The Latvian Economy, No 4, 20 May 2011: Demographics – can one see a forest behind the trees?

1. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Mārtiņš Kazāks and Dainis Stikuts No. 4 • 20 May 2011
Demographics – can one see a forest behind the trees?
• The rebound effect of Latvian economic growth gets weaker. Future growth will
increasingly depend on the economy’s fundamental strength, i.e., the ability of
businesses to invest and export, as well as the ability of households to spend.
Surprisingly, the weak economic growth in the first quarter of this year clearly shows
a need to continue structural reforms.
• Negative demographic tendencies are becoming an increasingly important challenge
– they place an additional burden on the government budget and undermine
economic growth. Moreover, this is not an abstract future question – the negative
influence of this risk can be felt already now. When developing and implementing
structural reforms, it is necessary to take into consideration demographic tendencies,
both regarding the sustainability of social and pension systems and the effectiveness
of regional administrative reform.
critically low levels and need to renew them when
Slower-than-expected growth in the first recession comes to an end. This has provided a
quarter of 2011 short-term support to economic growth. With this
According to a flash estimate by the CSBL, Latvian effect fading away, the economy can rely only on
seasonally adjusted GDP increased by 0.2% the ability of businesses to invest and export, as
quarter -on quarter in the first quarter of 2011. The well as the ability of household to spend. Domestic
average quarterly increase last year was 0.9%, demand is still weak, while the growth of the smaller
1
implying quite a rapid deceleration of growth this exporting sector is not able to compensate for the
year. Furthermore, Latvian economic growth is vanishing rebound effect. Furthermore, tax hikes in
significantly falling behind that of its neighbours – the beginning of this year are putting additional
Estonian GDP grew by 8% in annual terms (2.1% pressure on private consumption.
quarterly growth) and the, Lithuanian economy by
To conclude, the economy continues to recover
6.9% (3.5%), while Latvia’s grew only by 3.4%
from the recession and growth is expected to
(0.2%). Last year, the average quarterly growth in
accelerate somewhat in the second quarter of 2011
Estonia and Lithuania was also stronger (1.7% and
due to investments picking up. However, the need
1.1%, respectively) than that of Latvia (0.9%).
to implement reforms has not disappeared. The
There are several factors that may explain this
delay of qualitative structural reforms (tax policy,
difference; for instance, the euro introduction and
diminishing grey economy, improving quality and
better fiscal situation in Estonia, the smaller
effectiveness of higher education, etc.) would imply
leverage in Lithuania (at the end of last year,
slower and more volatile economic growth, fewer
household and corporate credit stock was 94% of
jobs created, larger emigration, smaller pensions,
GDP in Latvia and only 59% in Lithuania). However,
and fewer resources for health care and education.
it still does not change the conclusion that Latvia is
Even if the revised GDP figures in June show
falling behind in the competition for improving the
stronger first-quarter growth (e.g., adjusting the
living standards of inhabitants.
effect of tax hikes and changes in the VAT
Although detailed GDP data will be published only drawback procedure to accrual basis), the
on June 9, leading indicators suggest that the
deceleration of growth has been partly due to the 1
See a more detailed overview of manufacturing and export
rebound effect’s gradually vanishing, while developments in recent Swedbank Analysis, “Recent
economic fundamentals are still quite weak. During manufacturing trends in Latvia – are there reasons to worry?”,
the crisis, businesses reduce their inventories to May 2011.
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46 8 5859 7720.
Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.

2. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 4 • 20 May 2011
conclusion will not change: back to work, the rest is living standards, so that inhabitants stay
not deserved yet! economically active longer and are less dependent
on the government budget, while emigrants return
The challenge of demographics to Latvia.
Negative demographic tendencies are becoming an Population in working age (15-74 yrs old)
increasingly important challenge for the Latvian
economy. During the last 20 years, the average age 80 2.0
of inhabitants rose from 36 to 40 years. If the fertility
rate does not improve and/or immigration does not 78
1.9
increase, this tendency will continue. In 2008, the
share of the population in the working age (15-74 76
years old) peaked at 79.1% of the total population; 1.8
during the next two years, it decreased by 0.3
74
percentage point. The true situation is likely to be
worse, as emigration flows increased during the 1.7
recession (especially for those in the working age), 72
2
which are underestimated by official statistics.
