Latvia

   

Economic Policies

#14
Key Findings
Showing strong recent gains, Latvia falls into the upper-middle ranks (rank 14) in the area of economic policy. Its score on this measure has improved by 0.7 points since 2014.

Growth rates have been strong and steady for a number of years. Since joining the euro zone in in 2014, the country’s economic focus has shifted to longer-term issues of competitiveness and inequality. A law capping the budget deficit is in place.

The overall unemployment rate has fallen dramatically in the past decade, but remains at a moderate 6.4%. Rising wages with labor shortages indicate a tightening labor market. The primary labor-market issues include the rapidly shrinking working-age population, internal migration out of rural regions, and high levels of net emigration.

A significant tax reform aimed at reducing inequality came into effect in 2018. However, observers say more as needed, as it did little to help the lowest-income households. Budget deficits have been at or below 1% of GDP for years, paired with low levels of general government debt by EU standards. The banking system remains stable, with capital levels well above the euro zone average.

Economy

#10

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
8
After a difficult post-crisis period of economic adjustment in 2009 and 2010, Latvia’s economy has fully rebounded and become more resilient, returning to the international markets and to favorable economic growth rates. In the last decade, there have been no significant economic imbalances, only moderate levels of inflation, with economic growth averaging around 3.5% (4.8% in 2018). The OECD has noted that Latvia’s economic growth is projected to remain strong, as exports strengthen and EU structural fund transfers boost investment.

Latvia’s economic policy had been governed by parameters accepted as part of financial assistance provided by the IMF and the European Union. Even though this assistance has since been repaid and parameters are withdrawn, they have provided a framework in which the economy established fiscal discipline. For example, in 2013, Latvia introduced legislation that placed a cap on the public budget deficit and launched a multi-year planning cycle. The Fiscal Discipline Council (FDC) plays an oversight function, consulting with the government on fiscal planning issues and compliance with the budget deficit cap.

In 2019, while commending the low budget deficit (in comparison with the EU average) as well as the government’s setting up a fiscal reserve for 2020 – 2022, the FDC also called for an increase of the reserve in the future urged the government to be more proactive in their counter-cyclical activities.

Since meeting the policy goals of joining the euro zone in 2014, Latvia’s focus has shifted to longer-term issues of maintaining competitiveness within the euro zone and addressing social inequalities. Over the coming years, Latvia will need to maintain progress with economic reforms and participate more actively in international trade to ensure continued economic progress. Domestically, there should be a stronger focus on innovation and research and access to jobs.

Citations:
1. Central Statistical Bureau (2019), Growth Rate Indicators, Available at: https://www.csb.gov.lv/en/statistics/statistics-by-theme/economy/gdp. Last assessed: 25.10.2019.

2. Fiscal Discipline Council of the Republic of Latvia (2018), Irregularity reports (05.02.2018, 23.05.2018, 29.08.2018, 01.11.2018). Available at: https://fiscalcouncil.lv/reports, Last assessed: 25.10.2019.

3. Fiscal Discipline Council of the Republic of Latvia (2019). Fiscal Discipline Surveillance Interim Report on Latvia’s Stability Programme 2019-2022, Available at: https://fiscalcouncil.lv/files/uploaded/FDP_1_08_393_20190423_Interim_report.pdf, Last assessed: 25.10.2019

4. OECD (2019), Budgeting and Public Expenditures in OECD Countries (2019), Available at: https://www.oecd.org/governance/budgeting-and-public-expenditures-in-oecd-countries-2018-9789264307957-en.htm. Last assessed: 25.10.2019.

Labor Markets

#22

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
7
In 2019, approximately half of the population of Latvia were economically active. The unemployment rate in Latvia has fallen from 20% in 2010 to 6.4% in 2019. Following increases in 2016 and 2017, the minimum monthly wage was further increased in 2018 to €430. Accordingly, in the second quarter of 2018, compared to the second quarter of 2017, the average monthly gross wage grew by 8.4% or €78. The average monthly income now exceeds €1,000.

However, rising wages with labor shortages is indicative of a tightening labor market. The main labor market challenges for Latvia remain a rapidly shrinking working-age population, internal migration from rural regions to the capital city of Riga and high net emigration. Furthermore, more than 40% of all emigrants between 2009 and 2016 were high skilled, which continues to contribute to rising skill shortages.

