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Tuesday, August 28, 2007

Migration and the Latvian Labour Market

The Baltic Times ran a story earlier this week about how the Latvian Welfare Ministry is in the process of formulating proposals whose purpose would be to crack down on the use of undocumented labor in the Latvian construction via the issuing special employee certificates. The efffect of such certificates will be to pass resposibility onto the companies themselves, since they will now have to ensure that no unauthorized uncertificated persons are present on any of their sites, and the regulations will also apply to sub-contractors involved in a project. The suggestion is thought to be the result of a recent influx of "irregular workers" into the Latvian construction industry, to replace those who have moved to points West (the UK, Ireland etc) in search of better paid work:

"Large numbers of illegally-employed construction workers are believed to be operating throughout the Baltic region, partly as a result of the movement of large numbers of indigenous workers to Western Europe where skilled builders, plumbers and electricians can command large salaries. Many of the illegal workers are believed to come from Ukraine, Belarus and Russia."

The proposals, we are informed, are to be included in an amendment to the Cabinet of Ministers’ regulations concerning "Labour Protection Requirements During the Performance of Construction Works". The Baltic Times notes that the Latvian government has yet to finalise these regulations, and it is to be hoped that they will have an 11th hour conversion and avoid taking the step of shooting themselves in the foot in this way. Latvia needs more migrant labour, and needs to make it easier (not more difficult) for migrant workers - at all levels - to enter the Latvian labour market.

And here's why:

Is Inward Migration A Solution To Latvia's Labour Shortages?

As has been repeatedly argued on this blog, given that a strategy of relying exclusively on fiscal tightening and strong deflation to address Latvia's overheating problem is fraught with risk, and may even in the best of cases fail to deliver the results anticipated, another possibility which could be be put under serious consideration would be the application of a determined policy mix involving both decreasing the pace of the present economic expansion and increasing the economy's capacity for expansion by loosening labour market constraints somewhat via the use of an open-the-doors policy towards inward migration. This would involve the active promotion and encouragement of a flow of migrants from either elsewhere in Eastern Europe or from points further afield. Such a move would seem sensible, and even viable given the fact that Latvia is a pretty small country. However, as Claus Vistesen notes here, this can only be thought of as an interim measure, since, as the World Bank has recently argued, all the countries in Eastern Europe and Central Asia are effectively condemned to face growing difficulties with labour supply between now and 2020 (so in this sense what is currently happening in the Baltics may be thought of as an extreme harbinger of the shape of things to come).

But given this proviso it is clear that a short-term inward migration policy may help Latvia escape from the vice within whose grip its immediate future seems condemned to lie. Such short term advantage may be important, since longer term solutions like increasing the human capital component in the economy and moving up to higher value activity, whilst important, need much more time to be able to have any noteable effect. You simply cannot take a 20 year old with a basic school leaving certificate and turn him or her into a high value technician overnight, and especially if you don't have that many twenty (or 15) year olds to play around with in the first place.

What is at issue here is transiting a fairly small economy from being locked onto an unsustainable path over onto a sustainable one.

As Claus notes in this post, Estonia has already taken some tentative steps in the direction of making access easier for external workers, and Estonian Economy Minister Juhan Parts is busy working on a set of proposals - which he is to put before the Estonian Parliament by November - which will attempt to address Estonia’s growing shortage of skilled workers. The quota of foreign workers will be doubled to about 1,300 and the bureaucratic paperwork is to be significantly reduced . Now it is true that Parts is still to bite the bullet of accepting the need for unskilled workers too, but in the present situation a start is a start.

Poland has recently being making more sustained efforts to attract workers from Russia, Ukraine and Belarus, but also from more distant lands like India, while the Czech Republic, which has already decided to introduce a kind of green card system for workers from other East European countries has representatives out in Vietnam. In this sense if Eastern Europe is to overcome the looming crisis, then she must certainly be imaginative, and be prepared to offer incentives and advantages to migrants, and not only to skilled ones, since if you have only a few children what do you really want them to do, the most menial jobs?

The last IMF staff report(September 2006) already drew attention to the fact that a number of Latvian economic analysts had been calling for an expansion in inward migration in an attempt to alleviate shortages and to dampen wage pressures. However, it seems that local policymakers generally have been taking the view that this would only have the effect of replacing domestic low-cost workers with imported ones, thereby holding down wages and promoting further emigration. The problem is that if the current wage-cost driven inflation continues then a hard landing will become inevitable, and with a hard landing their will most probably be another exodus of people driven out in search of work, so this is really no solution.

The IMF was, in fact, cautiously positive on the need to open up the labour market:

The mission saw a role for targeted temporary immigration of high-skilled workers to relieve growth bottlenecks, and cautioned that Latvia’s current labor shortages may be short lived if growth were to slow at home or in those countries where Latvians are currently working. To boost domestic labor supply while moderating demand, the mission recommended easing the pace of economic growth, improving productivity in the public sector to free up labor, and further increasing labor force participation by raising the untaxed minimum under the PIT.

However being realistic, we need to note that Latvia certainly faces significant difficulties in introducing any kind of pro-migrant policy. One of these is evident, since any broad opening of the labour market may ultimately simply serve to put downward pressure on unskilled workers wages in a way which only sends even more of the scarce potential labour Latvia has out to Ireland or the UK or elsewhere. A recent report by the US Council of Economic Advisers made some of the issues involved relatively clear. The report cited research showing immigrants in the US on average have a “slightly positive” impact on economic growth and government finances, but at the same time conceded that unskilled immigrants might put downward pressure on the position of unskilled native workers. Now in the US cases these US workers are unlikely to emigrate, but in Latvia they may do.

Another difficulty which arises is the lack of availability of accurate data on the actual scale of either inward or outward migration in Latvia (this difficulty is noted by both the IMF staff team and the Economist Intelligence Unit).

As the IMF staff team note in IMF Selected Issues (2006) official statistics show that Latvia's population has declined markedly over the past 15 years, owing to both net outward migration and to a birthrate which has been well below reproduction rate since the early 1990s.

According to Latvian government data, Latvia had nearly 400,000 fewer residents in 2005 than it had in 1990. And according to the IMF calculations the population decrease is about equally explained by net outward migration (71 per 1,000) and by natural population decrease (births minus deaths, 75 per 1,000).

As the IMF comment:

"The fall in the population due to natural causes.......is also quite worrisome, as it continues unabated and will begin to exacerbate a shrinking labor market in a few years’ time."

