Yes, they're leaving 20

Up until last Friday, we knew little about the effect of this crisis on migration. Yes, nearly everyone seems to know someone who left to the UK, Ireland, Australia, Canada… somewhere, but we had no reliable evidence on the big picture. It all changed when Mihails Hazans, definitely the best labor economist in the Baltic States (and probably the only serious labor economist in Latvia), gave us some figures on social registrations in the UK and Ireland. Turns out in the first quarter of 2009 there were more Latvians registering in these countries than in any other quarter in 2004-2008! Clearly, there is a new wave of migration.

Iesaki citiem:

Is it good or bad for those who stay? In the short run, it's probably a good thing. Since those who migrate are likely to be the unemployed, this reduces the likelihood of the rerun of the February events. The families of migrants (if they stay behind) benefit from remittances. Migration may explain why the streets are relatively calm in spite of horrific unemployment figures. In the long run, however, it's all bad. Many of those who left, probably, won't come back. This means smaller GDP and greater per capita tax burdens required to pay the pensions, public debt etc.

Some may argue that labor pool can be 'replenished' by opening up to migration from non-EU countries. Actually, I doubt it can work in the foreseeable future. EU labor market is increasingly 'free', which means that migrants can effectively 'shop' between different countries in the EU. This raise two questions. First, can Latvian government really prevent a migrant from 'moving on' to a higher-wage EU country? Second, consider a relatively high skilled migrant who is choosing an EU country to move into. High skilled jobs require knowing the language of that country and learning languages is costly. Naturally, the migrant would consider things like size of the labor market, i.e. how easy it is to find a job. How many would choose Latvia over, say, Germany, or the UK, or France? I am afraid small countries that are sensitive about their languages are at a big disadvantage here.

Another point I'd like to stress is how little do we know about this important phenomenon. How many people leave ? Where do they go? For how long? Do they take families with them? How educated are they? Lots of very important but unanswered questions. And this in spite of substantial resources poured into lots of local 'research' which mostly produced silly 'findings' like "people migrate to UK because of higher wages". Well, I eagerly await what the census (planned for 2011) would show...

Finally, the following should be crystal clear. This wave of migration is largely a consequence of the stabilization program that is centered on keeping the peg. Both devaluation and 'internal devaluation', in theory, produce equal reductions in the real wages. But it is 'internal devaluation' that operates through creating so much unemployment. And inability to find a job is a powerful force that's pushing so many people out of the country.

Iesaki citiem:

Komentāri (20) secība: augoša / dilstoša

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V Dombrovsky ---> -- 20.09.2009 08:34
I can only fully agree with you. It's a relief to see other "pseudo-economists" finding time to contribute to the argument.

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V Dombrovsky --> K.G. 20.09.2009 08:28
You're trying to make a professional argument, but your attitude is not very professional. "…the data is unrepresentative and puny at best"?!! Wherever you come from, the likelihood you know much about this dataset is close to zero. I am sorry, but jumping to such conclusions without sufficient information signals lack of rigorousness. The data I referred to actually comes from the Business Registry. So if it's "puny", so is any statistic about Latvian economy.

The "models" you're talking about. I can only surmise you mean the calibrated ones. WHERE are they? Where are these working papers, data, etc, so that anybody could have a look for himself? Are these the same models that produce BoL famous 'estimates' of zero price elasticity of demand for imports? Do you understand that such findings imply the need to rewrite all economics textbooks? And probably introduce communism, too. If you're from where I think you are, tell me: Can a BoL economist be an advocate of devaluation and keep his job? I suspect not.

There are numerous lapses in your argumentation, e.g. equating devaluation with "defaults", you "can easily assume negative effects outweigh the positive ones"(?!), devaluation being "beggar-thy-neighbor" policy here. You say you "don't have the numbers" to evaluate significance of some effect, but next conclude that "the prospects are not promising". You call the data you don't know "puny", and then start supporting your arguments using your "feelings", and the feelings of some businessman (building inferences from a sample of one, aren't we?) Frankly, your reasoning is all over the map.