According to the 2019 OECD recommendations, future labor policies in Latvia will have to focus on reducing long-term unemployment, supporting discouraged workers and expanding the menu of active labor market policies, which target disadvantaged groups. Key active labor market policies will focus on job seeker mobility between regions, raising older workers’ skill levels and supporting unemployed young people. Furthermore, it was recommended that the general operation of the State Employment Agency be improved, establishing new training programs, promoting regional mobility and making more effective use of existing employment data.

Citations:
1. European Comission (2019) Labour market information: Latvia, Available at: https://ec.europa.eu/eures/main.jsp?catId=2776&acro=lmi&lang=en&countryId=LV, Last assessed: 25.10.2019

2. Central Statistical Bureau (2019) Increase in Earnings, Available at: https://www.csb.gov.lv/en/statistics/statistics-by-theme/social-conditions/wages/key-indicator/increase-earnings-still-observed, Last assessed: 25.10.2019

3. Central Statistical Bureau (2019), Unemployment rate in the 2nd Quarter of 2019, Available at: https://www.csb.gov.lv/en/statistics/statistics-by-theme/social-conditions/unemployment/search-in-theme/2589-unemployment-2nd-quarter-2019, Last assessed: 25.10.2019.

4. Central Statistical Bureau (2018) Changes in Wages and Salaries 2018/02 (in Latvian), Available at: https://www.csb.gov.lv/en/statistics/statistics-by-theme/social-conditions/wages/search-in-theme/310-changes-wages-and-salaries-2018-02-only. Last assessed: 25.10.2019.

5. OECD (2019), Connecting People with Jobs, Evaluating Latvia’s Active Labour Market Policies, Available at: https://www.oecd-ilibrary.org/sites/6037200a-en/index.html?itemId=/content/publication/6037200a-en&mimeType=text/html&_csp_=7e3e648a3c9515adb77706dbc1ea4d13&itemIGO=oecd&itemContentType=book, Last assessed: 25.10.2019.

Taxes

#12

How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
7
Overall, Latvia has one of the lowest rates of tax in the European Union. However, more than in many other EU member states, the tax burden falls disproportionately on wage earners, particularly low-income earners. To address this issue, tax reforms were undertaken in 2016 – 2018 to shift the tax burden away from low-income wage earners and increased the tax burden on the wealthy.

However, the reforms have since been evaluated as insufficient by the European Commission and the OECD. Even though personal income tax has become more progressive overall, it has been lowered on average without labor tax measures significantly reducing income inequality or poverty.

For example, the 2017 tax reform only targeted low-income households and not the lowest-income households, who gained little from the reduction of personal income tax. In addition, a reduction of the standard personal income tax rate from 23% to 20% amounted to 0.8% of GDP, of which 60% would go to the richest 30% of taxpayers – who are the main beneficiaries of the recent tax reforms. Further improvements are therefore needed for the Latvian tax system to reach its redistributive potential.

When it comes to ecological sustainability, effective tax rates on CO2 emissions from energy use in transport are low and fully exempt in other sectors, where emissions from fuel use are not taxed at all. This was highlighted by an OECD report (2019), which recommended that Latvia increase energy taxation by eliminating exemptions and taxing pollutants at the same rate across different fuels and sectors. As of 2019, the annual vehicle tax will be based on CO2 emissions, although only for newer cars – a progressive tax model for all cars would improve the overall impact on environment.

Economic recovery, structural reforms, improvements in tax collection and a reduction in the overall share of the informal economy have enabled the government to exceed its target for reducing the budget deficit. Since 2013, the budget deficit has been decreasing, dropping to 0.0% of GDP in 2016. It then reached 0.5% of GDP in 2017 and 1% of GDP in 2018. Though, according to the Ministry of Finance, it will remain 0.5% of GDP in 2019. It has also been predicted that, provided constant policy is maintained, the budget deficit will further decrease to be 0.3% of GDP in 2020 and 0.4% of GDP in 2021, before switching to a budget surplus of 0.2% of GDP in 2022.

Citations:
1. Ministry of Finance of the Republic of Latvia (2019), Amendments to the Latvia’s Stability Programme for 2019 –2022, Available at: https://ec.europa.eu/info/sites/info/files/2019-european-semester-stability-programme-latvia-annex_en.pdf, Last assessed: 29.10.2019.

2. OECD (2019), Economic Survery: Latvia, Available at: https://www.oecd.org/economy/surveys/Latvia-2019-OECD-economic-survey-overview.pdf, Last assessed: 29.10.2019.