According to the most recent estimate from the Bank of Latvia some 70,000 Latvians, or around 6% of the labour force, are currently working abroad - mostly in the UK and Ireland - but the true number is very likely considerably higher (IMF Selected Issues Latvia 2006, for example, put the figure at that point at nearer 100,000).

One of the difficulties that anyone trying to make an assessment of the labour shortage situation in Latvia faces is that official statistics measure only long-term migration, and, following the practices of Latvia’s Citizenship and Migration Board, long-term migration refers to "individuals who leave Latvia with the intent of settling in a new country for at least one year and who report this intention to an appropriate authority". As a consequence most of the data do not capture several important categories of migration:

a) illegal migrants who move permanently to another country without proper authorization from the receiving country,
b) permanent migrants to another EU country who do not report their change of residency, and
c) temporary migrants to another EU country who are not required to report their arrival in the receiving country.

The latter two categories would seem to be especially important in Latvia’s case, given that since EU accession, many Latvians have been moving to Ireland and the U.K. - either permanently or temporarily - to seek and obtain work.

On the other hand, if we look at the situation the other way round, in terms of arrivals in the UK or Ireland - as Latvian Abroad has in this post here (and this one) - then we may be better able to get a better idea of the numbers involved due to a difference in the quality of the statistics maintained. As Latvian Abroad points out, the numbers we actually find are somewhat below the normal headline-making level, but still substantial:

It's actually Lithuanians who have been the quickest to leave their country. 3.3% of Lithuania's population has ended up working in UK or Ireland. (Since UK only registers those foreigners who work there, the percentage of working-age Lithuanians who have left is probably 5-6%.) Latvia is second, with 2.5% of population gone. Slovakia is third and Poland is fourth. That surprised me a bit, because there are so many newspaper stories about Poles in UK and hardly any about Slovaks. Estonia is fifth. The emigration rates from Hungary, Czech Republic and Slovenia are much smaller.

As Latvian Abroad also notes the numbers leaving for the UK and Ireland have been dropping steadily since 2006 (although in the Irish case it is not clear to what extent the slowdown in the Irish economy, and in particular in its construction sector, is responsible for this, in any event the Irish data can be found here, and the UK data here).

Several recent surveys also suggest that the potential for outward migration remains substantial. For example, a survey conducted by SKDS (Public Opinion on Manpower Migration: Opinion Poll of Latvia’s Population) in January 2006 revealed that about 22 percent of Latvian residents see themselves as being either “very likely” or “somewhat likely” to go to another country for work “in the next two years”. Based on the current estimated population, this translates into between 350 and 450 thousand residents (between 15 and 20 percent of the 2005 population). The survey also indicated that these respondents were significantly skewed toward the relatively young (15-35), which would significantly reduce the working-age population and labor force in the near future. These respondents were also slightly more likely to be male, less educated, low-income, employed in the private sector, or non-Latvian.

But the biggest problem which arises in the context of projected in-migration as a partial solution to Latvia's present difficulties is a cultural one, and is associated with the historic legacy arising from years of unwilling participation in the old USSR, namely the presence in Latvia of large numbers of Russophone Latvian residents who are non-citizens. The scale of the situation can be seen from the table below.

(please click over image for better viewing)

Essentially out of a total Latvia population of 2,280,000, only 1,850,000 are Latvian (and hence EU) citizens. Of the remainder the majority (some 280,000) are Russians. And these Russians are not recent arrivals, but live in Latvia as part of a historic Russophone population which build up inside Latvia during the period that the country formed part of the Soviet Union.

In fact, if we look at the chart below, we will see that during 2003 the rate of out migration from Latvia seems to have increased substantially, as membership of the European Union loomed.

(please click over image for better viewing)

But what happened in 2003/4 wasn't simply an increase in the volume of migration, it was also a change in the direction of migration, away from the CIS and towards the EU. The majority of the pre 2004 out-migration was actually towards the CIS - official Latvian statistics suggest that over half of the Latvian residents who left Latvia between 1990 and 2005 emigrated to CIS countries - and it is reasonable to assume that many of these migrants came from the Russian speaking population.

So obviously any attempt to revert the flows will confront Latvians with some awkward and difficult cultural decisions, but then these are in-principle no more complex than those which would be posed by following the Polish example and attempting to establish a significant Indian community, or the Czech one and looking to bring in Vietnamese. As I say, Latvia is a small country, and the numbers involved are not necessarily huge, but perhaps the leap in the mindset which is required in fact is. As such the sustained exit of Russophones back into the CIS may only have served to delay, and make more difficult, a process of reconciliation which now, above all, has become economically expedient for everyone concerned.

Sunday, August 19, 2007

Fitch downgrades Latvia to BBB+

Fitch ratings agency has downgraded Latvia’s foreign currency issuer default rating (IDR) to ‘BBB+’ from ‘A-. It has also downgraded the Latvia's currency IDR to ‘BBB+‘ from A, –‘both of these ratings with a stable outlook. In defence of its decision Fitch argues that the Latvian economy is severely overheating (and who can disagree about that) whilst considering the policy reaction of the Latvian government to be insufficient to restore the economy to a sustainable growth path (again it is hard to disagree, although it would be simply unjust to pour all the blame on the Latvian government here, since there are important structural factors at work which are to some considerable extent beyond the control of the Latvian government”. For a fuller analysis of this see this post, and this one.

At the end of the day it is hard to disagree with Fitch and the downgrade should as such not have come as a surprise, especially since Standard & Poor’s earlier this year also made a similar downgrade, and we are still only waiting to hear from Moody's (who still maintain an A2 investment grade on Latvian sovereign deb). Should Moody's also revise their rating then Latvia would be without a single investment grade rating from a ratings agency, and their would be consequences from this since the ECB have earlier signalled that they are no longer prepared to accept paper from countries in this position as collateral (more on this below).

But there is another issue which arises here, and that is the actual role of credit ratings agencies in protecting both investors from serious financial risk, and citizens of sovereign states from the profligate practices of their political leaders.

This issue has recently been getting some coverage in the case of Italy, where of course public debt has over the last decade spiraled upwards almost out of control (to 107% of GDP) and the European Commission has proved itself to be completely incapable of rising to the challenge which this situation presents in the context of Italy's rapidly ageing population. (For more analysis of the role of the credit agencies in the Italian context see this post).

The ratings agencies question has also been entering particularly muddied waters in recent days due to the insistance of some EU Commissioners and the French President Nicolas Sarkozy on holding an investigation into the role of these self same agencies in the US sub-prime mortgages problem.

