Latvian authorities in refusing to devalue the lat currency. The talk that Latvia might benefit from devaluation by making itself more competitive is at best debatable – one can argue plausibly that it would bankrupt everybody without much help in boosting exports because Latvia has little industry that could benefit. A devaluation followed by entry into the euro zone – another common recipe from Latvia afficionados — is dubious because it would increase nominal and real deconvergence between Latvia and the euro zone (and most likely boost inflation). It i unrealistic also because it would create a risky precedent for the EU. If Latvia is allowed into the euro zone with a ruined economy and following a devaluation, how will anybody stop Poland (whose economy is big enough to matter) from arguing its should be let in with a devalued and fundamentally undervalued currency (and high inflation) as well? This is political fiction in today’s EU. In fact, sticking to the fixed exchange rate may be the only credible exit strategy for Latvia because it is more likely to earn it euro zone membership a few rather than 20 years away.

Finally, if the doomsayers insist on making Latvia a paradigm of anything, they should take a closer look on how different it is from Argentina in 2000-2001, with which it is often compared. They would discover that the country is boldly taking the very painful medicine of pay cuts and the unwinding of the paper wealth created there during nearly 10 years of boom rather than engage in blaming the West for self-inflicted ills and seeking maverick ways out. Argentina made no credible effort to curb its bloated public spending and responded to its trouble by defaulting and effectively robbing foreign investors (as well as its own citizens). For Latvia, a small country with no commodity wealth to sustain itself, this is not a way out but a way to hell. Sure, Latvians are worried and angry but they also remember where they are coming from – the poverty and isolation of the late Soviet Union. Like other central Europeans, the Latvians do not take prosperity for granted and therefore are prepared to tighten their belts. That’s why protests in Latvia have been nothing compared to those that hit “western” Iceland. Its open, flexible economy, supported by IMF and EU cash will get on an even keel with a much more sustainable macroeconomic framework sooner than many think.

In this only is Latvia indeed emblematic of the EU’s new members from the east. Their overall flexibility coupled with entrepreneurial spirit and belief in self-reliance will get them out of this mess faster than some of the countries which have yet to understand that the bloated welfare state model is not going to come back after the crisis.

* Author is Director of Programmes and Member of the Board of demosEUROPA – Centre for European Strategy.

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