My impression is that you're not after 'truth', you're defending a 'religion'(is that why you accuse other of following "mantras"?). You want to believe that devaluation is "evil", and you do your best thinking up all the arguments you like and dismissing the ones you don't like. Your arguments are (at best) 10% economics, and 90% emotions. And herein lies the problem in that I don't know how productive arguing with religious adepts is. You tell me.

And last, there is nothing unorthodox about devaluation. On the contrary, it's boring, boring orthodoxy. Deflation, in contrast, can be defined as 'fun'. Hope you're enjoying it.

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-- -->K.G. 20.09.2009 05:24
I am still waiting for a reference for those models you were mentioning ;-)

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-- -->K.G. 20.09.2009 05:22
Actually there is a lot of evidence that devaluations are followed by rapid V-shaped recoveries. Look at Mexico, most of SE Asia after 1997, Argentina 2002, etc. Usually 2 years after the D countries are back in the growth track. Evidence for internal devaluations is more tricky. The problem is that in the past almost all the big crises have been accompanied by the D. This fact alone should make us think twice about the current LV policies. Is Latvia really some special case, or is this just another crisis. I think its just another crisis, although I must addmit it is tempting to think that LV is special... it is not!

This lack of historical precedence is behind my earlier claim that we know much less about the scenario with internal devaluation than about the one with the D.

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Kaspars Gasūns -> -- 19.09.2009 20:01
Going a little "off-top" - I think that a more immediate short-term priority is tariffs and speedy energy market liberalization. The regulator and energy/utilities monopolies, I think, is the weakest spot in the devaluation plan. And it hurts our businesses no less than the strong lat does.

Of course, that is not an easy task, but that would be worth the blood-shed (political). There sems to be something slowly progressing with the regulator - the small "scandals" could be reflections of the real power-struggle below the public vision.

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Kaspars Gasūns -> -- 19.09.2009 19:51
Did you really take the 5% estimate seriously?! :O I am sure even the ones who publicised it did not! :D
I do not know why politicians and bureaucrats lie, but the logic seems to be that the audience is dumb (which is by a great margin true!) and it is not worth communicating to the sane part of population anyway - it will understand everything by themselves. :)

Here is a realistic and rather early estimate for 20%:

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Kaspars Gasūns -> -- 19.09.2009 19:28
I do not have much time to answer, but I will surely return to this discussion later on. It only started to get interesting. :)

Just two notes - I think that we have to have something to replace Nordic banks before devaluation. So I am very anxious about ERAB at Parex and developments at Hipoteku banka - if it will really work as a full-time development bank.
Otherwise the destruction created by defaults and a temporary market freeze (minding the loonatic psychology and economic perception of aborygenies I fear this the most) in the local market could not be rebuilt fast enough - would not have creative aftermath.

Exports - with Lithuania and Estonia devaluating too, the increase in exports could be really small. (I agree I do not have the numbers to back this up.) Borrowing your point - the question is "BY HOW MUCH" - it is not worth the turmoil, if the prospects are not promising.
And please remember that there are many companies that are not "pure" exporters. For them a freeze and mass defaults in the local market could be fatal. This is an argument by a real businessmen, who was against devaluation, because his enterprise was in the process of re-orientation to exports, but was still very exposed to the local market. His intuition was that the local market would fall into panic and freeze, bancrupting series of businesses overnight. And that is also my feeling.
That is why I am against the devaluation at this moment of time. High possibility of mass default, which could result in high unemployment, emmigration, hyper-inflation and eventually lead to all the same bad things related to internal devaluation. So a massive damage first, and then the same slow death with a "D" seal over our international image.