Now why am I pointing the finger especially at Nicolas Sarkozy here? Well, according to the Financial Times:

In a letter to Angela Merkel, the German chancellor and acting president of the group of eight industrialised nations, which includes the G7, Mr Sarkozy highlighted his concerns over the weaknesses of the international financial system revealed by the present crisis.

He called for G7 finance ministers to draw up proposals for their meeting in Washington in October to address transparency and risk awareness among market participants and regulators.

He said the G7 should join the European Commission in investigating the role played by credit ratings agencies in the crisis, and said that bank involvement in credit markets should also be addressed.

Now obviously, in general terms, there may be little to disagree with here. A nice theoretical discussion of transparency, and the role of the ratings agencies (which could also be extended to the role of the EU Commission and the ECB when it comes to the tricky question of the sovereign debt ratings of some delicate EU member states, including unfortunately the Baltic ones) may well be in order. But, I ask you, is now, precisely now, the moment to be airing all this. Isn't the number one priority for everyone right now to settle the global financial markets down, and to try and pass through this storm without incurring any excess damage?

But no, we need a scapegoat for our problems apparently, and the scapegoat it would seem is to be the ratings agencies, forgetting conveniently in the process that only last week they were being regarded as the last firewall of our collective defence.

So what do you expect, the agencies themselves hit back, at least to cover themselves. On Thursday it was Chris Mahoney, vice chairman of Moody's who responded in kind:

Moody's Investors Service fueled concern that the global credit crisis is worsening by speculating that a hedge fund collapse on the same scale as Long-Term Capital Management LP in 1998 is possible.

Hedge funds face potential losses on collateralized debt obligations, securities packaging bonds, loans and other assets, Chris Mahoney, vice chairman of Moody's, said on a conference call today. The funds are unable to agree on prices to sell riskier assets, causing the market to seize up, Mahoney said.

Then on Friday it was the turn of Fitch:

Latvia's long-term sovereign rating was cut to BBB+ from A- by Fitch Rating Service as government plans to keep the economy from overheating are ``insufficient.''

Now I really don't see that you can expect the ratings agencies to respond in any other way. You suggest you want to criticise them for being insufficiently vigilant, and so naturally they respond by starting to be "extra-vigilant". You can hardly blame them for this.

But as I indicate above, this decision by Fitch also begins to put the ECB in an interesting situation. Let us go back to November 2005, and the ECB decison to only accept bonds with at least a single A- rating from one or more of the main rating agencies as collateral in its financial market activities (and the original article here).

Well technically Latvia still has an A2 rating from Moody's, and this is equivalent to an A- (as has Italy in the case of Moody's), so the ECB will in theory continue to accept Latvian paper, but at this pace it would only seem to be a matter of time before Moody's downgrade too, especially with Sarkozy loading on the pressure. This will, apart from making it much more difficult for the Latvian government to raise credit, effectively take away the guarantee which underpins the present structural distortion in the Latvian economy, put even more distance between Latvia and membership of the euro, and complicate the task of the Latvian government in trying to steer the economy forward. Bottom line: is all of this a good idea. Answer: what you ask for is what you get, so my advice in future is to think first before opening your mouth.

The principal point I want to make here is that while in the normal course of events such downgrades - or the threat of them - may serve a useful purpose by putting pressure on governments to change course, in the current climate these very same downgrades may only serve to provoke the very situation which they are intended to avert, and that is the danger now. Let us remember what Buttonwood wisely, and possibly presciently, said:

As central banks lose authority, might credit-rating agencies play the watchdog role? By acting swiftly to downgrade debt, they would constrain companies (and countries) from borrowing too much. But the agencies tend to lean with the wind, rather than against it. They upgrade debt when the economy is booming and downgrade it when recession strikes. If the central banks do eventually slam on the brakes, therefore, the rating agencies will only exacerbate the downturn. As asset ratings fall, investors will be forced to sell their holdings and credit will be withdrawn from the system. Thanks to the financial markets, central banks now struggle to police the economy. But this may imply that the bust, when it comes, is as hard to control as the boom that preceded it.

Emerging Markets and Safe Havens

Danske Bank's Lars Christiansen had another research note last week which is of some interest for Latvia's current situation (see this post for his earlier research note). Entitled "Emerging Markets: Looking for the safe haven" (watch out pdf), and published last Thursday, Christiansen accepts that there is a global credit crunch, and that it is now spreading to Emerging Markets (EM), with many of the high-risk EM currencies (the Turkish Lira, the Hungarian Forint, etc) now coming under heavy fire. As to the question what countries may be most at risk, he answers the following:

In a situation where liquidity is tightening there is no doubt that the most liquidity-“hungry” countries are those with large current account deficits and large external debt. In this category we find Turkey, South Africa, Hungary, and Iceland. Furthermore, risks are heightened in the Baltic states, Romania, and Bulgaria.

That would seem to put Eastern Europe pretty generally on the map I would have thought. Chrisiansen seems to accept the arrival of the credit crunch as now a fact:

For the last couple of weeks, we have warned that the global credit crunch could spread to Emerging Markets. This has now clearly happened, but given the major moves in the global credit and equity markets there clearly is potential for even more contagion to Emerging Markets. Therefore, there is also reason to start looking for safe havens within Emerging Markets. Here external funding needs will be the key.


The credit crunch has triggered a strengthening of the yen and to a lesser extent, the Swiss franc. We would in particular watch the Swiss franc as many households in Central and Eastern Europe have funded their property investments with Swiss franc loans. Hence, if the Swiss franc strengthens further then it could put additional pressures on the CEE markets mostly exposed tothe Swiss franc.

This is really code language for speaking about Hungary (although there may be more) since in Hungary around 80% of the mortgages which have been taken out in recent times have been Swiss Franc denominated (via Austrian banks I should mention, so the Austrian banking sector is also partially at risk, although the Austrian Central Bank think they can withstand the shock if you look at the "Stress Testing the Exposure of Austrian Banks in Central and Eastern Europe" paper presented here.

So here are Danske Banks recommendations. The countries you are told to avoid are in red:

One bright spot - or potential safe haven - does exist in Eastern Europe however: the Czech Republic:

Finally it should be noted that the Czech koruna (CZK) – unlike most other CEE currencies – should be expected to strengthen in the present environment due to unwinding of CZK-funded carry trades. That said, the CZK is fundamentally not undervalued and the Czech central bank should be expected to keep interest rates below the ECB rate – especially if the CZK strengthening accelerates. That will limit the potential for strengthening of the CZK.

