Saturday 29 May 2010 - Summary of the meeting of the Economics and Security Committee
Hall B, Kipsala International Exhibition Centre
I. Opening Remarks
1. The Chairman, Hugh Bayley (UK), declared the committee open and welcomed all members and speakers. He extended a special thanks to the staff of the Latvian Parliament for hosting the meeting and for their wonderful organisation.
The draft Agenda [050 ESC 10 E] and the summary of the meeting held in Edinburgh, United Kingdom, on Sunday 15 November 2009 [233 ESC 09 E] were adopted without comment.
The Chairman noted that there had been an agreement with NATO that it would submit to the committee an annual report summarising Allied defence budgets and, where possible, Allied contributions to operations. The first report would probably be available for the Spring 2011 session.
2. Ilmars Rimsevics noted that the Latvian economy has suffered a greater contraction than any other EU or NATO member. To understand how this has come about it is essential to look more deeply into the recent economic history of Latvia. He noted that since joining the EU and NATO, Latvia had been the fastest growing country in the region. It is legitimate now to ask whether that growth was sustainable. Initially it was thought that a very high rate of growth was justified as Latvia was catching up with the other member states.
3. The dangerous overheating of the Latvian economy, due mostly to large and increasing foreign capital inflows, was recognised as a potential problem by policymakers as early as 2005. By 2007 inflation had became a serious concern and measures were put in place to slow price growth. Wage inflation was particularly worrisome as it was eroding the competitiveness of the economy. Mr Rimsevics noted that wages grew much faster than labour productivity, effectively “wiping out the most important part of our economy – our labour competitiveness.”
4. While productivity did accelerate in this period the current account deficits of plus-20% were clearly unsustainable in the long term. A great amount of the inflowing capital underwrote loans for housing and building construction. Much of this capital financed imports and bolstered consumption rather than investment. Importantly, many of the private loans taken out by Latvians were euro-denominated because the fixed exchange seemed to lower the risk to lenders and because equivalent loans in lats were two to three times more expensive. Unfortunately, as the economy slowed and inflationary pressures rose, the sustainability of the peg was increasingly questioned.
5. At the height of the crisis, the Central Bank of Latvia took the strategic decision to maintain the tight peg of the lat to the euro (LVL 0.71: EUR 1). This, in effect, disabled the use of monetary policy for fighting the recession. But this also exacerbated the recession. Mr Rimsevics argued this was the wisest policy as it assured long-term stability in the eyes of foreign investors while protecting the euro-denominated debt held by many Latvians. Moving to a free floating exchange rate would have boosted private and public debts to unsustainable levels. This, he said, would have been “a poison” for the Latvian economy.
6. The Governor noted that as a small and open economy, Latvia had little choice but to engage in “internal devaluation” rather than allow depreciation of the currency. However, he noted that in retrospect many now realise that fiscal policy “is not the only or most important tool in fixed exchange rate regimes”. Of course, fiscal policy does play a crucial role and the fact that the Latvian government had not been in a budgetary surplus meant it had few reserves for the downturn.
7. The first quarter of 2010 saw the first quarter-on-quarter growth since the downturn at the end of 2008. As the wage/labour productivity gap is narrowed, Latvian competitiveness is being restored. Imports and exports are both on the rise and retail sales are now rising well above the trough. The current account balance has swung from a 30% deficit in 2008 to a 9% surplus in 2009. The governor expects the current account to remain in surplus in 2010 and 2011.
8. Fiscal consolidation poses a central challenge to the government. The Governor reiterated that the sooner consolidation is implemented, the sooner the overall economy will be positioned for a full recovery. Overall, the situation remains difficult, but the right measures have been taken and Latvians are still aiming for full euro membership in 2014.
9. In the discussion that followed, members asked first about the role the IMF has played in providing emergency funding to Latvia (the only Baltic state to engage in such an agreement). The Governor noted that the IMF has changed its practices greatly from 20 years prior and now provides advice based on the government’s proposals and does not advance a one-size-fits-all approach to financial crises. He believes the decision to engage the IMF was the best one as Latvia currently pays slightly more than 3% interest on international markets. Payments would have been three times higher without IMF support.
10. Members also asked about Latvia’s aspirations to join the euro area. The Governor emphasised that a small and dynamic economy like that of Latvia can meet the Maastricht criteria, and it has learned many lessons from the recent crisis. Secondly, Latvia’s monetary position would be stronger were it to adopt the euro.
11. Members asked about the social disruptions and reactions to the internal devaluation. There was some unrest in the country, but it was rather minimal as Latvians generally understood the need to stabilize the situation. Admittedly the grey economy did grow as unemployment reached 20%, but this is now beginning to reverse as the economy returns to growth.
12. Spyros Economides began by noting that his “own understanding of the current crisis in Greece is that it is primarily a political one.” The root causes go back to the attitude of citizens toward the State – the Greeks see the state as a system of provision rather than one of support. Thus, he felt that standard Greek economic practices – such as clientelism – were part and parcel of the running up of the enormous public deficits and debt. Indeed, while the Greek debt crisis is a recent phenomenon, it is the result of decades of poor State management.
