Growth shifting into higher gear

High rates as such are quite characteristic of a country where the level of income is significantly different from the regional average, e.g. that of the European Union (EU). The given rate is also logical considering the comparatively low base from which growth rebounded. It is also quite far from what was seen during the economic upsurge. At the same time, the rising growth signals several important things to the economic policy-makers.

On the one hand, the acceleration of growth should be viewed as a cyclical recovery from the low levels observed in the previous years, on the back of the strengthening of both the external and domestic demand. A significant role is played by the external environment which has improved and has encouraged exports. The problems with the absorption of the EU funding that were dampening investment last year have also been largely resolved at the moment. As a result, several sectors are developing quite successfully, including construction which receives a positive contribution also from EU funds non-related projects.

Just like last year and in the first quarter of this year, the growth of private consumption remains steady. Wages have increased quite considerably, thereby supporting the return of the growth of the real net wage, previously experiencing a short-lived drop, to the average level of the previous year already in the second quarter. Moreover, the recently published data on wage growth by the Central Statistical Bureau of Latvia (CSB) point to more substantial rises in most of the sectors.

The consumer sentiment indicators, released by the European Commission (EC), are also more optimistic than at the beginning of the year. What we see is clearly not the development of a lending or consumption boom. Although retail trade reports higher sales of household equipment related goods, the overall growth of the sector so far is even lower than two years ago.

Consequently, the acceleration of growth should be overall viewed as a positive thing, suggesting that the recovery from the post-crisis period of low growth has finally shifted into a higher gear and is becoming increasingly more broad-based. It also means that good times have set in for the economy and this should trigger the build-up of precautionary savings in the government budget for the case of a potential future economic downturn, which would also be a step closer to a balanced budget.

Yet, on the other hand, higher growth unfortunately brings along some not so positive effects. What is worrying is that signs of imbalances have emerged even at the current considerably moderate growth rates.

• First of all, like my colleague already wrote, there are signs of overheating on the labour market and the wage growth is already far higher than productivity growth.
• Second, the productivity growth is dampened by the low level of investment. Looking at investment, it has to be noted that the industrial capacity utilisation remains at a historically high level, similar to that observed during the impressive pre-crisis development period. This suggests that further growth requires investment. At the same time, the contribution of gross fixed capital formation (investment) to GDP is considerably below the historical highs. Being over 30% in the pre-crisis period, it failed to reach even 20% in the first half of this year. It will be difficult to raise the productivity without further investment, and the sluggishness of the productivity growth has already become a challenge in the context of maintaining competitiveness.

This means that, although the demand has finally started to recover and lay the foundation for further growth, restrictions on the supply side can become a significant obstacle for the economic development. In other words, structural reforms are becoming increasingly more important, so that the leap in GDP growth does not end as quickly as it began and the businesses do not lose competitiveness due to the tightness of the labour market already in the coming years.