In case any of you notice some inconsistency in this view of the Czech Republic, since of course Czechia is also one of the "reds" (though to a much lesser extent than some of the others), I think it needs to be pointed out that other factors beyond the CA deficit need to be taken into account when evaluating the situation (the value content of exports would be one of these, what the deficit is based on would be another - ie are you importing machinery and equipment which can subsequently be used for exports - and the openness of the labour market to immigration would be another - there is of course an acute labour shortage in the Czechia , but they are they are actively attempting to address this and they are even out trying to recruit in Vietnam). Essentially the Czech economy seems to be on pretty solid ground (as may also be the Slovenian one), and you do need islands of tranquility in Oceans of tempest. So some countires will for this very reason prove to be win-win, while others may well, by the same token, prove to be lose-lose. Unfortunately historic reality is seldom just.

I also would be much more cautious than Christiansen is about Russia, political instability is evident, as are labour shortages. We need to see what happens next to oil and other commodity prices before sticking our necks out on Russia I think.

Will The Lat Come Under Pressure Again?

Well we all know about the turmoil that is taking place in the financial markets at the moment. Last Friday the Federal Reserve surprised everyone by suddenly lowering the discount rate. This has lead to all sorts of speculation about the future direction of interest rate policy in the major economies. It is now extremely unlikely that the Bank of Japan will now proceed with a quarter point raise later this month, and it is very doubtful in my view that the ECB will raise in September. It is pretty much a foregone conclusion that the next move by the Federal Reserve will be down, the only outstanding question really is when.

Obviously we need to wait and see how the financial markets respond to the latest move from the Fed, but my feeling is that the so called "credit tightening" (or liquidity crunch) isn't over yet (and not by a long stretch), and that even were the "liquidity crunch" to come to an end soon the consequences for the real economy are going to be important, since credit - both corporate and private, and possibly even sovereign - will more than likely be harder to come by. What this "harder to come by" really means is that you will have to pay more for it, especially if your credit valuation is not of the highest (as was the case with the US sub-prime home purchasers).

It is important to be clear here that what we have at this point is a liquidity crunch and not a generalized credit crunch, but evidently the danger is that the former spreads to the latter, which it may well do if the impact of the liquidity crunch on the real economy is seen as being sufficiently important as to warrant a good deal more caution in lending. It's as simple as that I think.

Basically liquidity crunches occur from time to time when asset prices decrease quickly, since banks typically demand more money and become more reluctant to lend out the money they already have. In order to maintain adequate liquidity (and guarantee its target refi rate) the ECB, for example, normally carries out a liquidity "top up" operation once a week. But what this means is that any sudden shifts in demand for and supply of funds which take place during the week in-between can lead to liquidity squeezes. When banks sense there is not enough liquidity in the system then they start to hoard it and as a consequence liquidity can dry up very quickly. In such situations the ECB (or the Federal Reserve, or the Bank of Japan) may provide liquidity at a higher frequency than normal until demand and supply stabilise again and overnight rates once more return to their normal levels. This is the process we have seen at work over the last week or so.

Now this kind of liquidity crunch is not to be confused with a more general credit crunch where credit conditions are tightened across the board vis-à-vis companies and consumers. At this point there are no real signs that this is happening. In the eurozone, for example, M3 growth and broad credit growth are still at very high levels and lending standards are still generally favourable. The problem is that if the current financial crisis intensifies, and in particular, if there are perceived to be ongoing consequences for the real economy which derive from the liquidity crunch, then there is a genuine risk that we may see a broader tightening of credit.

In order to address this we need to think about why this liquidity crunch has happened now, and indeed what it is that has been the immediate cause provoking it.

On the first count, the broad background has to be that the current cycle of economic expansion - which after all started back in 2001/2002 - is quite possibly nearing its peak. Volatility has been steadily creeping into the markets since the spring of 2006 - in Hungary, in Iceland, in Turkey - and often such events are early warning signals of bigger trouble coming further down the road, especially if the volatility increases.

Since the spring of 2007 volatility in financial markets has steadily increased, and the bigger problem is now with us.

As to the immediate cause, it is important to think about the fact - as few commentators seem to have done - that the whole issue has started with sub-prime lending in the United States. Now this detail would seem to be important for three reasons. In the first place these mortgages were made to people in what you might consider to be a "high risk" group for lending, and obviously the risk was too high. This appreciation will now lead all the banks and other financial institutions to examine all the other "high risk" assets they have in their portfolios and to begin the process of systematically discarding them. This I do think will happen.

Secondly, it is not insignificant that the high risk group which set things in motion was associated with the property sector and this little detail will have implications (see below) which reach right across the real economy given the important role which construction and housing have been playing in the current cycle.

Thirdly it is important to notice that the sub-prime defaults problem surfaced in the United States, and that the Federal Reserve started the interest rate tightening cycle at least a year before most of the central banks in the other major economies did (with the significant exception of the Bank of England). So this means that the sub-prime population in those other economies (who of course have also been receiving money) have yet to start experiencing significant "distress" in the way their US counterparts have. But they will do. It is just that we are most probably still at 6 to 9 months distance from that stage elsewhere, and this is just another of the reasons why I think the problem will be a drawn-out affair, and any real economy slowdown may also have some duration attached to it.

Coming back to any possible general credit crunch, as I say, were this to occur it would undoubtedly make itself felt at all levels, since the banking sector has clearly had a big shock, and any credit tightening will clearly involve individuals, companies and even governments (and again it is interesting to note that the Fitch rating agency has already replied to some of the criticism by downgrading Latvian government debt). Just how it may affect them is what we are now waiting to see. But it is important to bear in mind that such impacts on new and rollover credit would occur regardless of the extent to which central banks lower their base rates, since what will have happened is that the lending environment will have deteriorated, and this deterioration is likely to influence conditions in new lending (or rollover credit) for years rather than months into the future.

Obviously existing mortgage holders on variable rate mortgages can get some fresh air from any loosening in the base rates, but it is the demand for new mortgages, and activity in the construction sector, and not locally but globally, that we need to be thinking about here. Clearly construction growth can slow, as lenders become more choosy about who - and under what conditions - they lend to. This becomes important for the real economy when we come to consider the importance which construction activity shares have had in economic growth in some major economies - the US, the UK, Spain, Australia etc - since the turn of the century, and the impact which the so-called wealth effect has had on the rate of growth of private consumption in this self same economies. So clearly, in some developed economies, economic growth is now likely to be rather weaker, and for some time to come.

But any looming "credit crunch" is also likely to affect the so called "risk appetite" (that is the willingness to invest in riskier areas or activities) and the place where this is most likely to be felt is in the emerging market area. Those emerging markets which are considered to be most vulnerable will undoubtedly have the hardest time of it, and this brings us directly to the Baltics, who must be considered to be in one of the riskiest situations of all. To quote the Economist's Buttonwood, "WHEN investors get twitchy, developing countries are usually the first to pay the price."