And I repeat that there is no whatsoever base for assuming that nominal devaluation in super-highly-unstable environment would bring U, V or whatever other shape of rebound. The argument about fast fall and fast rebound is just a nice visual picture people like to imagine - there is no economic base for assumption that faster fall eventually speeds up the recovery. I want to hear where that recovery would come from. And as I mentioned before - the gain for exports could easily be not enough - so lead to the same dragging as internal does now.

P.S. Regarding the statistics of 2005 to 2007 - yes, that is a crime! But it is "our" crime. Whenever one gets to this argument, I cannot stop reminding, that it is people who voted and backed (even by not pushing for re-elcetion hard enough) Kalvitis-Slesers duo. And it is their government that provided the framework for the madness - the banks operated just as market agents within this framework. (Of course, their lobby was present... but in the end it was government's responsibility against the people; the banks' have responsibility against their shareholders.) If we blame banks, we could blame the construction companies and developers just as well - but within a given framework and market conditions one has either to play the game or let competition take over.
So it was "our fault" in the first place, and "beggar thy neighbor" scheme to let the banks bear the full cost alone would be passing our responsibility (at least two thirds of it are ours) to the Swedes.

P.P.S. And I cannot stop reminding that the one party most responsible for any loan is the BORROWER - and only then comes government, banks, destiny, ...

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-- -->K.G. 19.09.2009 01:48
I agree with yout argument about 'taking responsibility'. One can only hope that people will remember these hard times and kick the governemnt out of power next time inflation hits 20%, current accoutn is -25% and there is fiscal deficit despite 2-digit growth. Every time I write these numbers I continue to be shocked at how screwed-up LV economy was in 2005-2007!!! Its going to make a great text-book case.
-- -->K.G. 19.09.2009 02:00
Concerning all your devaluation pros and cons. To me the question of 'to devalue or not to devalue' for Latvia largely reduces to a question about the prefered speed of the adjustment. Sort of like a choice between V, U and L-shaped collapses. Its not obvious which one is the prefered scenario, but the governemtn needs to be consistent in its policies. If they decide on an internal devaluation then dont tell people that the recovery will come sometime in 2010. It will not come until the banks are fixed and price level has fallen (relative to EU) by a sizable amount. Neither will happen within the next 2 years.
-- -->K.G. 19.09.2009 02:09
I dont agree with you about devaluation and exports. Devaluation always increases exports. The right question is: by how much? the answer depends on the size of the devaluations. If LVL falls by 50%, exports will experience sizable and pretty immediate jump.

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-- -->K.G. 19.09.2009 01:37
Some relies in random order:
1. "It is controllability and predictability of the situation." LOL. Yes, but predictability of what? A lost decade or two? A fall in LV population to 1.5 million 10 years down the road? Variability is not the only thing that matters.

2. In a high income country stability can be of primary importance. But can LV afford to be poor and stable. E.g., the promissed fical cuts of 500ml a year are very predictable under the current policies, but somehow I dont think it will lead to any social stability, increase in consumption or foreign investment. And by saying this I dont mean that a devaluation would fix anything. Lets focus on current policies. I think current policies will lead to an slow desaster. We'll have zombie banks, governemnt that spends more and more of its revenues to pay interest on external debt, people leaving the country. This could potentially continue slowly spiralling down for a very very long time.

3. Last fall it was predicted that with 'internal devaluation' GDP in 2009 will be -5%. 6 month later it was closer to -20%. Would you call that 'predicted general trend'???

4. I completely disagree that effects of an internal devaluation are easier to understand and model. If anything, I would argue that its even harder, especially the long-run effects. And the long-run is what really matters.

5. Can you give me examples of those 'models' that you keep refering to?

6. Concerning Sweden, I think there is a lot of us against them. The fact is that Latvia's baning sector is best described as a big hole. I think its about 30% of GDP in the 'red' and someone will have to fill this hole (30% of GDP is a lot of money). Really, there are only two possibilities: (i) LV taxpeyers/depositors or (ii) Swedish taxpayers/banks. The way I see it the more this crisis is dragged out (or using your words, the more STABLE it is), the larger the share paid by the LV side.