3. European Comission (2019) Country Report: Latvia, https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-report-latvia_en.pdf, Last assessed: 29.10.2019.

4. European Comission (2018), The Effect of Taxes & Benefits Reforms on Poverty and Inequality in Latvia, Available at: https://ec.europa.eu/info/sites/info/files/economy-finance/eb039_en_0.pdf, Last assessed: 29.10.2019.

Budgets

#6

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
9
Latvia’s budgetary policy has been recognized as prudent and fiscally sustainable by the European Commission, the IMF and the OECD. Overall, the budgetary situation can be described as strong, with low public debt. The budgetary framework is based on the transparent national fiscal legislation (Fiscal Discipline Law) and overseen by an independent fiscal council. The framework has been described as rigorous by the OECD (2017).

The budget framework and government-debt cap of 60% of GDP, prescribed by the Law on Fiscal Discipline, has been maintained. Latvia remains broadly compliant with the principles of fiscal discipline.

During 2018, Latvia recorded a government deficit matching 1% of the country’s GDP and maintained policy continuity, which was not been impaired by the current election cycle. The Ministry of Finance has predicted that the budget deficit for 2019 will not exceed 0.5% of GDP. In the 2018 Fiscal Sustainability Report, the European Commission identified Latvia as having low fiscal sustainability risks over the short, medium and long term.

The current coalition has emphasized a commitment to addressing challenges that the Latvian economy is facing. The 2019 budget and the government’s medium-term plans are expected to reverse the previous year’s pro-cyclicality and ensure continued fiscal prudence. Furthermore, no immediate risks of fiscal imbalances have been detected by the IMF, OECD or the European Commission.

Citations:
1. IMF (2018), Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Latvia, Available at: https://www.imf.org/en/Publications/CR/Issues/2018/09/05/Republic-of-Latvia-2018-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-46206, Last assessed: 11.11.2019.

2. European Comission (2018), Semester Stability Programme, Available at: https://ec.europa.eu/info/sites/info/files/2018-european-semester-stability-programme-latvia-en_0.pdf, Last assessed: 11.11.2019.

3. European Comission (2019), Country Specific Recommendations: Latvia, Available at:
https://ec.europa.eu/info/sites/info/files/file_import/2019-european-semester-country-specific-recommendation-commission-recommendation-latvia_en.pdf, Last assessed: 11.11.2019

4. IMF (2019) IMF Executive Board Concludes 2019 Article IV Consultation with the Republic of Latvia, Available at: https://www.imf.org/en/News/Articles/2019/08/06/pr19312-latvia-imf-executive-board-concludes-2019-article-iv-consultation-with-latvia, Last assessed: 11.11.2019

5. OECD (2017), Economic Survey: Latvia, Available at: http://www.oecd.org/economy/surveys/Latvia-2017-OECD-economic-survey-overview.pdf, Last assessed: 11.11.2019

Research, Innovation and Infrastructure

#27

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
6
Even though there has been some improvement in Latvia’s performance in research and development investment over time (0.62% of GDP in 2015, 44% of GDP in 2016 and 0.51% in 2017), investment remains lower than the EU average.

At the same time, investment into R&D from foreign sources in Latvia is significantly higher than the EU average. In 2013, the EU average was 9.9% of GDP, while in Latvia it was 44% of GDP in 2014 and 45% in 2015. In 2014 and 2015, private sector investment in R&D was 0.19% and 0.12% of GDP respectively, significantly below the EU average of 1.3% of GDP in 2014.

Even though Latvia’s productivity growth has been solid, innovation performance remains average at best. In the Union Innovation Scoreboard 2018, Latvia ranked 24 out of 28 EU member states in terms of innovation, up from 25 in 2017. Consequently, Latvia remained in the category of “moderate innovators.” The share of high-tech companies in the Latvian economy is small, as is the private sector’s demand for R&D activities. In budgetary debates, innovation remains a low priority.

Nevertheless, the OECD has recognized Latvia for improving its research and development, and innovation framework, noting the consolidation of research institutions, the introduction of quality-based financing models and incentives to boost research. For example, a support program for the development of new products and technologies has been set up, managed nationwide by eight competency centers. The program seeks to attract at least €12.8 million in private sector investment for research and development. Nearly 200 projects have been launched thus far, which signals an appetite for similar incentives to be introduced in the future.