And investors are definitely twitchy right now, and, as Danske Bank Senior Analyst Lars Christensen commented last Wednesday (pdf link), the markets are beginning to show signs of pressures on the lat re-emerging. In his research note Christensen argues that the atmosphere surrounding the Lat has been rather calm since May, following being under significant pressure during February-April period (as reflected in this speech from Latvikas Banka governor Ilmārs Rimšēvičs back in February, which was an irate response to an article in the pages of Diena by the Swedish Economist Morten Hansen, who was arguing that the Lat/euro peg needed to be broken, more on all this in another moment).

Basically Christensen sees this pressure re-emerging, largely for three reasons:

Firstly there is the above mentioned worsening of global credit conditions, which will make it much harder to fund the large current account deficits in Latvia and the other Baltic states. Scandinavian banks naturally are also showing less willingness to fund the Baltic credit boom with global credit conditions worsening and concerns are mounting about the vulnerability of over-leveraged households and investors across the Baltics.

Secondly there are clear signs that the property markets are coming under fairly strong selling pres-sure in all three Baltic states. Christensen suggests that property prices have dropped nearly 10% in Estonia over the last two quarters, while Latvian property prices have declined 5%-8% over the last two months. Meanwhile, Lithuanian property prices are no longer rising. In addition to this he mentions anecdotal evidence that property developers in the Baltics are freezing property projects that have already been initiated.(Latvian Abroad is covering the unwinding of the Latvian property boom here, and here).

Thirdly, there is the fact that the Baltic economies are now clearly slowing. As I argued yesterday, the Estonian economy is now showing very significant signs of a fairly sharp slowdown with the rapid second quarter GDP screech to a halt (only 0.2% growth in the quarter) marking the lowest rate of growth in seven years on a quarter-on-quarter basis.

On the property market angle, Christensen has a separate report (again pdf), and he makes a number of important points here:

Property price statistics are fairly unreliable and hard to compare from country to country in the Baltics, but most sources now point to fairly heavy declines in property prices – at least in the three capital cities. Property prices have dropped most in Estonia’s capital, Tallinn, where official statistics and anecdotal evi-dence indicate that property prices have dropped around 10% this year. Latvia’s capital, Riga, is also ex-periencing falling property prices – down 5-8% over the last couple of months and most indicators suggest-ing an acceleration in the rate of decline.

There are also signs of slowing property prices in Lithuania’s capi-tal, Vilnius, but it is still too early say that property prices are actually declining. There are a number of rea-sons why property prices are now declining in the Baltic States. In our view the primary reason is simple – prices have simply risen far too much relative to fundamentals. Furthermore, a number of negative shocks have hit the Baltic property markets. Most importantly, interest rates have gone up in line with European rates over the last year. Furthermore, the banks have tightened credit standards on the back of rising con-cerns about the large imbalances in all three countries. Hence, it looks like the boom in the Baltic property market is coming to an end. It is very difficult to assess how far property prices in the Baltics could potentially fall, but given the large imbalances in the Baltic economies we think the downturn could be quite severe and long-lasting. It is debatable whether there has been a Baltic property bubble, but there is no doubt in our view that property price growth has been exces-sive, and therefore property prices should be expected to slide further going forward.

So basically, and the bottom line here, the Baltic economies are extremely vulnerable to any sudden turn in investor sentiment. We are in the middle of a major sea change in global sentiment even as I write, so at the end of the day all I can say is, do watch out.

Thursday, August 9, 2007

Latvian Fertility

Well, while we are looking at the economic straights which Latvia is now in, it may also be useful to see how we got to where we are. Basically the Latvian economy is growing very rapidly, in all probability too rapidly even in the best of cases. But Latvia does not have the best of cases. If there were a plentiful and adequate supply of fresh labour, growth rates near the present one might not be unthinkable (remember China's GDP is currently growing at around the 11% annual rate, and India may well soon overtake this - over say a 5 to 10 year window). So why not Latvia? Well you have to look at the fertility and migration situation, that is why not.

Latvian Abroad had a post over the weekend which gave some details of the numbers of Latvians in the UK and Ireland (which must surely be the principal destinations since 2005), while Latvijas Statistika offered us some useful information on Latvian fertility earlier in the week.

But before we get into some of the more recent details, I've compared a simple chart showing live births in Latvia since the late 1980s (and in the process, documented the natural population decline by making a comparison with deaths, as can be seen the crossover point is around 1992).

And before going any further I think it important to point out that, from an economic point of view, it is live births and not the Total Fertility Rate statistic which matters, since these births are what regulate the actual flow of new people into the working age groups. As can be see there was a very dramatic decline after 1987 (ie 20 years ago). The decline steadied after 1999, and the number of births has risen slightly, but it is important to point out here (and even forgetting for the moment about the impact of migration) that the number of births will surely soon start to fall again.

This is principally for two reasons:

In the first place there is the fact that the median age of first birth for Latvian mothers at around 25.5 is still comparatively low by West European standards (in Western Europe the numbers normally are approaching the 30 mark). Let's have a look at a chart from Latvijas Statistika:

So we can see that mean ages at first birth have been steadily rising. This process is known as birth postponement, and produces what is known as a "birth dearth" as women delay having children. This process also produces artificially low readings on period based fertility indicators (like the standard Total Fertility Rate), but this, as I say, is largely irrelevant from an economic point of view, since what we are interested in is how many people will be arriving in the labour market in the years ahead. And as I say, since postponement has only run approximately half its probable course, we should expect more from the "birth dearth effect".

But there is a second reason why births are likely to go down with time rather than up, and this is known as the population momentum effect. If we look at the number of children born in 1999 (just under 20,000), then even assuming that Latvia achieved that magical 2.1 perfect reproduction fertility number, they would only produce 20,000 children, not the old level of 40,000 or so. And we can be pretty sure that these 20,000 children born in 1999 won't do this even under the best of circumstances (which, of course, we aren't) since even being optimistic they are only likely to have completed cohort fertility of somewhere in the 1.5 - 1.7 region if other countries examples are anything to go by. So these 20,000 children will produce say 16,000 or 17,000 children.

And there is worse to come, since these children will start to reproduce, on average, in 2030, and not 2025. So the smaller number of births will be spaced out over even longer periods of time, etc , etc.

