Since Latvia joined the EU in 2004, our country has been receiving funding from EU grants and support mechanisms. Thanks to this money, roads have been built, infrastructure developed and numerous crucial projects have been improving the lives of our citizens.
Sixteen years later, a difficult question is looming – is it sustainable for a state apparatus to rely so heavily on external funding?
The COVID-19 pandemic only aggravates this problem, making Latvia (and other countries) even less able to maintain a healthy balance between borrowing money and investing it in projects that will improve our national productivity and ability to pay back loans. Will we be able to keep our economy running if EU funding runs out?
Allocating state funding needs a long-term vision
Accelerated by the COVID-19 pandemic, Latvian state debt has increased by more than two billion euros this year. Even if interest rates have been at an all-time-low, the debt will still have to be repaid by all the society. The repayment will either take the form of raising taxes or reducing expenses – neither of these options being a positive perspective for Latvian businesses and households.
We are facing a threat of our economic growth being slowed down for many years to come. Therefore it’s crucial that the funds our state borrows now be invested in such financial instruments that will add value to our economy in the future. Such a tactic will result in an ability to grow income and repay the loans faster.
“For example, if we borrow 100 euros today (with 2% interest), and if this loan lets us supplement the state budget by 20 euros every year, then in five years we will have repaid our debt and increased the state revenue by 20 euros for every year to come. In practice, this means lending money to successful entrepreneurs, by evaluating their ideas and ability to implement them. Investments should be made in education, medicine, in people who will add value to our economy”, says Jānis Dzenis, Assistant Director in Financial Advisory, Deloitte Latvia.
The risk of nurturing “zombie economies”
Some experts believe that the present crisis may not provoke the painful (but sometimes necessary) cleansing of the economy because many state and private companies continue to operate. Thus, we are facing a risk that some futile business models will continue to exist.
As the Financial Times put it, the pandemic may be creating “a generation of zombie companies”. These are businesses characterized by very slow growth and significant debt, and being dependent on refinancing this debt continually and cheaply. Such companies may be able to repay the interest on their debts but not the principal.
But what if the circumstances of the pandemic allow for creating whole “zombie economies” that would depend on new and new forms of support and bailouts from governments and central banks until they reach a moment when such a system is no longer possible to sustain?
The International Monetary Fund (IMF) estimates that Latvia’s GDP will drop by 6% this year (1.8% drop for Lithuania and 5.2% for Estonia). It’s clear that the economy will have to be restructured, but this is not a time to moralize about business sustainability. In today’s circumstances, austerity measures can be destructive and create an economic depression, especially if all three major sectors – households, businesses, and state – cut back spending.
On the other hand, the money spending machine needs to remain sustainable. In its World Economic outlook document (October 2020), the IMF emphasizes that countries need to invest in growing productivity:
“Besides combating the deep near-term recession, policymakers have to address complex challenges to place economies on a path of higher productivity growth while ensuring that gains are shared evenly and debt remains sustainable. Research spending can facilitate innovation and technology adoption—the principal drivers of long-term productivity growth.”
The Juncker plan binge
Presently there are significant financial resources available to the state and municipalities within the framework of the so-called Juncker Plan (European Fund for Strategic Investments – EFSI). The concern is about potentially getting hooked on this money. When the funds run out, will the municipalities be able to switch their focus and learn to finance their own operations while repaying debts?
At the moment it seems that “Juncker’s money” is being grabbed and lavishly spent on programs that pose a question: are they really necessary or are they artificially created in order to attract the funding?
The investment plan for Europe is a document predicting the macroeconomic impact of the Juncker Plan from boosting jobs and new businesses to triggering €439.4 billion in additional investment across the EU. That sounds great but how is the funding seen and processed on “our side”? Is it used as responsibly as the program stipulates or is it more of an artificial bloodstream for keeping ineffective institutions alive?
More funds will be available from the new EU Recovery and Resilience Facility (RRF), created to mitigate the economic and social impact of the coronavirus pandemic. Already 2.170 billion euros have been allocated to Latvia, with a possibility to gain more funds in 2022.
This “New Generation” EU program poses not-so-new risks – ones associated with weaning developing economies off the ever-present funding options.
Latvia needs a business plan
It seems that there are always several programs available for EU countries to apply to receive funding. The question is this – will we be able to allocate these funds to projects that can raise our future economic productivity? Or will these funds be squandered because, well – we can’t refuse something that’s given to us, can we?
For a positive result, the state and municipal projects that receive EU funding, need to comply with the following:
- Raise national productivity
- Allocate money to R&D operations
- Avoid creating an addiction (when the funds run out, entities won’t be able to implement investment projects under normal economic conditions).
Out of 12 approved projects of the “Juncker plan” framework (financed by the European Investment Bank (EIB) and backed by EFSI), until now, only one private company (HansaMatrix) has received funding.
In fact, the business sector should be an example to the state and municipal institutions. In the private sector, before launching a sensible business project, a business plan is always developed, highlighting the business goals, KPIs, and plans on growing revenue and generating return on investment.
Does the state have a business plan for investing the acquired capital in a meaningful and sustainable way? You tell me.
A way forward – fostering rapid growth high technologies
Without being too negative, let me offer an alternative. Namely – implementing a high technology park for emerging technologies.
Rapid economic growth is the only way forward, and one of the most successful ways to generate rapid growth in a short period of time is to invest in and foster the growth of high tech companies, which can attain infinite scalability.
With the right support instruments from the government, this is very doable, and it looks like a consolidated tech park with specific eased tax regulations. But more about that next time.