Latvia may be a member of the European Union, but like its neighbors it falls firmly in the middle of the global income distribution. With a national income per capita of between $10,000 and $15,000 per year, it is a member of a club that includes Lithuania and Estonia, but also Mexico, Russia, and Turkey. It is not rich, but it is not poor.
Despite its moderate national income level, Latvia has no mass poverty of the kinds found in Mexico, Russia, and Turkey. It has a lower infant mortality rate, a higher high school graduation rate, and more internet users per capita than any of its peers. Latvia has clean drinking water and relatively good public services. In short, Latvia makes reasonably good use of its limited resources.
The challenge for Latvia is neither its current situation (which is not bad) nor the economic crisis (which will pass). The challenge for Latvia is to grow into a modern European economy. Ireland, Portugal, and Spain more or less managed this feat through a massive infusion of European Union structural and agricultural funds. In today’s political climate, Latvia cannot rely on such generosity from its richer neighbors.
Instead, Latvia will have to follow one of the three paths that other middle-income countries around the world have used to grow (or try to grow) into the top tier of the world-economy.
All development paths require an infusion of resources from somewhere. If EU money for development is not forthcoming, the three remaining choices for Latvia are to rely on low wages to draw in foreign investment, to become a regional hub that attracts foreign spending, or to develop internally through shared sacrifice and re-investment of the country’s own resources.
I call these three choices the Alabama model, the Singapore model, and the Finland model.
In the Alabama model, foreign companies are offered low corporate taxes and generous investment incentives. Wages and unemployment benefits are kept low to ensure the steady supply of a large and willing workforce. Unions are discouraged and the government makes no effort to promote collective bargaining. Minimum wages are low or non-existent.
The Alabama model has been used for the past thirty years by the southern states of the United States in their efforts to catch up with the richer northern states. The state of Alabama in particular has been very successful in attracting auto makers and other industrial companies. Like Latvia, Alabama is heavily forested. Government regulation is kept to a minimum for the benefit of forestry, wood, and paper products companies.
The Singapore model is to attract foreign spending instead of foreign investment. All four Asian tigers — South Korea, Taiwan, Hong Kong, and Singapore — have promoted the exports of their own domestic companies. They have also benefited as trade hubs for their surrounding regions. Singapore especially takes advantage of its geographical position to generate large incomes from port services, air transport services, trade finance, insurance, and warehousing.
Lately Singapore has developed more sophisticated service export sectors in education and healthcare. For Singapore it is southeast Asia, especially Indonesia and Malaysia. Just as middle-class Russians enjoy vacationing in Riga, the new rich in southeast Asia enjoy shopping trips to Singapore. Location and transport links are key.
The Finnish model is both the most challenging and the most rewarding of the three. Like Latvia, on independence in 1918 Finland was a poor, rural, forested country. In many ways it was less advanced then Latvia. Over the years, however, Finland invested its own resources in raising the productivity of its citizens. It is now one of the richest countries in the world.
Finland’s situation was unique. Its geopolitical position made it difficult for Finland to attract large-scale foreign investment, and Soviet Communism meant that Finland had no real opportunity to exploit its proximity to Russia. So Finland had to rely on its own resources rather than money from abroad.
Finland used high taxes on the rich to create first-class public education and health services. Strong labor unions pushed for on-the-job training and skills upgrading. Wage growth was strongest at the bottom of the pyramid, with ordinary workers decade after decade getting bigger raises than their bosses. The Finnish strategy is the same as that used by Sweden a generation earlier and Japan a generation later. It sacrificed some current income in exchange for future growth.
In the twenty years since it re-emerged as an independent country, Latvia has mainly followed the Alabama model. Flat income taxes and low corporate taxes ensure that foreign investors pay the least in tax, rich Latvians a little more, and working-class Latvians the most. Labor unions are almost non-existent. To top it all off, the global financial crisis was used as an excuse to impose cuts in government salaries and services.
The problem with the Alabama model is that it restricts development to the few rather than spreading its benefits out among the many. The Alabama model will give Latvia gleaming shopping centers, luxury car dealerships, and the outward trappings of wealth and international respectability. Unfortunately, it won’t give ordinary Latvians jobs with decent incomes and opportunities for self-advancement. In an integrated EU labor market, many ordinary Latvians will do the only rational thing: they will emigrate.
The Singapore model, on the other hand, opens up real opportunities for Latvia and Latvians. While it may be culturally difficult for independent Latvia to cater to Russian tourists, it would be economically attractive. To take this path, Latvia should allow and encourage the creation of a full-service Russian-language university, promote Latvian-Russian bilingualism, and seek to build a high-speed rail link to Moscow.
Latvians might find it very difficult to rely on Russian money for development, but the third option is even more difficult. To follow the Finnish model, Latvia must tax all of its citizens, especially its richest. This is easy to do in theory but hard in practice. As in other countries, patriotism in Latvia ends at the bank doors. It’s easy to show patriotism by scorning Russian money; it’s hard to show patriotism by spending your own.
Nonetheless, history shows that the choice for Latvia is clear: become a two-track society where the rich prosper and the poor emigrate, cater to Russian interests, or sacrifice the interests of the wealthy in favor of the interests of the country as a whole. Latvia needs strong unions, strong government regulation, and a progressive tax system. These are all within Latvia’s ability to achieve with no outside help. All it takes is the will to do so.