Is Iceland doing better than Latvia?
Who has done better in the crash: Iceland or Latvia? I wrote an article today in which I contrasted the two and suggested that Iceland has done better, in part, because it has allowed the krona to depreciate, while Latvia has retained its peg to the euro and attempted to close its budget and trade deficit by crushing state spending and domestic wages.
In one respect, the point is obvious.
Paul Krugman has contrasted the performance of the two economies on GDP:
Iceland lost around 12 per cent of GDP output. Latvia shed 25 per cent – one of the biggest drops in economic history.
Krugman also compares employment performance (ignore Estonia for the moment):
Iceland now has an unemployment rate of 6.7 per cent. In Latvia, joblessness is around 17 per cent.
So Iceland has clearly done better on these basic measures.
But there’s a counter argument. Morten Hansen of the Stockholm School of Economics in Riga points to this graph which suggests that, despite Latvia’s massive drop in output since 2007, its economy is still outperforming Iceland’s over the past decade:
Hansen also doubts that the 50 per cent depreciation of the Krona has helped Iceland’s economy that much yet. It’s also sometimes pointed out that since 89 per cent of Latvian residents’ debt is in foreign currency (mostly euros), the pain of breaking the peg would be greater than the present internal devaluation.
It’s an interesting debate. I’m personally more inclined to the Krugman view, that Latvia would be better off breaking the peg. The latest IMF report (p4) says that Icelandic recent growth has been been driven by an increase in inventories of marine products, suggesting that one of Iceland’s main export industries, fishing, is benefiting from devaluation. And this paper from Mark Weisbrot and Rebecca Ray from the Center for Economic and Policy Research in Washington points out that Argentina ultimately benefited from breaking its dollar peg in 2001, despite the immediate-term pain.
In the end, the fate of the Latvian euro peg will probably depend on the strength of the recovery there. Unless that unemployment rate comes down it is hard to see it surviving.Tagged in: iceland, internal devaluation, Latvia, Morten Hansen, Paul Krugman
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