Latvian Prime Minister 'We Have Learned From Our Mistakes'

Just a few years ago, Latvia was on the edge of bankruptcy. Now, it's poised to join the euro zone in 2014. In an interview with SPIEGEL ONLINE, Prime Minister Valdis Dombrovskis explains why austerity turned the country's economic fortunes around and insists Latvia is not becoming a tax haven.
Riga, Latvia's old city center. The country joins the euro zone in 2014.

Riga, Latvia's old city center. The country joins the euro zone in 2014.

Foto: Uwe Zucchi/ picture alliance / dpa

SPIEGEL ONLINE: Mr. Prime Minister, Latvia was almost bankrupt just a few years ago. Now you are joining the euro zone. What happened in the meantime?

Dombrovskis: We have learned from our mistakes. Latvia's problems started back in 2004, when the country entered the EU . At that time, the government poorly controlled the financial markets, which lead to a real estate bubble and an inevitable burst. Since then, we have cut down public spending, increased the productivity of our industry and transformed our banking sector into one of the most stable in the whole common currency area.

SPIEGEL ONLINE: Why did austerity work in Latvia , while in Greece it has deepened the crisis?

Dombrovskis: Latvia started to restore financial stability quickly. Greece and the other countries waited too long. They postponed necessary measures, as they believed austerity and structural adjustments would be bad for the economy. It turned out that not doing anything, sometimes for years, was much worse.

SPIEGEL ONLINE: It sounds like you're seeking to join the club of Germany, Finland and the other northern countries that have been trying to discipline the south.

Dombrovskis: Living on deficit never pays, but we should not overstress the divide between north and south. Debt is high in the entire euro zone -- around 90 percent of the gross domestic product, a consequence of a failed stability policy. Ten years ago, a lot of Euro member states started to break the Maastricht criteria …

SPIEGEL ONLINE: … Germany among them …

Dombrovskis: … including Germany, yes. And since nobody was penalized, debt grew. That culture of discipline has been changing radically since the euro crisis  started.

SPIEGEL ONLINE: Latvia will have to contribute 228 million Lats (€325 million) to the European Stability Mechanism (ESM). How do you feel about paying for the mistakes of others?

Dombrovskis: Europe helped us when we were in crisis, now we are helping Europe. Give and take. Moreover, the money we pay into the ESM is not gone. It can be compared to a life insurance policy. We are investing in the financial stability of the entire euro zone, which is a reasonable thing to do. The euro is a package deal for us. Our converting costs will vanish, rating agencies might upgrade us, our interest rates might drop, which will attract new investors. The bottom line is: We will gain more than we will invest.

SPIEGEL ONLINE: In the Latvian countryside, we met a woman whose salary was cut by one-third during the recession and has not yet returned to pre-crisis levels. She thinks money from the current boom should be used to improve her standard of living, not to rescue other countries.

Dombrovskis: In the long run, people like her will also benefit from the euro. A common currency will boost our economy. Eventually, this will be filling people's pockets.

SPIEGEL ONLINE: Most Latvians do not seem to agree. Only 38 percent are in favor of the euro.

Dombrovskis: The approval rate used to be even lower. Since we launched an information campaign to explain the benefits of the euro to the citizens, it has been constantly going up. I am confident that when we will finally introduce the euro, a majority of the population will be in favor of it.

SPIEGEL ONLINE: On that same day, Latvia will not only enter the euro zone -- holding companies will also be granted huge tax benefits. You advocate fiscal and financial stability, and yet you are creating a tax haven at the same time. That seems somewhat contradictory.

Dombrovskis: The change of tax law does not endanger Latvia's stability. Our banking sector is small, it only adds up to 128 percent of our GDP. That's three times less than the average in the European Union and roughly seven times less than in Cyprus  before the crash. Also, our banks are very well capitalized, even better than the banks in Germany.

SPIEGEL ONLINE: Yet there are worries that the change in tax law might cause a drastic expansion of your financial sector.

Dombrovskis: Statistics show that the money which has been withdrawn from Cyprus is not flowing into Latvia.

SPIEGEL ONLINE: Not yet. But according to our research, Latvian law firms specializing in holding companies are receiving a lot of phone calls from investors in Belarus, Ukraine and Russia who are interested in transfering their money to your country next year.

Dombrovskis: The new tax law was introduced in order to strengthen the competitiveness of our financial marketplace, but it will definitely not create a massive capital influx. The law does not conflict with the stability criteria of the euro zone. The European Commission is projecting that our financial system will remain stable, and we agree.

SPIEGEL ONLINE: Still, the timing of your tax law is pretty awkward. For a couple of months, the EU has been debating ways to fight tax dodging.  Now, the newest member of the euro zone is introducing a law that facilitates exactly that.

Dombrovskis: We are involved in many EU groups on how to fight illegal tax avoidance, and we are willing to contribute as much as we can to improve the situation.

Interview conducted by Stefan Schultz in Riga
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