The worst of the cuts

It's 3 days since the last budget proposal is out. So far, most of the public anger has concentrated on the cuts in the retirement benefits (70% for working retirees, 10% for the rest). But there are far worse things in the proposal.

The budget for healthcare services (hospitals, doctors, etc.) is being cut by 42 million lats. If we look at the previous version of the budget, there were 336 mln lats for healthcare. About half of that has been spent in the first half-year - which means that there is about 168 mln left for the second half year. The amount that is being cut is 25% of the entire budget!

I don't know how our healthcare system will survive that. In many other parts of public sector (for example, education or public administration), the main costs are salaries and 25% cut means 25% (or slightly more) off from salaries. Healthcare has many non-salary costs: medical equipment (and, even if hospitals don't buy new equipment, they still have to pay off loans for the equipment bought in the "fat years" of 2005-2007), medicines, etc. Does one stop giving drugs to patients? Or does one cut salaries of doctors and nurses by 40-50-60% to achieve a 25% cut in total costs?

Healthcare Ministry official proposes higher payments from the patients themselves:

For example, if the medical investigation costs 50 lats (70 euros), the
patient pays half, the government pays half.

This also looks like a non-starter, since many people don't have 25 lats. If someone is earning the minimum salary, it takes them almost a week to earn 25 lats and there are so many other costs! Same about retirees (the average retirement benefit in Latvia is about 170 lats/month). And unemployed. And many other categories of people.

There was a previous increase in the patient co-payments in March and hospitals reported that many people started coming in only when their disease has progressed to an unbearable condition. What's next?

Complete craziness

Latvian government is having to choose between several ways to balance the budget, which all look equally crazy. The first proposal, on Monday:

• 20% cut in all public sector salaries (on top of earlier 15-35% cuts);
• VAT increase from 21% to 23%;
• introduction of progressive income tax, starting with income of 300 lats/month (430 euros/month!) which would be taxed at 29% (instead of current 23%) plus the social security tax;
• the income tax on incomes above 800 lats/month (1150 euros/month) would increase from 23% to 40% (also not including the social security tax);
• many smaller cuts and tax increases.

The second, yesterday:

• no tax increases, except for alcohol tax, but
• 40% cut in public sector salaries (on top of earlier 15-35% cuts);
• 10% cut in retirement benefits;
• many smaller cuts.

Either way, it's crazy. Crazy tax increases or crazy salary cuts.

And the craziest of all things. Either of those two proposals only brings Latvia to a budget deficit of 5-6% of GDP. Next year, more cuts or tax increases will be needed. Can a country run out of salaries to cut or taxes to increase?

Devaluation vs. salary cuts, part 1

In December 2008, Latvia, IMF and EU had the choice between devaluating lat or trying to pursue the "internal devaluation via salary cuts" strategy. The second option was chosen. A half-year has passed from that decision and we now have a substantial amount of evidence (both statistical and anecdotal) about the consequences of that decision. Latvian Statistical Office press release says:

Compared to the first quarter of 2008 growth of wages and salaries in
private sector in first three months of 2009 comprised 5.1% (from LVL 422 to LVL
444), but in public sector wages and salaries reduced by 1.4% (from LVL 520 to
LVL 512).

How is that possible? The private sector is in deep crisis, with GDP declining by 18% and the public sector salary budgets were cut by 15%. How does that all match up?

The explanation comes in the next paragraph:

It should be noted that number of employees for which wages and salaries
were calculated has decreased. Compared to the first quarter of previous
year the number of employees recalculated in full-time units,
which are used for the calculations of average monthly wages and salaries, in
the first quarter of this year reduced by 125.8 thsd or by
13.9%. Fund of wages and salaries during this period diminished by LVL
134.0 mln or by 10.9%, but compared to the fourth quarter of previous year – by
LVL 227.3 mln or by 17.2%.

We have indeed had massive cuts in both public and private sector but, often, they have been in the form of layoffs, rather than salary cuts. The public sector organizations were free to choose whether to cut salaries or people - and, often, they choose to cut people, rather than salaries. Same in the private sector.

With a 15% devaluation, we would have had everyone losing 15% of the salary. Now, we have 13.9% people losing all of their income. The unemployment rate approaching 20% (17.4%, by the latest Eurostat number, and rising). I now think the devaluation, with losses distributed more evenly across the society, would have been the less destructive option.

The same choice, devaluation vs. salary cuts is coming up again and it looks like the government/Bank of Latvia will make the same choice. Not enough economic destruction?