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Kaspars Gasūns -> -- 19.09.2009 01:09
And the last anti-devaluation argument from my side. Taking responsibility for our own deeds (and debts) is a responsible and, I would say, grown-up thing to do. Trying to trick ourselves out with Beggar thy Neighbour schemes is not - we would still loose out long term, because our business credibility would be badly damaged.

Yes, Swedish banks did actually participate in a Beggar Thy Neighbour scheme themselves with their massive loans and real estate bubble - against the Baltics, but that was within the government backed and (indirectly) stimulated policy. Banks are in notably more passive position (even with the whole lobbying) - they are not legislators. We cannot just say we did not like the game and change the rules after we started loosing badly.
Then who will want to play with us economics again? We do not have the Russian gas, or do we?

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Kaspars Gasūns -> -- 19.09.2009 01:01
There is another argument for the pro-devaluation team. It is improved availability of lats and increased money flow in the country.
But this argument has its ready counter-argument. With the practices of fiscal indiscipline of the "fat years" and the economic inbalances still largely in place, any short-term inflows of "easy" money would be (quickly!) spent without lasting benefit and would only increase the risks of hyper-inflation.

I say devaluation is not bad by itself, but you have to be ready to take advantage of it. Also any state action has to be responsible and predictable to reasonable degree - government that takes bets on 50% chance of default does not sound serious to me.

For those who fantasize default as an exit strategy, I repeat - the deeper you fall the longer you have to crawl back. And the steepness of fall, is in no way a guarantee of faster recovery - one may just as well spend some time at the bottom. For a small, open (dependent) economy without spare resources - during a global crisis! - default is practically suicidal.

Yes, we could write down some of our existing loans, but where that would practically destroy our finacial base - which is in fact Nordic banks, one may like it or not.

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Kaspars Gasūns -> -- 19.09.2009 00:42
Well, perhaps my wording was not precise enough. What I actually meant would be better to call modeling. And only secondary to that calculations with the limited data available - to back those models as far as it is realistically possible. For example, the energy inflation as a result of devaluation and its proportional effects.

After all there are specific aims to be achieved with either internal or external devaluation. So some modeling is in order - and that is what Mr. Dombrovskis is trying to do with his insolvencies argument, but the data is not representative and puny at best.
What is obvious now is that there are just two models-arguments from the pro-devaluators: export increase and internal competitiveness for local companies. (There were more: the reserves of Bank of Latvia and devaluation expectations, but these have stepped back.)
Well, it has been already modeled and even proved by comparative statistics that currency is irrelevant for exports at the current date. But I hear the argument repeated again and again by the "pro-devaluation" team as a mantra - does not sound better than the "sacred lat" to me.

The benefits for internal competition - the spectrum of speculation for devaluation effects is so large, that we can easily assume the negative effects would outweight the positive ones. Mass insolvencies in a short time can lead to default and a whole array of scenarios we dare not imagine. And an abrupt default is not a guarantee of a fast recovery (that is a baseless assumption), but is surely a fast way to financial lock-out and regional instability. Do we need any of the latter? No! And neither does the EU and Sweden - it is not us against them, but rather all of us against our economical imbalances.
Kaspars Gasūns -> -- 19.09.2009 00:42
Regarding the internal devaluation - you made the argument yourself. It is controllability and predictability of the situation. And it is by far more prone to modeling and calculation. By far! We cannot guess the exact numbers, but we can predict general trends, follow them and react, if necessary.
With internal devaluation we have much more time and control on our side. And TIME and TIMING is crucial! Time gives economy opportunity to adapt and re-allocate resources (the scarce ones left). Mass defaults overnight - do not.
Also STABILITY is a merit of its own in economics. E.g. it is one of the crucial aspects for attracting investors. Also a major impulse for internal spending (by those who still have money).

