This volume consists of a background report prepared by the OECD Secretariat to support the Labour Market and Social Policy Review of Latvia which is currently being undertaken by the OECD Employment, Labour and Social Affairs Committee as part of the process for Latvia’s accession to the OECD [see the Roadmap for the Accession of Latvia to the OECD Convention: C(2013)122/FINAL]. In accordance with paragraph 14 of Latvia’s Accession Roadmap, the Employment, Labour and Social Affairs Committee agreed to declassify the report in its current version and publish it under the authority of the Secretary General, in order to allow a wider audience to become acquainted with the issues raised in the report. Publication of this document and the analysis and recommendations contained therein, does not prejudge in any way the results of the review of Latvia by the Employment, Labour and Social Affairs Committee as part of its process of accession to the OECD.

Like other economies in Eastern Europe and the former Soviet Union, Latvia underwent major economic and social change since the early 1990s. The transformation from planned to market economy was accompanied by fundamental reforms of political institutions and integration into the European Union and, in 2014, into the euro area.

Latvia is a small open economy with a population of around 2 million. Like other economies in Eastern Europe and the former Soviet Union, Latvia underwent major economic and social change since the early 1990s. After regaining independence in 1991, the transformation from planned to market economy was accompanied by fundamental reforms of political institutions and integration into the European Union and, in 2014, into the euro area.

During the pre-2008 boom years, per-capita GDP growth in Latvia was among the highest in the European Union, averaging some 8.5% per year between 2000 and 2007. But highly volatile economic growth, one of the highest levels of income inequality in the European Union and a rapidly declining population create a pressing need for effective social policies. They also highlight the importance of well-functioning labour market institutions that support a continuation of Latvia’s economic transformation, while encouraging the creation of employment opportunities for groups that remain underrepresented in the labour market.

Latvia’s population is declining at a rapid pace due to ageing and very high emigration. Emigration has slowed after peaking during the recent economic crisis, but continues to exceed natural population decrease and has been higher than in any OECD country over the past decade. The working-age population has also been shrinking faster than in any OECD country, and the old-age dependency ratio is expected to increase by some 20% over the next decade. Approximately 12% of Latvian-born people now live abroad and many of them are unlikely to come back. To stem the negative impact of falling population numbers on economic progress and social cohesion, Latvia should invest significant additional efforts to strengthen links with Latvians abroad, retain talent in Latvia, actively target labour migrants to help address skills shortages, and review existing barriers to labour migration, such as formal language requirements.

With a challenging demographic outlook, future growth prospects rest on Latvia’s ability to make the most of its available human resources. Although labour productivity has increased significantly since 2000, a number of structural barriers slow a further narrowing of the remaining gap relative to well-performing OECD countries. Factors that hold back Latvia’s productivity growth include a very sizable shadow economy, long-term joblessness, as well as significant skills shortages and mismatch. To tackle productivity barriers and reduce labour market inequality, active labour market policies should be strengthened and upskilling strategies should be more directly linked with the needs of employers. Efforts to curb informality and under-reporting of earnings should be maintained and stepped up further, including by reviewing a range of regulatory provisions that may push some groups of workers into informal employment.

Major reforms of social protection policies in the 1990s addressed the pressing fiscal challenges arising from a relatively generous social protection system during the transition to a market economy. The reforms also aimed to strengthen work and reporting incentives by introducing strong links between earnings histories and support entitlements. Today, Latvia’s weakly redistributive government taxes and transfers are one reason why income inequality is significantly higher than in most OECD countries. Public perception echoes the limited effectiveness of government policies in this area, and making social protection more effective and adequately resourced should become a more central element of the government’s inclusive growth strategy. Volatile economic growth and periods of substantial long-term unemployment underline the role of needsbased assistance benefits and associated services as essential complements to contribution-based social provisions. Unemployment benefits for active job seekers should be made more accessible, and a comprehensive review should analyse the consequences of the expected pensions gap for poverty and income adequacy during old age.