Well of course, all of this is so far into the future that it is not exactly the burning topic of the present crisis. On the other hand do not forget about it altogether, since that is what people did back in 1990, and look where we are now. If countries like Latvia are ever to be put on a stable footing this fertility issue needs to be addressed, and seriously, and pronto.

In the meantime the only alternative is inward migration, and if the Latvian government is serious about trying to avoid a hard landing then it had better get serious about migration, and how to facilitate it.

Incidentally, in the light of everything said above, this extract from Latvijas Statistikas is the next best thing to "gobbledygook":

As girls born in the eighties of the 20th century have reached the fertile age, the number of women at this age does not reduce further more. At the beginning of the 2007, as well as in 2000, in Latvia there were 590 thousand women aged 15-49 or 48% of the total number of the women (in comparison: in 1997 - 45%). Women aged 20-29 has the highest birth rates. The share of women in this group in the total number of the women at fertile age has increased from 27.2% in 2000 to 28.7% at the beginning of the 2007. The increase of the number of young woman, as well as the growth of the number of the marriages, promise the increase of the births also in the future.

They don't really seem to understand how this process works, and promising an increase in births in the future on this basis is to offer one more time false hopes and more reasons for inaction. Latvia deserves better.

And also just for the record, here's the fertility chart based on TFRs:

As you will notice, the fertility rate registered has started to rise again slightly. Now take a look at the earlier chart on mean first birth ages, and note how the rate of increase slows in the second half of the period covered over the rate of increase in the first part, and here's your "improvement in fertility" (in large part). There really is no big mystery about this.

But completed cohort fertility in Latvia never was as low as 1.13, this number is just a statistical artifact. We simply do not know what the completed fertility rate for the women born in the years 1980-1985 will be, but as I say above, looking at societies in Western and Southern Europe (Germany, Italy etc) without a systematic child support system in place, I would say 1.5 to 1.7 TFR would be a fair (and reasonably optimistic) guess.

Also the map in below presents the mean ages of mothers at first birth in Europe around 2003, and shows the extent of postponement in the timing of parenthood. To put these data in perspective -- in 1975 the highest mean age at first birth registered in Europe was 25.7 (in Switzerland), and in the majority of countries the indicator was between 22 and 24 years. Most researchers interpret this as part of the general trend towards postponement of choices that are irreversible or hardly reversible, usually associated with the ideational and other changes linked to the so-called “second demographic transition”. Again in line with the predictions of the second demographic transition theory about the importance of individual autonomy and self-expression, the differences between individuals within a population in the timing of parenthood are also increasing. And also as you will note, the differences between Western and Eastern Europe in terms of birth timing is still striking.

(Please click over image for better viewing)

Latvia Foreign Trade June 2007

Well this time here's a chart (see below) from Latvijas Statistika, showing the recent evolution of foreign trade and the trade deficit. Again the picture does not differ from one area to another. In June 2007 both exports and imports fell slightly in comparison with May 2007, and the monthly deficit accordingly reduced ever so slightly.

As we saw yesterday, manufacturing industry actually contracted slightly in June when compared with the previous year. May retail sales were up, on the other hand,by a seasonally adjusted 2% over May, and a year on year 24.4% (although this was a marginal reduction with the aggregated increase of H1 2007 over h1 2006). None of this bodes well. The changes, insofar as they are occurring in the right direction are moving too slowly, and meantime the price index is ticking away upwards.

On the

Latvia Q2 2007 GDP Growth Rate

Well second quarter GDP certainly hasn't slowed, which is leading to all manner of speculation. As stated in the previous post when looking at inflation, either the package of measures aren't working, or they aren't working quickly enough. The trouble with this rate of GDP growth is that it continues to put pressure on wages and prices, and this will send them to levels which will be very difficult to correct later with a fixed exchange rate.

Below there is a chart showing how the rate of GDP growth has varied (or should I say hardly varied) since the start of 2005.

July 2007 Latvia Inflation

Well, not unexpectedly the July inflation reading came in on the high side (9.5% year on year). This is not especially surprising given all the inflation there must be in the pipeline after all the wage rises. Things will have to get worse before they get better on this front. The first sign that inflation pressures are easing would come from the Q2 wages data, assuming these have improved.

Of course coupled with the Q2 GDP data (see next post), there are few signs that Latvia is slowing anything like quickly enough (in order to avoid having a very dramatic deceleration later), so this must raise question marks about the effectiveness of the policy measures introduced so far.

For the record, here are the time series graphs for the consumer price index and the yaer on year inflation rate.

Tuesday, August 7, 2007

Latvia Industrial Output June 2007

According to Latvijas Statistika - and as can be seen in the graph below -

Compared to June of the previous year, industrial production output in june 2007 rose 1.2% to seasonally adjusted data (seasonal and working day influence is taken into account) of the Central Statistical Bureau. There was an increase of 6.5% in electricity, gas and water, but a decrease of 0.2% in manufacturing and 5.2% in mining and quarrying.

So in fact manufacturing actually decreased y-o-y in June 2007. This is not a good sign, when most manufacturing industry in the EU27 is accelerating rapidly.

Meanwhile in an earlier press release we are informed that:

The volume of cargo reloaded at the ports of Latvia in January - June 2007 was 31.4 mln tons, an increase of 4.6 % compared to the 1st half of 2006, according to data of Central Statistical Bureau. 27.6 mln tons of cargos were loaded at ports, an increase of 0.6 % compared to January – June 2006.......

The volume of cargo unloaded at ports in the 1st half of 2007 increased noticeably. In January – June 2007 3.8 mln tons of cargo were loaded and unloaded at ports, what is 1.5 times more than in 6 months of 2006. Cargo in containers accounted for the bulk of cargo unloaded: 0.7 mln tons. The volume of this cargo unloaded has increased by 28.1 %, in comparison with January-June 2006.

That is the volume of loaded outgoing product rose 0.6% y-o-y (reloaded 4.5%) while unloaded cargo has increased "noticeably" with container contents rising 28.1%. Significant increases we also noted in the volume of construction materials unloaded which seems to have doubled.

Saturday, August 4, 2007

Latvia Trade Shares

One of the issues to consider when thinking about the susceptibility of the Latvian economy to any external shock is the composition of exports. Now over the last years we have seen a significant change in this respect (as can be seen in the charts below), basically the EU 15 now accepts a much smaller share of the total, whilst other Baltic states and Russia are rising.

In 2003 the EU15 took almost 62% of Latvia’s exports, but in January-October 2006 this share had reduced to less than 44%. Conversely, the economies of Latvia’s two Baltic neighbours, Estonia and Lithuania, have grown rapidly in recent years, and their share in Latvia’s foreign trade has increased accordingly. On the import side, Germany is still the most important country, providing some 15% of Latvia’s imports, especially machinery and cars, which is another way of saying that Latvia is a good German customer.

