OECD Economic Outlook, Volume 2019 Issue 1

Latvia

Economic growth is projected to decline as export market conditions worsen and the disbursement of EU funds slows. Robust household consumption will continue to support growth. High wage growth will gradually translate into rising inflation.

Fiscal policy will be broadly neutral. More efficient tax collection is essential for financing higher spending on healthcare and better access to housing, education and training. The new government’s commitment to bolster efforts to reduce informality and fight economic crimes, including money laundering, is welcome.

Economic growth is led by domestic demand

Latvia enjoyed strong economic growth in 2018, supported by double-digit investment growth due to some large investment projects in the trade and logistic sectors and an exceptional surge in the disbursement of EU funds. Labour tax cuts and strong wage growth, driven by higher minimum wages, labour shortages and productivity advances, supported robust household consumption. However, the weakening in global trade has weighed recently on business confidence, industrial production and exports. Rising labour costs have not resulted in significant inflationary pressures so far.

The labour market remains tight and the number of job vacancies is elevated. The unemployment rate has declined but remains above 7%, as labour mismatches across skills and regions hold back faster employment growth. There are also many involuntary part-time and discouraged workers and individuals that are ready to work but not actively searching for jobs. This is a serious challenge for economic growth, not least because the labour force is decreasing due to continuous emigration and population aging. The average wage grew by 8% in 2018, resulting in a rise in unit labour costs relative to Latvia’s trade partners.

Economic growth and labour market: Latvia

Source: Central Statistical Bureau of Latvia; Eurostat; and OECD Economic Outlook 105 database.

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Latvia: Demand, production and prices

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Policy measures should be mobilised to make growth more inclusive

The fiscal stance will be broadly neutral, as the personal and corporate income tax reforms phased in since 2018 are compensated by higher excise taxes and spending restraint. The government also raised social contributions to finance a part of the increase in health spending. The fiscal stance is adequate given limited inflationary pressures and the need for more spending, in particular on healthcare, education and training to address skills shortages and inequalities in access to social services. However, the government should monitor the impact of higher wages on prices and stand ready to react with some more fiscal tightening should inflationary pressures rise more than expected, in particular towards the end of the projection horizon.

Strong productivity growth is needed to ensure robust economic growth against demographic headwinds stemming from ageing and emigration. Aligning vocational and tertiary education better with labour market needs and increasing the participation in adult learning are essential for addressing skills shortages that constrain innovation and the adoption of digital technologies. Developing a rental housing market would help strengthen labour mobility and address regional job mismatches. The capacity of the judiciary, law enforcing agencies and supervisors must be strengthened to fight economic crimes, such as money laundering and tax evasion, to address informality and reputational risks as well as inefficiencies in insolvency procedures that hold back more efficient resource allocation. Improving access to healthcare and strengthening social protection would contribute to both higher and more inclusive growth.

Economic growth is projected to remain robust

Economic growth will slow down somewhat, as investment will moderate to a more sustainable pace on the back of a deceleration of the disbursement of EU funds. Export growth is projected to recover only gradually. A disorderly exit of the United Kingdom, Latvia’s sixth largest export destination, from the European Union could delay the recovery of exports further. Wage growth will remain high as skills shortages and labour mismatches are expected to persist in the short term. This will support consumption via higher household incomes, but risks undermining the price competitiveness of Latvian firms, if not matched by sufficiently high productivity growth. On the other hand, recent structural reforms to foster innovation and training may take effect faster than expected, allowing Latvian firms to strengthen their non‑price competitiveness. This would contribute to stronger growth and employment.