www.oecd.org/eco/surveys/economic-survey-latvia.htm

OECD OECD Economics

2015 OECD ECONOMIC SURVEY OF LATVIA

ENSURE INCLUSIVE AND ROBUST GROWTH Riga, 25 February 2015

Latvia has recovered from the crisis

Real GDP, 2007 = 100

Source: OECD Economic Outlook 96 database.

2

The economy slowed but should gain momentum

2013 2014 2015 2016

Percentage changes, volume (2010 prices)

GDP at market prices 4.2 2.5 3.2 3.9 Private consumption 6.2 2.7 3.0 3.7 Government consumption -4.2 2.7 2.8 2.8 Gross fixed capital formation -5.2 2.4 2.7 5.2 Exports of goods and services 1.5 1.9 3.1 5.2 Imports of goods and services 0.3 1.7 3.2 5.0

Net exports1 0.7 0.1 -0.1 0.0 Harmonised index of consumer prices 0.0 0.8 1.9 2.3 Unemployment rate 11.9 10.9 9.7 8.8

Macroeconomic indicators and projections

1. Contributions to changes in real GDP, actual amount in the first column. 2. As a percentage of GDP. Source: OECD EO96 database.

• The economy has slowed due to geopolitical tensions and low growth in main trading partners.

• The growth outlook is highly uncertain with predominantly downside risks. 3

Main challenges

1. Reducing income inequality

• Spending on social programmes is low and not targeted enough.

• The tax system weighs on employment and is weakened by informality.

2. Raising productivity and ensuring robust convergence

• Deficiencies in the business environment undermine productivity growth.

• The vocational education and lifelong learning systems do not fully provide the skills needed.

3. Limiting the risk of repeated boom and bust cycles

• The economy is volatile and vulnerable to external shocks.

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Key recommendations

1. Reducing income inequality

• Make social benefits better targeted to low-income households.

• Reduce taxes on low-paid jobs.

• Strengthen efforts to tackle tax fraud and improve tax collection.

2. Raising productivity and ensuring robust convergence

• Reduce entry barriers and red tape, improve governance of state-owned enterprises.

• Proceed with the reform of vocational education and training, including the extension of work-based learning.

3. Limiting the risk of repeated boom and bust cycles

• Build up a fiscal reserve to cope with adverse macroeconomic shocks.

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• Latvia has made significant progress, achieving important milestones, such as the euro area membership (2014).

• GDP per capita remains well below the best performing OECD countries.

Convergence has resumed

Income gap to the upper half of OECD countries, %

Percentage gap with respect to the simple average of the highest 17 OECD countries in terms of GDP per capita (in constant 2005 PPPs). Source: OECD National accounts database and World Bank, WDI database.

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But well-being can be improved

Note: difference with the OECD average normalized by the standard deviation. A positive difference means that the country does better than the average of OECD countries in terms of this variable. Source: OECD National accounts database, Eurostat database, World Development Indicators Database, OECD Labour Force Statistics database, OECD PISA 2012 database, International Institute for Democracy and Electoral Assistance (IDEA) database, OECD Health Statistics database, Central Statistical Bureau of Latvia, WHO Mortality database and Gallup World.

Difference with the OECD average

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• GDP, inflation, unemployment tend to fluctuate significantly.

• Latvia is particularly exposed to external shocks.

And the economy remains highly volatile

GDP growth rate compared to the same quarter previous year, %

Source: OECD Quarterly national accounts database.

8

Reducing income inequality by improving public sector efficiency

9

• Long-term unemployment and the low progressivity of the tax-benefit system contribute to high income inequalities.

Income inequality is high

Gini coefficient of disposable income adjusted for household size, scale from 0 "perfect equality" to 1 "perfect inequality", 2. OECD Secretariat calculations from EU-SILC – preliminary results. Source: OECD Income Distribution database and OECD calculations.

Level of income inequality Gini coefficient, 2011

10

Social benefits and income redistribution are low

Make universal social benefits more targeted at low-income households.

Gradually withdraw benefits targeted at low-income earners when they take up a job.

Social public expenditure % of GDP, 2011

Source: OECD National Accounts at a glance database and Eurostat.

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• High taxes on low-paid jobs are a deterrent for working in the formal economy and undermine job creation for low productivity workers.

• Reducing personal income tax to 22% will of course be welcome, but not significantly reduce tax on low wages.

Reduce taxes on low-paid jobs.

The tax system discourages formal employment…

Source: OECD Tax-Benefit Models (2013 provisional).

Labour tax wedge Income tax plus employers and employee contributions less cash benefits

for a single person without children earning the minimum wage, % of labour costs, 2014

12

• Fighting informality offers significant revenue potential

• The difference between VAT revenues that should be perceived and those that are effectively perceived amounts to 3.5% of GDP.

