The 'high value-added' fallacy in Latvia

A recent report titled “Increasing investments and competitiveness for Latvia’s economic security” from the influential American Chamber of Commerce in Latvia (AmCham) calls, on page 3, for a “transition to a high value-added economy”.

My first reaction to this was a “Oh no – not again!” I have seen and heard this statement in various formulations plenty of times over the years but it is actually quite useless. I hasten to add that the report makes up for this – to some extent – on page 5 but it should have formulated this differently. Allow me to retain my preferred formulation until the end of this article in order to maintain excitement and suspense...

'Value added' is another way of saying production or output or, as we economists prefer, GDP (Gross Domestic Product). Calling for higher value added is thus the same as advocating for economic growth, which is not exactly something new or revolutionary.

Value added in Latvia in 2023 amounts to about 40 billion euros. Average employment during 2023 was 888,000 persons. So the meaning of the 40 billion euros – value added or GDP – is that those 888,000 persons created total production, of goods and services, in all their different jobs of a value of 40,000,000,000 EUR or, on a per employee basis, 45,000 EUR per employed person.

Value added may also be used as a measure of all the income that is created in society. 40 billion euros' worth of goods and services were produced and (mostly) sold, the revenue from these sales pays for salaries and profits in society. A common measure for comparisons of incomes across countries is income per person or, as we like to say, GDP per capita.

Figure 1: GDP per capita 2023 estimate from October 2023 (USD adjusted for different price levels)

Source: IMF World Economic Outlook Database

In an EU context, Latvia’s GDP per capita is one of the lowest, making it one of the poorer EU countries. But think positively: it's poor-ish among some of the richest countries in the world.

A comparison of perhaps more interest is Latvia’s position among the Eastern European countries. This is portrayed in Figure 1. We see that Latvia is in the top-half, way ahead of several countries but also significantly behind its Baltic neighbours, a fact that is painfully well-known to just about all of us, I guess.

Given this background it is not so strange that AmCham calls for a “transition to a high value-added economy”. But how to do it? Allow me, for those not so familiar with GDP and productivity a couple of simple but reasonably good, hands-on examples.

In supermarkets, the introduction of barcodes was a transition to a higher value-added economy. An employee at the checkout counter could service many more customers than before, so this person’s productivity grew: more goods and more customers serviced per hour, higher value-added per employee.

This productivity increase has been further enhanced by letting us do the checkout ourselves – even fewer employees needed for the same amount of turnover in RIMI or Maxima. Good for them, good for the economy as it makes employees available elsewhere in the economy – but hardly what AmCham was thinking about.

In some types of production, such mechanization is not possible – think of a hairdresser for instance. But there, value added can increase via the use of more sophisticated equipment, shampoos and what have you. And I certainly wouldn’t like doctors to become more productive by doing surgery faster – but also they see higher value-added creation via new technologies for operations etc.

But these examples are also not what AmCham has in mind. Rather, it is high-tech companies such as Mikrotik that is on their mind. Companies, using sophisticated technology to produce advanced goods that are competitive world-wide and can be sold at high prices, thus creating high value-added.

AmCham argues (correctly) that this requires better education to equip potential employees with the right skills for such jobs. But they should go further and ask: why do we not have such education in sufficient amounts? They could also ask: why does Latvia not attract more firms such as Mikrotik? Is it just because of insufficient training of the potential workforce? Or could it also be a less-than-warm-welcoming attitude towards investment in this country? Or other factors?

Thus, a much better formulation of AmCham’s call for a “transition to a high value-added economy” would have been these questions: why, after 33 years of independence has this not happened yet? What is holding Latvia back? And, crucially, what are those Lithuanians doing that makes them shine while we fall further behind?

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and former Vice-Chairman of the Fiscal Discipline Council of Latvia

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