Should Latvia have joined the Euro?

Latvia is a reasonably new country as it only gained independence from Russia in 1991. With a population of 2 million, it has one of the smallest in the EU since joining the union in 2004. For Latvia to move to the next level of economic integration it had to meet the five regulations of the Maastricht Criteria which included restrictions on levels of inflation, debt and the ability to fix their currency to the Euro for two years. These are in place to ensure that economies sharing currency (in this case the euro) are similar and sync business cycles.

Probably the most obvious, but also potentially the most important benefit of joining the Euro for Latvia was that it will remove financial transaction costs of international trade. Although restrictions on trade such as tariff, quotas or regulations are already exempt to Latvia as they’re a member of the European Union, by joining the Euro the cost of exchanging currencies will be removed for Latvian firms. This will reduce Latvian firms costs as they will no longer have to ‘hedge’ their prices incase exchange rates change between the time an order is made and when it is paid for which can often be months down the line. This is especially beneficial for Latvia as it as an extremely open economy since they adopted a policy of internal devaluation, implementing austerity and a fiscal tightening, consequently making their exports cheaper which has since lead to a reliance on international trade for Latvia.

A second benefit to Latvian firms and also their people is that by joining the euro it guarantees that any debts to European countries will not increase due to fluctuating exchange rates. This may actually have a double positive effect for Latvia as this guarantee will ease the stress of debts for Latvians and could lead to an increase in domestic consumerism which would be more than welcomed by yet another economy recovering in an unbalanced manner from the deep recession of 2008.

However as with all economic decisions there are drawbacks or at least potential drawbacks! In the case of joining a single currency it places restriction on an economy, Latvia will no longer have control over their monetary policies, these will be controlled by European Central Bank in Frankfurt. It is unlikely that monetary policies will be consciously made in the interests of Latvia as they contribute little to the EU in comparison to economies such as Germany and France. An additional restriction is Latvia’s ability to undertake Keynesian policies of high government spending and low taxation. This is because even after joining the Eurozone Latvia must conform to the criteria concerning levels of Government debt.

Furthermore although joining the Euro does bring financial transaction benefits, it will intensify the competition on domestic Latvian firms from other countries within the Eurozone. Having a separate currency adds protection to domestic firms as Latvian consumers buying imports would have to pay for the transaction costs included in the price of goods, however now that these will be removed they will become more attractive. The extent of this effect will depend upon the elasticity of demand for the goods that Latvians import from within the EU, however they are likely to be elastic luxuries unavailable in Latvia, such as expensive German cars. This will reduce consumerism in Latvia on domestic goods, resulting in a fall in demand leading to a drop in investment from Latvian firms. This is a prime example of the negative multiplier effect within an economy. The significance of this is that Latvia’s reliance on exports will be greater.

Was it a good move?

We must remember that Latvia had no choice but to join the Euro at some point because they didn’t join the European Union until after the Euro was incorporated, however they could have delayed the transition like Poland who have done so for over 10 years and are still yet to show any interest in following suit. It is difficult to say whether it will be a success and we will not be able to judge this for some time, but although many of the effects of joining a single currency are economic, these may not have been the primary motive for Latvia. Only 25% of Latvia’s international trade is with other EU members which reduce the significance of the trade benefits already mentioned; however by furthering their integration with the union they will receive protection against any potential political confrontation with currently boisterous Russia. 

Submitted By Jack Murray