The IMF economists also say this:

In the aftermath of the Russia crisis, Latvia successfully reoriented the destination of its exports, but failed to transform its product structure. Exports therefore remain concentrated in resource and labor-intensive goods (wood and wood products comprise 30 percent of exports), embodying inputs of low- and medium-skill blue collar workers. Among the EU8, Latvia has—by a wide margin—the largest share of low-tech, labor-intensive exports which compete directly with low-cost countries. In contrast to several other new EU members which are moving up the technology ladder, in recent years Latvia has seen some regression in the skill- and technology content of its exports.

The Dynamics of Product Quality and International Competitiveness

Stefania Fabrizio, Deniz Igan, and Ashoka Mody
IMF WP 07/97

Despite the appreciation of the exchange rate, the eight Central and Eastern European countries (the CEE-8) that entered the European Union in May 2004 have achieved a decade of impressive export growth, expanding significantly their shares of world markets. Does this mean that the real exchange rate is irrelevant? If not, what other factors compensated for the appreciation to explain the apparently strong competitiveness of these economies? And will these favorable factors continue to power export growth? This paper places in international context the achievements of the CEE-8 and helps more broadly to identify the determinants of international competitiveness. Building from data at the six-digit level of disaggregation, it shows that the CEE-8 made an impressive shift in product quality and in the technological intensity of exports, and that these shifts associated with the structural transformation were also associated with increased market share. The analysis strongly suggests that, when trading in international markets, countries benefit from higher product quality. However, while the structural transformation achieved was valuable in raising market shares, the easy gains from this process may be over.

The IMF selected issues had this to say:

Analyzing the product composition of Latvia’s exports can also shed light on the ease with which Latvia can expand its export markets. This is done by examining the quality and technology content of Latvia’s exports, and by analyzing demand growth in the markets in which Latvia competes and the characteristics of its major competitors. 24. To assess the quality and technology content of Latvian exports, we apply three alternative classifications:10 (i) Technology and resource content, whereby exports are divided into (a) low-tech and labor-intensive products, (b) resource-intensive products, and (c) medium- to high-tech products (Appendix II, Figure 1). (ii) Comparative advantage, in which exports are classified into (a) mainstream manufacturing products, (b) labor-intensive products, and (c) capital-intensive and techdriven products (Appendix II, Figure 2). (iii) Skill requirement in which exports are allocated into (a) low-skill products, (b) mediumskill blue-collar products, and (c) medium-skill white-collar and high-skill products (Appendix II, Figure 3).

Data indicate that Latvia’s exports remain concentrated in resource- and labor-intensive goods that are produced with low- and medium-skill blue-collar labor.

Moreover, this structure has changed very little since 2000. In contrast, all other EU8 countries have steadily increased the technology content of their exports, particularly the Czech Republic and Hungary—which have also been the largest recipients of manufacturing FDI. This finding does not bode well for Latvia’s export prospects. This is confirmed by Fabrizio, Igan, and Mody (2006), who find that improved export quality and technology upgrading among the EU8 during 1994-2004 contributed significantly to the increase in their international market shares.

The second approach to analyzing the structure of Latvia’s exports examines the speed of growth of individual export markets and the intensity of price competition that Latvia could face. Figure 11 depicts ten industrial branches that accounted for more than 70 percent of Latvia’s export sales in 2004. The size of each circle represents the branch’s share of Latvian exports. The vertical position of a circle measures the share of emerging market countries in global trade for that industry. A horizontal axis is drawn at 28 percent, which reflects the average presence of emerging markets in world trade. With the exception of pharmaceuticals, all of Latvia’s major export sectors currently face an above-average degree of emerging market competition, with some (e.g., textiles) facing very high levels of competition from low cost countries. The horizontal axis captures the strength of global market growth. Each sector is positioned horizontally according to how rapidly the worldwide market for that industry grew in nominal U.S. dollar terms—relative to the 37 percent increase in world trade—during 2000–04.

This analysis finds that Latvia’s exports are concentrated in industries in which world demand is growing relatively slowly, and where there is a heavy presence of low wage countries. In Figure 11, the most desirable location for an industry is the south-east quadrant, with the least desirable being the north-west quadrant. The intuition of this analysis is that Latvian exporters could do well even if they were losing market share to low-cost producers provided the global market for that product is expanding rapidly. However, only two of Latvia’s major export industries—iron and steel, and pharmaceuticals—are growing rapidly worldwide, and they accounted for just 12½ percent of Latvia’s exports in 2004. Moreover, nearly 30 percent of Latvia’s exports are in goods where competition from emerging markets is above average or intense (clothing and apparel, textiles and fabrics, and electrical equipment).11 Latvia’s largest export category—wood and cork—would not seem to offer significant growth potential since market growth has been marginally below average, while emerging market countries are participating in the sector at close to the average for all industries.

Wednesday, August 1, 2007

Hard Or Soft Landing in Latvia?

The Batic Times had an article during the week which offered a summary of a recent report from Hansabank Markets (full text available here in event of link rot).

Now as Latvian Abroad points out in comments, neither the article nor the report it summarises really add anything new to the the extensive airing that this topic has already received in the economic and financial press. In this context see, for example, the Financial Times here and here, the Economist here, here and here, and EU Business here. EU Economy Commissioner Joaquim Almunia has also joined in the act, although he explicitly avoided direct reference to the hard landing possibility, as did the IMF staff economists in their last IMF "Mission to Latvia" statement. The same essentially goes for the widely quoted BICEPS report (caution pdf). Carsten Valgreen, who puts his finger on one part of the present problem judiciously avoids voicing an opinion about what exactly the future might have in store for Latvia.

Hansabank, however, is rather more explicit than most, and this explicitness isn't too hard to understand, since they come down on the more optimistic side of the fence.

The Estonian and Latvian economies are settling into the eagerly awaited “soft landing,” as Estonia’s growth in the first quarte of this year eases off a rapid 9.8 percent year-to-year increase, and Latvia’s slows from 11.2 percent, says a new report released by Hansabank Markets.

Perhaps this optimistic tone is not all that surprising, given the amount of money Hansabank have invested in the happy ending scenario. The report also touches on the rather more delicate issue of the currency peg, and what might happen to it. Again they are pretty positive.