Strengthen efforts to tackle tax fraud and improve tax collection

… and is weakened by informality

VAT gap, % of GDP, 2012

Note: The VAT Gap is the difference between the VAT theoretically due and the VAT effectively perceived. Source: European Commission, "2012 Update Report to the Study to quantify and analyze the VAT Gap in the EU-27 Member States", September 2014 and Eurostat database.

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Raising productivity and ensuring robust convergence

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Productivity increased and can strengthen further

• Significant increases in productivity, even during the crisis.

• Further productivity gains are crucial for growth since the working-age population is shrinking.

Source: OECD Productivity database and OECD National Accounts database.

Level of GDP per hour worked, 2013 Labour productivity (GDP per hour worked) growth

0 5

10 15 20 25 30 35 40 45 50 55

Latvia Estonia CzechRepublic

SlovakRepublic

Slovenia OECD

USD PPP

- 1 0 1 2 3 4 5 6 7 8

OECD Slovenia CzechRepublic

SlovakRepublic

Estonia Latvia

Annual % change

2000-2005 2007-2013

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• Despite recent improvements, Latvia still lags behind in terms of exports, FDI inflows and participation in global value chains.

Latvia can become more competitive

1. Average 2009-2011 for Czech Republic and Slovak Republic. 2. Financial sector refers to financial and insurance activities and real estate activities. 3. Backward participation shows the use of foreign intermediates in a country’s exports and forward participation the use by other countries of a country’s inputs in their exports. Source: OECD Economic Outlook database, Eurostat database and OECD Global Value Chains indicators – May 2013.

Global Value Chain participation indices³. % of gross exports, 2009

Exports of goods and services, % of GDP, 2013

FDI inward stocks, average 2009-12¹, % of GDP

0

20

40

60

80

100

LVA SVN CZE EST SVK0

20

40

60

80

100

LVA SVN EST SVK CZE

Forward participationBackward participation

SVN LVA SVK CZE EST

Non-financial sectorFinancial sector²

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Regulation weighs on the economy

Make regulation more competition-friendly by reducing entry barriers

Source: OECD (2013), Product Market Regulation Database

Product Market Regulation (PMR) is more restrictive than in the average OECD country

Overall indicator

0.00.51.01.52.02.53.0

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The business environment can be enhanced

Product Market Regulation (PMR) sub-indicators 2013, index scale of 0-6 from least to most restrictive

Source: OECD (2013), Product Market Regulation Database

Improve the governance of state-owned enterprises.

Continue reducing red tape, by simplifying the permits and licenses system.

Continue improving the connectivity of energy networks with the rest of the European Union.

Government involvement in network sectors Licenses and permits system

0 1 2 3 4 5 6

CZE SVK EST LVA SVN OECDaverage

0 0 1 2 3 4 5 6

SVK CZE EST SVN LVA OECDaverage

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Energy intensity is above the OECD average

• Reducing energy intensity would improve cost-competitiveness, reduce greenhouse gas emissions and lower the vulnerability to supply disruptions.

Increase energy taxes and phase out tax exemptions and reductions.

Total final energy consumption per unit of GDP toe per thousand 2005 PPP USD of GDP, 2012

Source: IEA (2014), World Energy Statistics and Balances database.

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• University graduates do well, but those with lower education level lag behind.

Proceed with the reform of vocational education and training, including the planned extension of work-based learning.

Employment rates can rise further

Employment rates among 25-64 year olds %, 2013

Source: Eurostat database.

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Lifelong learning has to play a bigger role

Encourage lifelong learning and training: Improve

information about training opportunities and adult learning

Ensure the portability of skills.

Participation rate in formal or non-formal education and training 25-64 years-olds, 2011, %

Note: Based on the adult education survey (AES). 2007 data for Turkey. Source: Eurostat database.

Formal education and training

Non-formal education and training

01020304050607080

02468

10121416

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• Both private and public spending on R&D is low.

• Number of incentives have been put in place to foster R&D and innovation.

R&D expenditure should be increased

Gross domestic expenditure on R&D, % of GDP, 2012 or lastest year available

Target 2020

0.00.51.01.52.02.53.03.54.04.5%

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Limiting the risk of repeated boom-bust cycle

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Imbalances came at a cost, but debt is set to decline

• The fiscal deficit and the public debt increased during the crisis.

• A major fiscal consolidation was implemented with a negative impact on domestic demand.

Source: OECD Economic Outlook 96 database.

Public deficit and government debt

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Fiscal policy

• The fiscal rules bring long-term view, should ensure public finances are sustainable and automatic stabilisers work freely.

• Latvia remains vulnerable to market turbulence that may generate access barriers to international financial markets.

Build up a fiscal reserve to cope with adverse economic shocks.

Financial sector supervision

• The financial supervision is appropriate but risks related to the large share of non-resident deposits in the banking sector are difficult to eliminate.

Continue monitoring non-resident banking businesses.

Policies need to lean against the wind

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More Information…

www.oecd.org/eco/surveys/economic-survey-latvia.htm

OECD OECD Economics

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