13. Economides noted that navigating through the State bureaucracy was best done through personal contacts rather than official channels, and that this is such a standard practice that few question its effects. There are also persistent problems with tax collection in a country where, in his opinion, tax evasion is the norm. Furthermore, civil servants take for granted perks that would be seen as profligate state spending in other EU Member States.
14. Athens is required to reduce its deficit by 10 percentage points over the next three years, and has announced it will reduce public spending by 30% by 2013. But there is a great degree of scepticism because “this is not simply a matter of economics, it is a matter of a society which wants to maintain a system” that is fiscally unsustainable. The unsustainability of Greece’s budgets had been hidden for years because growth appeared sufficiently strong. However, most of this growth (from the Olympics, joining the eurozone, etc.) was of a short-term nature and externally generated.
15. The EU bears its own portion of the blame for not waking up to the problem earlier, he said, as it has not established “any kind of centralized regulatory mechanism” to check that Member States’ treasuries were keeping to the guidelines laid down by Brussels. Economides noted that “The eurozone is a highly politicised mechanism.” It is not guided by the market’s ‘invisible hand’, it is rooted in the politics of the EU. And yet it lacks a central authority to regulate it as would be expected within any of the national economies. It was also out of political considerations that “corners were cut when Greece was forcing its way up the ladder to make it into the eurozone,” he added.
16. As far as the consequences for the EU are concerned, the political aspects outweigh the economic ones. With less than 3% of European GDP, “a Greek insolvency wouldn’t really matter for the European Union” in terms of trade and prosperity. But the EU’s international standing on the political stage may suffer as a result of Greece’s economic travails, he said. The underlying problems are not limited to Greece. “The time has come to start clearing up financial irregularities across the European Union,” at both national and European levels. This does not mean a wholesale restructuring of EU economic cooperation, as “it is not the right time to open Pandora’s box” in that area. “But I could envisage a two- or three-speed eurozone in which some countries decide to pool whatever they want to pool, and others are left in some kind of peripheral system,” he said.
17. The debate surrounding the Greek crisis and aid package has had the positive effect of encouraging a frank discussion of national interests within the EU. “We mustn’t forget that even though this is a European project, it has been created and maintained because there are state interests at stake. Germany did not enter into this series of arrangements out of some form of altruism.”
18. Several members questioned the effects that this crisis will have on Greece’s regional ambitions. It seemed clear to all participants that Greece may have to cede some ground on its more costly and controversial positions as part of an overall retrenchment of finances. In particular, there is much hope that a joint agreement between Greece and Turkey can produce mutually acceptable cuts to military spending and force draw-downs in the Aegean Sea.
19. The eurozone’s stability and long-term viability dominated the remainder of the discussion. Several members were concerned about a possible ejection of Greece from the monetary union. However, the speaker made it clear that this was extremely unlikely as the impact would be devastating for the eurozone and beyond. Several members recognised that the Stability and Growth Pact had proven ineffective, but it nevertheless should remain the starting point for any future reforms. Members were also concerned with endemic fraud across the eurozone and that the convergence aims of the EU in general had led to the financing of failing or outdated institutions. Clearly, fundamental reform of the EU’s and eurozone’s growth and integration policies will have to be reconsidered to ensure long-term sustainability.
20. Petras Austrevicius (LT) presented the sub-committee’s draft report and provided an assessment of the various economic policies adopted by Central and Eastern European governments in the run-up to the crisis. He suggested that integration with the world economy had reinforced these governments’ discipline, but excessive government spending during the years of exceptional growth had proven burdensome. Clearly, business cycles and volatility remain important features of the global economy. The Rapporteur suggested that the countries of the region must be even more vigilant in maintaining economic discipline in order to possess the resources to manage downturns. This will compel governments to look more closely at national budgets and slash excess spending. Defence budgets are not likely to be spared. It will nonetheless be essential to maintain core capabilities even as cuts are made.
21. In the discussion, the critical role of free trade in creating prosperity was stressed. Proper regulation of financial markets was also identified as critical to long-run stability. The Rapporteur suggested that parliamentarians must stand strongly for freer trade in the face of calls for protection. Members were more divided on the best manner to prevent market bubbles. While some saw the need for lower, sustainable growth targets and harder rules against speculation, several participants including the Rapporteur noted that regulation can also undermine competitiveness and thereby lower growth prospects for emerging economies.
22. John Sewel (UK) noted that the sub-committee had recently travelled to Norway and learned much about that country’s approach to development, climate change, arctic environmental matters and the energy sector. He thanked the Norwegian hosts for putting the excellent visit together. The sub-committee will next travel to Ethiopia the week of 25 October. That visit will be supported and largely coordinated through the contacts at the World Bank.
23. Petras Austrevicius described the sub-committee visit meeting held in Sofia where the members were briefed on the financial crisis in Bulgaria. He thanked the Bulgarian delegation for all their efforts in organising the very interesting meetings. The next sub-committee visit will be to Prague during the last week of September.