70 1.6
Population age structure, thousand persons 1990 1995 2000 2005 2010
100+ Share in total population
Number of persons, million Source: CSBL
90 In this newsletter, we will point to two areas where
in our opinion the demographic aspects have not
80
been sufficiently discussed. The first one is the
sustainability of the current pension and social
70
security system. With the employment rate (i.e., the
share of taxpayers) diminishing, the existing
60
pension system will not be able to sustain the
currently rather high ratio of average pension to
50
monthly average net wage (about 66% last year).
40
Although employment will grow in the nearest future
and the share of employed in the private sector of
30 the total number of inhabitants is likely to increase,
demographic tendencies suggest that in the long
20 term this share will decrease. This implies that
someone employed in the private sector will need to
10 support more employed in the public sector,
pensioners, children, and other dependents.
0
50 40 30 20 10 10 20 30 40 50 Employment and pension/net wage ratio, %
1990 2010 2050 forecast 35 80
Sources: CSBL, Eurostat forecast
Continuously high unemployment (a job-seekers’ 30 70
rate of 16.9% in the fourth quarter of last year) and
slow job creation provide incentives to emigrate,
25 60
undermining the economic growth potential. The
declining share of taxpayers in the total population
is putting an additional burden on the government 20 50
budget. The long-term challenges are to increase
the fertility rate, reduce emigration, and improve
15 40
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
2 Hired workers in the private sector, % of population
E.g., according to the CSBL, 10,700 persons emigrated from
Average pension / average net monthly wage (rs)
Latvia last year (net outflow of 7.9 thousand), while other
Source: CSBL
indirect estimates point to tens of thousands of people moving
abroad. The currently occurring Population Census is expected
to shed more light on the actual number of emigrated.
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3. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 4 • 20 May 2011
Employment and productivity in agriculture and fishing (2010)
400 40
300 30
200 20
100 10
0 0
RO PL LV LT BG SI PT EE GR C Z HU AT CY SK IE ES IT DE LU UK BE FI NL FR DK SE
Productivity in the sector, % of EU average
Employed in the sector, % of total employment (rs) Source: Eurostat
In order to maintain the current pension/net wage It is expected that, with the agriculture sector
ratio in times when the number of taxpayers developing (small farms disappearing or
declines, taxes might be increased. However, by consolidating into bigger ones), it will become more
increasing taxes the motivation to emigrate or move productive and less labour intensive, naturally
to the grey economy increases – this solution leads resulting in the migration of inhabitants (especially
nowhere. youth) from rural areas to regional centres. If the
demand for this labour is not there, these people
Consequently, a decline in the pension/ net wage are likely to emigrate, worsening demographic
proportion (implying lower living standards for tendencies. In order to proactively lower these risks,
pensioners) is inevitable. This can happen either in one of the possible solutions is to develop a
the current way, i.e., not indexing pensions and regional development policy that promotes a higher
benefits due to inflation, or in a more appropriate concentration of labour and financial resources than
way to our mind, i.e., evaluating the validity of currently. It is necessary to continue with regional
additional pension supplements for different income administrative reform, significantly reducing the
groups, assigning social benefits according to the number of municipalities, in order to be able to
recipient income level, and strengthening the increase the critical mass of resources, attracting
motivation of the social benefit system’s participants investments and creating jobs.
to become employed (e.g., requiring unemployment
benefit recipients to participate in public works).
The second area that has not been sufficiently Mārtiņš Kazāks
discussed is regional development. For instance, Dainis Stikuts
labour productivity in Latvia’s agricultural sector is
lower than in other European countries –
productivity is lower only in Rumania and Poland.
This outcome can be interpreted in the following
way – currently there are too many people working
in agriculture and thus their incomes are quite low.
Swedbank
Economic Research Department
Swedbank AB. SE-105 34 Stockholm. Swedbank’s monthly newsletter is published as a service to our customers. We believe that
we have used reliable sources and methods in the preparation of the analyses reported in
Legally responsible publisher this publication. However, we cannot guarantee the accuracy or completeness of the report
Cecilia Hermansson, +46 8 5859 7720 and cannot be held responsible for any error or omission in the underlying material or its
use. Readers are encouraged to base any (investment) decisions on other material as well.
Neither Swedbank nor its employees may be held responsible for losses or damages,
Martiņš Kazāks, +371 6744 5859 direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter.
Dainis Stikuts, +371 6744 5844
Lija Strašuna, +371 6744 5875
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