So the argumentation of pro-defaulters looks rather unserious at the moment. (Surely not better than that of the anti-defaulters.) It is just optimistic opportunism that devaluation will miraculously solve it all. Nothing more than betting, but any risks have to be proportional to potential gains/losses and taken responsibly.
So I expect arguments/models much more heavyweight and varied than “export miracle” from the pro-devaluation team. All I see now is campaigning from Mr. Skele (designation by Edward Hugh) and macro-economist school-boys’ joy over a fancy idea to play with.

The argument that we are too deep in sh*t now to get out of it in a "decent", orthodox way, so we need something revolutionary, is just empty words. Imprudent acts can easily bring us even deeper with even more time needed and less resources available to climb out. There just cannot be an easy way due to the thrift of the "fat years" (I do not use "prosperous" intentionally here), so let's stop dreaming escapist's project of miraculous escape with happy end. There are good reasons why Latvia is right where it is, and any way out will be painful at best.

P.S. I still think that with the new budget, export markets in order, world finances on stable base, and businesses and households re-adapted - we could really go for CONTROLLED devaluation with notably less risks than now and notably more potential gains.

P.P.S. The disadvantages of getting Euro later than the other two Baltic countries is not a joking matter - we could loose momentum for just as many years as it would take us to get out of the current crisis. I would appreciate counter-arguments on this. The matter is actually undeservingly under-discussed/under-modeled.

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--> K.G. 18.09.2009 21:58
Your implicit argument that anyone who favors devaluation needs to show 'credible calculations' about it benefits is too simplistic. Sorry to disappoint you but any serious 'pseudo'-economist would tell you that the issues at stake are too complex for 'credible calculations'. However, this does not change the reality. LV is in a deep hole and, at least conceptually, we can get out of it through implicit or explicit devaluation. WITHOUT any 'credible calculations' governemnt thus far has decided to pursue the policy of implicit devaluation. Why? Because its easier to implement in the SHORT RUN and because EC and Sweden let LV do it (they have their own reasons).

PS. Lack of any 'credible calculations' can be used as argument against explicit devaluation. But it can equally well be used as argument against the current 'implicit devaluation'. So how can you use it to descriminate between the two policies? I dont understand the logic behind your argument.

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Kaspars Gasūns 17.09.2009 21:36
Just wanted to add that I see the devaluation option as viable even in the closest future, the criteria being economic rebound in our export markets.

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Kaspars Gasūns 17.09.2009 21:33
While agreeing to the "general beauty" of devaluation, I still do not see any credible calculation of its actual effects in Latvia today. Your speculation about insolvencies looks very unconvincing. We can put it in the category of guesses.
Well, here is my guess. The other side of of your argument are reserves and profits of SMEs - to repay the loans whatever these are. If managers followed the same phylosophy as "lay people", they had little reserves and tended to do bad planning. (Some behavioral economics.) In that case many could be walking on dangerously thin ice and are just one step away from insolvency.

Local market advantage - the turmoil and enterprise/individual bankrupcies of euro borrowers could probably wipe out the momentum of lower costs for local producers.
And I do not see how mass bankrupcies (possible with devaluation) in short time is better than extended over longer time.

I would also beg not to count export as beneficiary of devaluation. Finnish and Swedish export curves almost copy each other regardless of currency. And there are more stats like this. So I tend to back the assumption that under the present circumstances fall in demand has very little to do with currency, hence its value is not the determining factor.

But I dod not rule out devaluation as an opportunity missed (well, who could predict future) and an opportunity ahead. After all the problem of overvalued Lat is still there. So devaluation is an open option. But in an open country with puny reserves, lots of loans and small economic capacity, plus, during a severe crisis, there are simply too many risks now.

P.S. Devaluating just for intellectual pleasure of macroeconomists is not the way. I somehow have this impression that many simply like the heretic sound and the air of unorthodoxy about the "D" word. Not personally Mr. Dombrovskis.

