Answer to Question #103545 in Macroeconomics for THEMBI MLAMBO

Question

One of the main macroeconomic objectives of any country in the World is economic growth as measured by the gross domestic product (GDP) per capita from one year to the other. However, the fast growth rate of the Latvia economy created significant macroeconomic imbalances.
1.1 Discuss the costs and benefits for Latvia following the transitioning from a planned to a market economy.

Answer 1

Thirty years after the restoration of independence, fundamental changes have taken place in the Latvian economy - from the socialist and planned to the market. Having become an independent state, Latvia has lost a huge domestic Soviet market: it has suddenly declined by a hundred times.

Such a rapid and significant reduction in the domestic market objectively led to a change in the entire structure of the country's economy. Instead of agriculture and industry, services became the leading sector of the economy, the volume of which in 2009 amounted to almost 77% of the total additional product created in Latvia. Services at their core are mainly provided to residents of Latvia: trade, transport, finance, real estate, education, healthcare, public administration and defense.Of course, part of the services - hotel, transport, transit, financial - are exported, but they cannot fully compensate for the losses from the decline in agriculture and industry. Trade became the leading branch of the economy, it created the largest surplus value, and the largest number of workers were employed in it. Latvia is a small state, without deposits of raw materials and energy that it is forced to import, with a limited domestic market, it cannot develop efficiently, continuously increasing the volume of services provided.

Advantages: in recent years, 70% of GDP is generated by the services sector. The country has relatively successfully passed through shock therapy to a stable market economy. Inflation was reduced before switching to the euro due to Maastricht criteria and remains low (less than 1% in 2018). The national currency, lat, was canceled with the transition to the euro (2014). A country that is a member of the single EU market has relatively high economic growth rates (above the EU average) and low government debt (below the EU average). Here, relatively cheap and well-educated, in comparison with the EU countries, the workforce.Amid falling unemployment and increasing labor shortages, wage growth as of 2019 is not constrained by a slowdown in economic growth.

Weaknesses: energy supply depends on imports of petroleum products, gas and electricity. Poor raw material base. The biggest problem (as in other countries - new EU members) is the growing shortage of able-bodied labor every year and the increase in the number of pensioners in the population structure due to the low birth rate and high emigration of the population to richer EU countries, which in turn forces employers pay more to staff, thereby artificially raising salaries and increasing the imbalance between productivity and wages.The main export goods of Latvia (2011): electric machines and equipment - 6.9%, machines and mechanisms - 5.4%, iron and non-alloy steel - 5.2%, lumber - 4.8%, pharmaceutical products - 4.1 %, iron and steel products - 3.2%, primary products from iron and steel (granular and powder products) - 2.8%, round timber - 2.6%, knitwear and textiles - 2.5%, non-ferrous metals and their products - 2.5%.

The Latvian economy has experienced one of the highest GDP growth rates in Europe. FROM

2005 to 2007, the average annual GDP growth rate exceeded 10%, since large inflows of foreign capital stimulated a substantial increase in consumer expenses. In 2008, a crisis occurred in the country as a result of instability trade deficit, real estate market crash and large numbers private loans at risk. During the crisis, GDP declinedby a quarter, external debt doubled, the number of people employed,decreased by 16%, and real wages decreased by 12%.Latvia successfullyovercame the crisis at the end of 2010 and economic growth resumed, mainlyway thanks to the growing role of exports.From 2011 to 2013, GDP grew by an average of 4.4% per year. In 2015, GDP grew by 2.7%, in2016 - by 2.0%, while in 2017 - by 4.5%. Slowdown in recentyears associated with trends in world economic situations - slowergrowth in the EU than expected, as well as weakening of the economic situation in Russia. However, it should be noted that current export volumes exceed pre-crisislevels of more than 25%.

Of course, at present, the development of the Latvian economy is mainly due to the export of services, but in the future in fierce competition in the world will it be able to maintain these development trends without sustainable industrial and agricultural growth, moreover, that energy supply depends on the import of oil products and gas and electricity, and the growing shortage of able-bodied labor and the number of pensioners in the structure of the population every year due to the low birth rate and high emigration to richer EU countries makes work givers to pay more staff, thus artificially raising wages and increasing imbalance between productivity and wages.This is what the leadership of the country should think about.