Anxiety this spring of a possible devaluation of Latvia’s currency due to the rapidly deteriorating balance of trade figures has subsided as well. Chief Economist at Hansabank Martins Kazaks says, “The risk of devaluation is minor at the moment. Due to our very thin and virtually sealed-off financial markets, external speculative attacks are very unlikely to be of any important volume, but with no improvements in macro imbalances the current situation is not sustainable.”

The last phrase, we might note. does cover virtually any possible eventuality.

But, more to the point, what exactly are these macro imbalances they refer to? Well as I have tried to argue at some length here, they stem from a virtually unique set of circumstances (historically unique I mean, at the present time the underlying dynamic across all the East European EU member states is remarkably similar, with the possible exception of Hungary). In brief Latvia is facing, at one and the same time, a massive inflow of external funds, and a massive outflow of people. Put another way, demand side factors are increasing rapidly, while supply side capacity not only is unable to keep pace, it is actually shrinking (if we think about the number of people of working age).

So there are two problems to correct here, and they are both large and important. Essentially Latvia needs:

a) more labour supply, both skilled and unskilled
b) a lower rate of inflow of structurally distorting funds, whether these be bank credit, remittances, or even (possibly, this needs investigating further) EU funding for projects which Latvia cannot reasonably expect to carry through in the time horizon outlined.
c) more Foreign Direct Investment to create value creating jobs, especially in manufacturing and services areas with export potential
d) increased spending on education and training projects to upgrade the human capital of the existing population

In this sense the Hansabank statement that:

"The main risk.....is if governments continue expansionist policies, and in the process fuel ongoing consumer spending growth."

is not really to the point, since it is not government policy which is fueling the overheating, and indeed the government is already aiming for a budget surplus this year. In this sense the Hansabank report only reiterates what the IMF staff economists stated after their Article IV consultation discussions back in May 2007, to the effect that the Latvian government should aim for a 4% of GDP budget surplus in 2007, an order of magnitude which the Latvian government has so far resisted. So the Latvian government may be blamed for excessive complacency. The March 2007 measures (summarized by the Finance Ministry here, and by the National Bank here) certainly fall short of what is needed, but at the same time it needs to be understood that many of these problems are not of the Latvian governments own making, and even under the best possible package of policy options, Latvian would still be having major problems, as the BICEPS report authors indicate when they state that Latvia has more problematic parameters than policy instruments available. This is simply a technical way of saying that they are really rather at the mercy of events, and not their master.

The central point here is that the fiscal surplus proposal really a form of positive policy, it is a last line of defence move, implemented as a result of the fact, as the BICEPS report makes clear, that given the fact that the major imbalance issues (shortages of suitably educated and qualified working population, and inflow of remittances and bank funds) are de facto outside of the control of conventional monetary policy instruments, neither the central bank nor the government have adequate policy instruments available. This is the real issue, and this is the longer term problem we all need to be thinking about, not only in Latvia but far more generally.

But the measures mentioned above are longer term and structural, what about the present situation, is it manageable? This is a very difficult question to answer. It depends on what they call the "global conditions". The financial markets, as is now well known, are currently in turmoil, and it is hard to know where the snowball which has been put in motion will actually come to rest. But to really decide whether or not the Baltic states will have a hard landing we really do need to know, as a prior, the answer to this question. Meanwhile, we must simply bide our time, and watch and wait.

My general feeling is that while there are no easy or immediate solutions to Latvia's long term problems, Latvia on its own won't "unwind". Nor is it likely to precipitate a more general unwind. In part this is to do with what the Economist rather impertinently calls the "pipsqueak" factor.

But then we need to think about the general global risk appetite. Certainly this has been somewhat volatile of late. And for the time being it seems set to remain volatile.

The issue really is that the global economy may be reaching(or even we may now have passed) the peak of the current growth cycle. Signs of a slow-down are evident everywhere (except of course in Eastern Europe, although obviously the Baltics and Hungary are clearly slowing now, and the others may not be too long in following depending on how "hard" the global landing actually is). From the US to the eurozone and Japan it is clear that GDP growth rates in 2007 will be lower than those in 2006, and even China is giving some indication that she will need to pause for breath at some point (especially if the rapid growth rates of exports to the EU and the US cannot be maintained), and while India may well be on the development launch ramp, she is not sufficiently large (in GDP terms), or sufficiently integrated in the global economy at this point, to make any decisive difference.

The decline in the value of the dollar is also a factor which needs to be considered here. In Europe we are not especially noticing the oil price effect, but in the US it is surely now a drag. Add to this the US housing woes, and the fact that almost a majority of the population *believe* that the US is headed for a recession ("animal spirits" do matter here). As a result I think it is not unreasonable to imagine that the US will gradually (I hope gradually) slow in the second half of 2007.

If we reach a recession call point in the US then Bernanke will undoubtedly unlease all that ammunition he has been storing up, and start to lower interest rates (Of course the surprise move by the Federal Reserve last Friday is now an early indication of this possibility). This in and of itself will present the ECB with a big headache, given the "normalisation" course they have been trying to steer. Any attempt to continue the upward march in Eurozone interest rates will only send the euro once more sharply upward, and with the euro, of course, the Lat.

But it is more what will happen in financial markets at this point we need to be thinking about.

Once the ECB moves away from rate "normalisation" as a discourse (as I feel it will now have to), and once we get into the area of possibile rate reductions again, then the global financial system will enter a "delicate moment", simply because what financial markets like best is a consistent story, and this is what we have been having, up to now. In the last few years everything has been all about relative yield and the search for the differential. But when we get a change in the "zeitgeist", then there is always the risk of increased problems, if for now other reason than that market participants don't really know how to respond. This, I think is the worry in the back of the Economist's Buttonwood's mind in the recent articles (here, and here). As he says in the most recent installment - Cold Turkey - "WHEN investors get twitchy, developing countries are usually the first to pay the price."

So what can the Latvian government do? Well beyond tightening up credit regulations (which it has already done, but there are limits to this process in an era of financial deregulation) and being more aggressive on the fiscal tightening side, there is precious little they can do. Obviously steps need to be taken to try and facilitate the return of some of those migrants who are in the UK and Ireland (mightn't some of the EU funding be better used for this purpose?), and evidently it would be very positive to follow in the initial footsteps of Estonia and open the labour market up to migrants from elsewhere (indeed they need to be actively encouraged to come, and not subtly resisted), and of course the underlying fertility situation which is fueling the problem needs to be addressed (once more a leaf can be taken from Estonia's book). But all these measures are longer term in nature. In the short term we now have little remedy but to sit it out and wait, and oh yes, to keep our fingers crossed that the current problems associated with the US sub-prime mortgage market don't turn into a globalised and general "credit crunch".