In Latvia, a high proportion of the population has completed tertiary education, which – paired with favorable business conditions – creates an advantageous climate for innovation-driven growth. In the light of the European Union’s 2020 strategy target that 3% of GDP in the European Union should to be invested in R&D, Latvia has also set a target of increasing R&D funding to 1.5% of GDP by 2020 and to 3% by 2030. In the coming years, the quality of public R&D has to increase, and links between academia and business need to be strengthened.

Citations:
1. Central Statistical Bureau of Latvia (2019), Latvia 2019: Statistics in Brief, Available at: https://www.csb.gov.lv/sites/default/files/publication/2019-05/Nr_03_Latvia_Statistics_in%20Brief%202019_%2819_00%29_EN.pdf, Last assessed: 11.11.2019.

2. European Comission (2019), European innovation scoreboard: Country Profiles: Latvia, Available at: https://ec.europa.eu/docsroom/documents/35899, Last assessed: 11.11.2019

3. Ministry of Economics (2018) Competency Centers Continue to Develop New Products and Technologies, (In Latvian) AvaibleAvailable at: https://mk.gov.lv/lv/aktualitates/kompetences-centri-turpina-attistit-jaunus-produktus-un-tehnologijas, Last assesed: 11.11.2019.

4. European Commission (2018), Research and Innovation performance and Horizon 2020 Country Participation for Latvia, Available at: http://ec.europa.eu/research/horizon2020/index_en.cfm?pg=country-profiles-detail&ctry=latvia, Last assessed: 11.11.2019

6. OECD (2017) Going for Growth-Latvia 2017. http://www.oecd.org/eco/growth/Going-for-Growth-Latvia-2017.pdf. Last assessed 11.11.2019.

Global Financial System

#13

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
7
The volume of bank deposits made by non-residents has presented a systemic risk to the Latvian financial system. However, this risk is declining. The share of non-resident deposits to total deposits shrank from 53.4% in 2015 to 42.8% in 2016 and continued to fall in 2017 as Latvia’s membership in the OECD and new international banking regulations saw Latvia’s regulators and banks tighten their anti-money laundering practices. Latvia was lauded for this in an annual report from the OECD. Non-resident deposits in Latvian banks dropped further to 19.5% in September 2019. Latvia’s banking system is increasingly interconnected with the Nordic and Baltic regional system, requiring increased collaboration to address Nordic parent bank vulnerabilities and their spillover effects. Overall, despite the suspension of activities of Latvia’s third-largest bank following allegations of money laundering, the banking system remains stable, well capitalized and liquid – with capital levels 40% higher than the euro zone average and average liquidity coverage four times the regulatory minimum.

In addition, Latvia adopted a National Risk Assessment for money laundering and terrorist financing in 2017, articulating an understanding of the vulnerabilities and risks that the country faces. In 2018 and 2019, further steps were also taken to implement MONEYVAL recommendations.

However, the absence of a robust risk assessment (e.g., which would address confusion between unusual and suspicious transaction reports) for terrorist financing still represents a key deficiency in the effective supervision of international financial security. Furthermore, there is a lack of clarity in the legal system regarding targeted financial sanctions. With the exception of the Financial Capital Market Commission, Latvia’s supervisory authorities are not active in international cooperation regarding money laundering and terrorist financing.

Citations:
1. OECD (2019) Economic Survey: Latvia, Available at: https://www.oecd.org/economy/surveys/Latvia-2019-OECD-economic-survey-overview.pdf, Last assessed: 11.11.2019.

2. The Financial and Capital Market Commission (2019), Transformation of Latvian banking sector, Q3, Available at: https://www.fktk.lv/en/news/infographics/infographics-transformation-of-latvian-banking-sector-q3-2019/, Last assessed: 11.11.2019.

3. IMF (2018), Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Latvia, Available at: https://www.imf.org/en/Publications/CR/Issues/2018/09/05/Republic-of-Latvia-2018-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-46206, Last assessed: 11.11.2019.

4. Council of Europe (2018), Anti-money laundering and counter-terrorist financing measures: Latvia, Fifth Round Mutual Evaluation Report. Available at: https://rm.coe.int/moneyval-2018-8-5th-round-mer-latvia/16808ce61b, Last assessed: 11.11.2019.

5. Cabinet of Ministers (2019), Financial Sector Update, Available at:https://www.mk.gov.lv/en/content/financial-sector-update, Last assessed: 11.11.2019.
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