24. Jeppe Kofod (DK) presented the sub-committee’s draft report which assesses the economic, developmental and security implications of the global financial crisis for the developing world. He noted that during the past decade, capital inflows to poor countries increased enormously, and that much of this capital went into productive investments and into the scaling-up of regulatory structures, particularly in the banking systems. Critical macro- and micro-economic reforms help explain the relative resilience of these poorer economies during the recent crisis.
25. While developing economies fared far better in this crisis than in the past, the Rapporteur noted that the global recession came immediately on the heels of the global food crisis, which severely hurt the health and vitality of many people in those countries. Indeed, the surge in commodity prices during the boom of the past decade reduced access to food for millions of people, resulting in widespread rioting and civil unrest. Although many developing countries rely heavily on the exports of commodities, millions of farmers and landless labourers gained little from price rises as their input costs (i.e. fertiliser and petrol for transport) had also increased.
26. The Rapporteur took particular note of the plight of the Least Developed Countries (LDCs), the populations of which suffered especially hard during the food price crisis and the global financial crisis. While these countries saw minor improvements in their economies during the boom, they were largely unable to establish stable political and economic structures. They thus remained vulnerable to absolute poverty and civil strife. From a security angle, these countries merit particular attention, and donor support is clearly needed. Yet some donor governments are slashing aid budgets, and this could have important humanitarian and security consequences.
27. The Rapporteur concluded his remarks with a call for western governments to remain committed to developing countries and to support both those that are emerging as global traders and LDCs. He suggested that the rapid completion of the Doha round of trade talks could bolster global growth. Donor countries need to remain committed to improving and coordinating aid programmes in order to ensure a strong development impact for given aid levels.
28. In the discussion members commented on the specific focus of aid programmes. The Rapporteur stressed that aid should be targeted on emerging countries and LDCs. But, again, aid must be better co-ordinated as stressed in both the Paris and Accra declarations. The role of China in Africa was also discussed, and in particular the questionable development impact of the aid it provides. Chinese investment is important, and the Rapporteur suggested that donor countries need to engage with China on the way in which it delivers aid and investment to the African continent. He argued that China be brought into multilateral frameworks to ensure that its dealings with African nations are consistent with the development goals of the international community. He agreed that the final version of the report should discuss China’s role in the region in greater detail.
29. Among other things, this report addresses the slow but steady shift of relative economic power from West to East. The General Rapporteur, Simon van Driel (NL) suggested that this shift should not be seen as a bad thing in itself as these broad trends present opportunities as well as challenges. Members of the Alliance, however, will have to think seriously about managing their economies and foreign policies in a world in which their own relative weight has diminished. Although the Euro-Atlantic Alliance remains the pre-eminent security and economic bloc in the world, ignoring the rise of other powers would be perilous to global security.
30. The Rapporteur noted that the key theme of the report is that economic and strategic powers are closely interlinked. Economic dynamism will continue to underpin military strength and political and diplomatic influence. This is epitomised in the challenges many member states are facing in consolidating their budgets while maintaining adequate funding for their armed forces. Alliance members will ultimately have to put their fiscal policies on a sustainable foundation and thereby ensure not only their long-term economic viability but also the sustainability of their military posture.
31. The rise of powerful players such as Brazil, China and India reflects a range of economic, policy and even demographic trends. As these countries become more self-assured, their policies will likely turn outward from their traditional domestic focus. The implications of this are not entirely clear, although it will certainly lead to new challenges as well as new opportunities. China, for example has been an engine of the global recovery and this has relieved the United States from what has been its traditional burden. But it is also a rising naval power with which the US will have to contend.
32. The Rapporteur argued “adjusting to these broad changes will require creativity and flexibility coupled with a strategic vision that is informed by our values.” The strengthening of the G-20 forum is a clear sign that this broad shift in power can be managed amicably. Maintaining the competitiveness of our aging societies will require serious analysis and discussion, focused on long-term solutions. The Rapporteur concluded his remarks saying our “greatest test as an Alliance may lie in how we respond both nationally and collectively to these critical challenges.”
33. In the discussion, several members questioned the assumption of a zero-sum game in the global economy. While there was general agreement that the improved economic situation for the world’s poor was a universal good, there was equally recognition that the investment role of China in Africa could undermine the push for democratisation and human development on the continent. There was a suggestion that the report include more specific data reflecting China’s rise and on the demographic and economic situation of the Alliance from a long-term perspective.
34. In terms of building greater fiscal sustainability over the long run, it was suggested that strengthening the EU’s Stability and Growth Pact would enhance economic viability. As for the role of the Alliance in the long-term, the Rapporteur suggested that we will need to learn to work with rising powers, because Allied countries can no longer operate as world policemen due to serious economic constraints, among other things.
35. The Chairman noted that there were two vacancies for the Ukraine-NATO Interparliamentary Council, and that Petras Austrevicius (LT) and Kresimir Cosic (HR) had expressed interest. The committee voted unanimously for their appointment.
36. The Chairman declared the closure of the Committee meeting.