Latvijas Banka and the European Investment Bank hosted a webinar on investment in Latvia

Ladies and gentlemen,

I would like to thank EIB for organizing this event. This survey and today's discussion should serve as a valuable input to assess the current situation, set policymakers agenda to remove obstacles for investment and identify opportunities in order to stimulate economic growth and income convergence. I hope that today we establish a tradition of such a seminar and EIB having close involvement and a strong foothold in the Latvian economy.

Let me start with an analogy. Most people who exercise with some regularity can run 5 kilometres. There are quite many who can run 10 kilometres. Then there are much fewer who can run a half marathon. And only very few can do the full marathon. In addition, despite the common wisdom about a second wind (or a "second breath" as we call it in Latvian), generally the further you run, the tougher it gets.

To me, it is a revealing analogy about economic growth and income convergence. Added complexity for income convergence is the element of competition, namely, it is not just the absolute distance of the marathon, but also the distance vis-à-vis the front runner. Most countries that get the basics of economic policy right, achieve some degree of economic convergence, but only very few manage to go all the way to become frontrunners themselves.

Latvia and our Baltic neighbours – Lithuania and Estonia, – have achieved a rather impressive convergence over the past 30 years. I dare to say that we have done a half marathon. Our PPP-adjusted GDP per capita is above two thirds of the EU average and we are among the champions in growing export market shares. Since 2004 we have been members of a strong and supportive team – the European Union, and, when things went wrong during the Global Financial Crisis, we got help from a decent pair of doctors – the IMF and the European Commission – helping us to get back on track. Yet, there is more to do to complete the full marathon. Furthermore, this time more depends on us ourselves as the help from teammates and doctors can only go that far.

Ample investment is a necessary condition for economic convergence. Investment can generally be financed in two ways – by domestic savings or by borrowing from abroad. The availability of EU funds has been a rather unique exception to this rule as it has allowed us to invest more without raising debt. But the closer we get to the EU average income level, the less support there will be. The forthcoming funds from the Recovery and Resilience Facility and the new Multiannual Financial Framework of the EU may well be the peak of such sizeable support and we shall make the most effective and productive use of them.

Of course, it is not just the size of investment, but also how it is used. Just having a high investment to GDP ratio as Latvia did in the run-up to the Global Financial Crisis may, in fact, add to overheating and deepen recessions. Investment in industries may fail to yield the desired future income flows if the tide turns and geopolitical developments make a U-turn, as it is seen with the transit infrastructure for the east-west cargo shipments.

For investments to grow, the environment must be right. It depends on many factors. Issues such as labour taxes, rule of law and insolvency regulation are often mentioned and are undoubtedly crucial, but there are many more. Corporate investment in R&D has been weak by any measure and the support tailored for SMEs seems to have failed over the past decades. The world experience has shown that the major contributors to R&D are large companies – I think it is time for Latvia to use methods that have proven right elsewhere rather than try to invent a bicycle all over again. I will not try to create an exhaustive list of measures to support investment. Measures such as the Global Competitiveness Index by the World Economic Forum, which in 2019 ranked Latvia 41st among 141 countries includes a broad range of such factors.

Yet, I would now particularly like to address two issues that the EIB survey presented today finds as key areas of concern – uncertainty and human capital.

It is widely known both from practical experience and academic literature that uncertainty is bad for business and investment. A part of uncertainty is beyond our control. For example, the further path of the Covid-19 pandemic is uncertain, although less so than a year ago. However, there is policy uncertainty, which policymakers can address. In the monetary policy domain, we in the Eurosystem have attempted to minimize uncertainty both by providing ample support from the very start of the pandemic as well as offering forward guidance with respect to our future actions. In a similar way, uncertainty can be addressed in the regulatory and fiscal policy domains. For example, we at the Bank of Latvia have repeatedly voiced that major revisions in tax policy should be done at most once every four years (which is the term for each Parliament), to reduce uncertainty for businesses and households.

Next, about human capital and the lack of skilled workforce. First, to an economist this means that the price of work in the future will go up, which is good news for those with relevant skills. This also means that we in Latvia need all the automation and digitalization that we can possibly get to free up hands and brains for tasks that cannot be done by an algorithm or a machine. Second, education and training are as important as ever. To develop the right skillset, businesses must get more involved in education and training. This is nothing new, but it needs to be strengthened - already now the most successful vocational training programs are those that pair a trainee with a company. Latvia is not a low labour cost country and we have no plans of becoming such. But high wages and incomes can only happen if there is corresponding productivity dynamics. As Paul Krugman wrote in The Age of Diminishing Expectations: “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

To wrap up, I would like to bring back the analogy with running. We cannot do much about the weather or the terrain, but we should make sure that we follow an appropriate diet and have our GPS and the best possible gear to be able to run the full marathon. Policymakers should reduce policy uncertainty and align our education system with the future work requirements. We should use the funds available from the Recovery and Resilience Facility to facilitate mighty, resilient, inclusive and green growth. I look forward to getting more insights from you on how Latvia can speed up in the marathon of income convergence. If we can make it happen in the next twenty years, I will retire a happy man.

Have a productive webinar today!