The 6% growth fallacy

Latvia posted one of the highest growth rates in the European Union in the third quarter of 2015 but "one of the highest" in the EU does not necessarily mean "high", given the anaemic growth we see in much of the EU and Latvia's 3.3%, though the best for two years, is still rather paltry, see Figure 1.

But, as I heard it once again in a conference a couple of weeks ago, stating that growth should be 6% is not very helpful either because it is just not going to happen for a sustained period and thus it becomes a rather empty statement.

Figure 1: Growth rates, %, year-on-year, EU28 and Latvia, 2011 Q1 - 2015 Q3

Source: Eurostat

True, Latvia posted very high growth rates prior to the financial crisis but this was the result of a) The Mother of All Credit Booms, b) an unemployment rate that went from 15% to just 6%, c) no private debt to speak of prior to the boom and d) Latvia being farther behind in terms of GDP per capita and thus having more catching-up potential than it has right now.

None of these four points can be repeated in the current situation (very high growth in 2011, Figure 1, was a result of coming out of the crisis and was partly due to unemployment coming down from astronomical heights): a) A similar credit boom is not possible (400% increase in loans in about four years - nope, not going to happen), b) unemployment is below 10% and close to full employment - not much to gain here, c) there is still deleveraging going on (banking sector loans still haven't started increasing from their peak in 2008) and, d), although Latvia has quite some way to go in terms of catching-up it is not as much as, say, 15 years ago.

The economy is also not helped by current external circumstances - the EU still grows very slowly and Russia is in recession. Combined, this gives us a rather dismal export performance, see Figure 2, i.e. exports that contribute next to nothing to growth.

Figure 2: Export growth rates, %, year-on-year, Latvia, 2011 Q1 - 2015 Q3

Source: Central Statistical Bureau and own calculations

So, 6% growth is a mirage, wishful thinking, and is quite unhelpful to the economic debate.

But with a weak demand side of the economy and with an economy that shows very few, if any, short run imbalances (no problems with inflation, no problems with the budget deficit (well, a bit but not much), no imminent overheating etc.) it is strikingly obvious that all political focus should be on strengthening the supply side of the economy. But that has been rather absent of late and I just wonder if a new government will pick up here?!? As always, I remain sceptical but hope for the best. 

Christmas is, after all, just around the corner.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council of Latvia