The extent of economic collapse in Latvia is shocking even to an Irish observer, writes JAMIE SMYTH, Social Affairs Correspondent

THE DIRT road is marred by potholes, which the autumn rain quickly turns into a muddy stream. Large piles of stones lie unused, stacked up on the roadside. One new home with a beautifully landscaped garden stands next to a row of half built houses, their timber frames exposed to the elements and gardens overgrown with weeds.

The forlorn landscape looks like the type of ghost estate that blights many Irish towns. But this is Marupe, an affluent suburb about 15km outside Riga, the capital of Latvia – one of the EU’s newest member states.

“We bought three years ago and it cost €300,000,” says Inara Trezinadlaff, who is digging up weeds on a grassy verge outside her home. “But when the crisis came, the workmen stopped building the houses beside us. The construction company went bust and the bank has just left these buildings to fall apart. I’m very angry at the banks,” she says.

Houses on the estate are worth half what they were at the peak of the Latvian economic boom in 2007. Some lie empty and unsold while a dozen remain unfinished – ugly monuments to a building bonanza that ultimately caused Latvia’s economy to collapse and forced the International Monetary Fund (IMF) and the EU to provide it with an €7.5 billion bailout.

The extent of Latvia’s collapse is shocking even for Irish observers. Since the recession began at the start of 2008, Latvia’s gross domestic product (GDP) fell by a quarter, one of the biggest falls in output of any country since the Great Depression.

The unemployment rate has tripled, hitting 22 per cent at the start of 2010 before falling back to 16 per cent in June. Tax revenues fell 30 per cent last year and government debt is projected to rise to 74 per cent of GDP this year, up from just 7.9 per cent in 2007.

So what went wrong for the fastest-growing of the “Baltic Tigers”, a country that enjoyed annual growth rates in excess of 10 per cent between 2004 and 2007?

“It was a kind of perfect storm,” says Martins Bicevskis, Latvia’s state secretary for finance. “We would have had a big economic decline due to the global financial crisis in 2008 but it certainly wouldn’t have been so deep if our system wasn’t so weak.”

Bicevskis blames several factors: a property boom inspired by successive governments’ lax fiscal policy, which provided tax breaks for developers and low taxes on real estate; a flood of cheap money into the economy from foreign banks, particularly from Scandinavia; huge increases in wages prompted by labour shortages; and the global liquidity crisis.

When Lehman Brothers collapsed in late 2008, Latvia’s banks struggled to raise funds, prompting the nationalisation of Parex bank on November 8th. A month later the entire country was forced to seek a bailout when it could not raise short-term funds.

There are obvious parallels between the Latvian and Irish economic busts, such as the building boom, flood of cheap credit and an overheated economy. But unlike Ireland, which is a member of the euro zone, Latvia could have chosen to devalue its currency, the lats, and export its way out of recession.

It chose not to, and instead has implemented the type of “internal devaluation” policy the Government is pursuing here.

“The main reasons we didn’t pursue devaluation of the currency are because this would only result in a temporary boost to exports for a few quarters, and would not have solved the structural problems in the economy. Secondly, 90 per cent of loans in Latvia are held in euro,” says Uldis Rutkaste, economist at Latvia’s central bank. Latvia also hopes that supporting the currency will allow euro entry by 2014.

Devaluing the currency would have heaped pain on mortgage holders, most of whom hold their loans in euro currency, and the foreign banks that fuelled the property boom. But pursing a policy of “internal devaluation” via massive public sector job cuts and wage decreases is a hugely controversial policy that risks prolonging the recession, say some economists.

The Centre for Economic and Policy Research warned in February that the end result of the severe austerity measures implemented by the government is that “the economy is trapped in a deep recession . . . [which] makes it very difficult to get out of recession”.

The government, led by prime minister Valdis Dombrovskis, has cut deeper and quicker than even the IMF austerity programme in an attempt to reduce its budget deficit from 9 per cent in 2009 to 3 per cent by 2012.

The measures include: salary cuts of up to 30 per cent across the public sector; halving the number of state agencies from 76 to 39; reducing the number of hospitals from 59 to 42; increasing income tax from 23 to 26 per cent; increasing VAT from 18 to 21 per cent; and increasing taxes on wine, cars, gambling, property and land.

The Dombrovskis government plans further cutbacks, including a major reform of the old age pension, and is arguing for full implementation of the IMF-EU programme following next weekend’s elections. It faces tough opposition from two rival parties, which are calling for changes to the IMF deal to ease the cutbacks – a popular policy among the poor.

“We have a very bad government,” says Inara, a 53-year-old woman returning with her husband from picking mushrooms in the forest near Marupe. “Life is difficult for us. We don’t get social welfare and there are no jobs for us. We survive by picking mushrooms and berries, and selling them at the local market. We live on 10 lats (€14) per week,” she says.

In Latvia, unemployment benefit is paid for a maximum of nine months. Income support payments are set at about 45 lats per month. However, a new mandatory community work scheme introduced by the government last October means all benefits can be withdrawn if a person does not sign up for community work such as cleaning streets. “When you get made unemployed over [the age of] 35 years they don’t need you any more. But in Latvia now even the young people can’t find work and have to go abroad,” says Inara, who now lives in a caravan because her house fell into such a state of disrepair.

Poverty levels in Latvia are the highest in the EU, with a quarter (26 per cent) of people at risk of poverty. The comparable figure in Ireland is 16 per cent, according to the EU statistics agency Eurostat.

The lower standard of living in Latvia promoted significant emigration following EU entry in 2004 (Ireland and Britain are the two most popular destinations) and this is continuing during the recession, with 30,000 people leaving the country every year.

This has the benefit of acting like a “safety valve” to cope with high unemployment in the short term, according to IMF mission chief for Latvia Mark Griffiths. But he has warned in recent interviews that losing skilled entrepreneurs and workers could end up hurting the country’s recovery.

Bicevskis says the government’s austerity policy is working and points to recent data, which show the economy stabilised and grew in the first two quarters of 2010. It also managed to sell a three-year bond with an interest rate of less than 6 per cent – a significant achievement for a country that couldn’t raise funds in 2008.

He acknowledges that people are suffering huge pain from the austerity measures, but says tough measures are necessary to show Latvia is credible to international investors to enable it to borrow the money it needs to survive.

“We know how to live in an economy in crisis. Our people haven’t forgotten that from our history. People are much better prepared to endure this than other western countries,” he says.

Next week’s election will test his theory.