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--> ... 17.09.2009 20:38
I think devaluation remains a very valid alternative, chiefly because the alternative (price reduction) is failing. It was sold with an assumption that Latvia is so special and so flexible. Turns out we are like any other country, i.e., reductions in prices and wages are too slow to solve the problem is a reasonable amount of time. I mean, one year after the crisis started Latvia is still a leader in inflation (lowest deflation) in Europe. That alone tells you everythign you need to know about the success of the current policies.

As to the uncontrolled fall in the value of Lats, its definitely possible but is not necesarily a bad thing in my view. The further it falls, the sharper the initial contaction in economic activity and the stonger the subsequent rebound.

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... 16.09.2009 19:19
It is clear that the devaluation would have been the better alternative and it is very silly to talk about "stimulating of the economy" in times when it is more about reducing the consequences of the deflation process with social and labour market programmes - but are you really sure that when starting the devaluation process the whole thing does not end with a currency worth nothing and there is a need for the implementation of a alternative one or the barter for some time? May be it is already too late for this - it is not more credible, it would have been may be a year ago e.g.

As to the research - I guess the research you were talking about was carried out by some Latvian higher educational establishments (including universities) - so may be it represents the "enormous potential" (as declared by some) for exporting educational services in the field of social sciences and nothing more or may be simply eventually the decision has to be made to close some of those and stop this waste of money.

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V Dombrovsky -> Gatis 16.09.2009 18:09
Good question. My answer comes in three parts.
1. Devaluation would have two relevant effects. The first is the balance sheet effects on those with FX loans (the one you talk about) - negative. So maybe some will go bankrupt and that would produce some unemployment - ok. The second effect, however, comes from substitution effects, as prices for (relatively) locally produced goods become cheaper relative to imports. This means an increase in demand for those SMEs so it's a positive effect. Of course, general price level would be higher, which would reduce real wages and demand, but not devaluing has the same effect through falling nominal wages, as everybody can now see.
2. Lets talk about that balance sheet effect. "Wave of [SME] insolvencies"? That depends on how many have those loans. An average for all SMEs is, naturally, a poor guide. Any body showed us data on this? No. But I happen to have something called SIBiL which is a firm-level dataset of 1000+ firms representative of manufacturing sectors and some services (ie not nationally representative). Lets look at "loans from the banks". First, the long-term ones. A median firm has zero such loans! Only 10% of all firms in the sample have these. Moreover, only 5% have more than 163 thousands LVL, which we may (arbitrarily) consider for "a lot". Short-term loans from banks? Same picture. 90% of the SMEs in the sample don't have them! And only 5% have >65 thous. LVL. Mass insolvencies leading to mass unemployment? I don't think so.
3. Finally, difficulty paying an FX-denominated loan after devaluation need not result in bankruptcy. It would only happen if a firm in trouble has many competing creditors. Firms with few largest creditors (especially if these are banks) that would be deemed potentially solvent would have their loans restructured. Of course, the success of this would also depend on the state of the legal framework.

To sum up, devaluation amounts to instantaneous reduction in wages, as measured in euros. Deflation means wages need to increase via a 'market adjustment'. In the presence of rigidities, this would only happen through unemployment. And that's what we're seeing.

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--> gatis 16.09.2009 18:05
Yes, devaluation would also increase unemployment, but I agree with the author that devaluation is a powerful wage cutting tool. The morning you announce that Euro is 15% more expensive all Lats salaries fall in Euro terms(and Euor terms is what matters). Whichever way you look at it, a broader fall in wages means lower unemployment.

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gatis 16.09.2009 15:40
Not sure I understand statement: "But it is 'internal devaluation' that operates through creating so much unemployment." I think one should assume a great wawe of SME insolvencies and further drop of consumption after a sizeable devaluation that would also lead to mass unemployment? Thanks

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