Tuesday, February 11, 2014

New Year, New Member: Latvia Joins Eurozone

This post was originally published on Diplomatist Online in February 2014.

by Chris Jackson and Matthew A. Rosenstein

Commissioner for Economic and Monetary Affairs and the Euro, Ollie Rehn, has stated that Eurozone membership has placed Latvia at the “political and economic heart of our continent.” Though there is no guarantee of success, Latvia joins the Eurozone with the potential to reap benefits for its own economy and strengthen the monetary union as a whole, write Chris Jackson and Matthew A Rosenstein.

Image from BBC News

European Commission President José Manuel Barroso believes such expansion is not symptomatic of a failing monetary union, asserting that Latvia’s membership gives the Eurozone a vote of confidence.

On January 1, 2014, Latvia became the eighteenth member of the European Union to adopt the common currency, the euro. The Baltic state with a population of just over two million joins Slovakia, Slovenia, and neighbouring Estonia as the fourth former-communist member of the Eurozone. Latvia’s entry into the Eurozone comes at a critical time in the history of the common currency and the EU itself. Currently, the EU is burdened with uncertainty. Economic crisis still plagues Spain and Greece, and serious economic problems linger in Italy and Portugal. Fuelled by concerns of immigration and subsidising failing economies, anti-Europe parties are on the rise in some of the traditionally most pro-Europe member states, such as France, Denmark, and The Netherlands. States have shied away from or delayed adoption of the euro. Though there is no guarantee of success, Latvia joins the Eurozone with the potential both to reap benefits for its own economy and strengthen the monetary union as a whole.

Aspirations of European Accession


At the collapse of communism in Europe, the European Union made efforts to attract former communist states and keep them from turning eastward again. Latvia along with the other Baltic States signalled its intentions of joining an integrated Europe early in its independence from the Soviet Union. Poland, Hungary, and Czechoslovakia were the first to sign ‘Europe Agreements’ in December 1991, and the Baltic States followed suit in 1995, formalising their aspirations of European accession. As Yale political science professor David Cameron notes, the signing of a Europe Agreement was only a formalisation of Latvia’s intent, and, in fact, the majority of strides toward democracy and a reformed economy were made prior to 1995. The primary barrier to Latvia’s accession was its failure to grant citizenship to non-Latvian speaking persons including most members of the sizeable Russian minority remaining in the country. Not until 1997 was this issue resolved in compliance with the Copenhagen criteria’s provisions for the respect for and protection of minorities.

Impressive Political and Economic Gains 

In addition to the adoption of existing European legislation and process, the Copenhagen criteria – a set of standards established in 1993 by the European Council to evaluate a country’s suitability for membership – can further be broken down into three requirement areas – geographic, political, and economic. Latvia is undisputedly within the bounds of continental Europe. Politically, democracy and a multiparty system had been introduced almost immediately following the dissolution of the Soviet Union. In fact, few gains in democratisation were even needed after 1991 and by the end of the decade, Latvia had earned near perfect ratings from Freedom House (an average of 1.5 on a scale of 1-7, with one being ‘free’ and 7 ‘not free’). Even more impressive were the substantial gains made in the economic area. After an unsteady period following independence, characteristic of most of the post-communist states, the Latvian economy rapidly grew as privatisation continued, and in 1999, Latvia became a member of the World Trade Organisation. 

Economic growth continued for Latvia after EU membership in 2004, the same year the country joined NATO. Between 2001 and 2005, unemployment dropped by 3.6 percent and investment in fixed assets increased by 40 percent. And in 2004 alone, exports across all sectors increased by 28 percent. However, like for the rest of Europe, 2008 spelled economic downturn in Latvia. A 21 percent decrease in GDP was one of the worst worldwide. Less well known than the efforts of Greece, Latvia immediately sought the help of the European Union, the International Monetary Fund (IMF), and the World Bank to assuage its hardship.


However, unlike Greece, Latvia has made a rapid and substantial recovery from its economic downturn. As early as 2010, Latvia’s economy returned to growth. The sudden rise in the country’s unemployment in 2008 and the ensuing downturn was reversed along with the GDP. With five percent growth in 2012, Latvia boasted the fastest GDP growth in the EU. And accordingly, Standard & Poor’s investment grade of ‘non-investment’ at BB has been raised to BBB+. 


At the ‘Political and Economic Heart’ of Europe

Adoption of the euro, at the outset of 2014, is an important step in Latvia’s exit strategy from its international loan programme. Membership in the Eurozone is, by no means, a cure-all solution for the Latvian economy. But it does carry with it a number of benefits. With adoption of the common currency, increased foreign investment is anticipated, through lowering of borrowing costs and eliminating currency exchange risks (the risk of an investment’s value changing due to exchange rate fluctuation). This has no doubt already contributed to the increase in Standard & Poor’s investment grade. 

In addition to the anticipated investment boost for Latvia, membership also carries with it benefits for the Eurozone, though more symbolic than economic. With the fourth smallest economy in the Eurozone, Latvia cannot be expected to make an impact on a monetary union dominated by the German super-economy. Benefit comes in the form of hope for other floundering Eurozone economies. Five years ago, Latvia was one of the most distressed economies worldwide, and today is the most rapidly growing within the EU. Strict adherence to its economic recovery plan and front-loading austerity measures has won the applause of the European Commission. Commissioner for Economic and Monetary Affairs and the Euro, Ollie Rehn, has stated that Eurozone membership has placed Latvia at the “political and economic heart of our continent.”

Economic growth since it independence has certainly outweighed the setbacks Latvia experienced both prior to and after EU accession. As a country, Latvia has displayed great resilience in the face of the greatest crisis faced by the European Union. It is important to note, however, that throughout Latvia’s relatively young existence as an independent entity, its accordingly young economy has been susceptible to drastic fluctuations, induced by external conditions. Economic downturn, both in Russia and the EU, has wreaked havoc on the Latvian economy, indicating that despite its growth and resilience in recent times, it is not a well-founded economy. Failure of the Eurozone to recover, or future tribulations within it have the potential to spur rapid downtown in the Latvian economy again. Thus, while the prospects are high, it is important to recognise and keep in mind the potential for future downturn, as an economy as small as Latvia’s will now fluctuate with the Eurozone as a whole. 


While economic unrest has dissuaded EU members Hungary, the Czech Republic and Poland from joining the monetary union, at least for the time being, Baltic integration is set to be complete next year with Lithuania slated to join in January 2015. European Commission President José Manuel Barroso believes such expansion is not symptomatic of a failing monetary union, asserting that Latvia’s membership gives the Eurozone a vote of confidence. A strong and growing Latvian economy enters a stable Eurozone on the path to recovery from crisis. Hardships have been contained and overcome in the case of Ireland. It can be concluded that the time is right for a small, yet strong economy such as that of Latvia to join a monetary union during what EU leadership sees as the early stages of the euro’s recovery. 


Chris Jackson is a Graduate Assistant at the European Union Center at the University of Illinois, USA.


Dr Matthew A Rosenstein is Associate Director of the European Union Center at the University of Illinois, USA. Previously, he was Associate Director of the Program in ACDIS at the University of Illinois from 2001 to 2010.

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