Latvia Wages and Salaries Q2 2007

Well Latvijas Statistika had the latest wages and salary data up last week, and they don't make especially pleasant reading, even if you do consider that Latvians are basically much poorer than their Western European counterparts, and that wage (and productivity) convergence in the longer run would be a thoroughly good think. The question is, can we get from here to there, and if so, how? Since one thing is plain enough, the present situation just isn't sustainable.

According to Latvijas Statistika compared to 2nd quarter of 2006, in the 2nd quarter of 2007 the average hourly labour costs increased by 31.6%. Hourly labour costs in this period increased from 2.46 lats to 3.23 lats or by 78 santims per hour.Quarter on quarter this was a rise of 6.2%.

Here are the charts. First the development of the annual rate, which is, quite simply, horrific.




Now here is the quarter on quarter rate. And we can, of course, notice some very slight slowdown in the second quarter, and this is consistent with other data - GDP, housing - that we have been seeing. The question is now how rapidly and how far this will slow.




Clearly these wages increases subsequently have a knock-on impact on costs, and this impact can be seen in the producer price index. This can be seen in the charts that follow. First the index itself.




Now the annual rate of increase each month. This has now been accelerating since about July 2005, although the rate of acceleration has slowed recently.



Then we have the rate of increase in export prices component. As we can see these prices have also risen considerably, although the rate has now, fortunately, been slowing down since April. The damage, however, is being done, and it is considerable.



The impact of all of this is reasonably predictable, Latvia is finding it harder and harder to export:



as we can see, since May the value of Latvia's exports each month has been falling. If we look at the monthly trade balance we get a similar picture:



As we can see, the deficit is not reducing in any systematic way, and indeed deteriorated a little in July, which is the last month for which we currently have data.

So all of this is unsustainable, and the end result will probably be an impact on the peg. Why?

Well economics isn't such a difficult subject as it sometimes seems really. Basically you have two key drivers of economic growth, domestic consumption and exports (in this sense both government spending and investment are secondary variables). Now if at some stage domestic demand is going to be reduced - as it has to be - then Latvia will have to live from export growth. But if you can't increase exports because your prices are too high, then the only real move left is to change the value of your currency. Its as simple, or as hard, as that really.