Cold winds are blowing through Latvia. The sun might be shining on the beautiful beaches along the Baltic Sea in this small European Union state, but the temperature of the economy is plunging below zero.Mats Engström is editorial writer at the Swedish newspaper Aftonbladet. He was special advisor and deputy state secretary to Anna Lindh from 1994-2001, and is author of Rebooting Europe: Digital Deliberation and European Democracy (Foreign Policy Centre, 2002). His blog is here

Also by Mats Engström in openDemocracy:

"The European Union and genetic information: time to act" (29 July 2003)

"Remember Anna Lindh" (25 September 2003)

"Democracy is hard, but the only way" (6 June 2005)

"The European Union's anti-terror plans: lift the secrecy" (28 November 2005)

"The fear haunting Europe" (26 May 2006)

"We still love the Swedish model" (19 September 2006)

"Europe's green power" (26 March 2007)

"Europe and terrorism: the wrong path" (7 November 2007) 

The global financial crisis has hit Latvia hard. Gross domestic product has fallen by 18% percent on an annual basis. As a response to the crisis, public- sector wages have already been lowered by 20% or more. Many schools and hospitals will be shut. The consequences are also political: Latvia's elections to the European parliament on 6 June 2009 showed increased support for the opposition.

The prime minister Valdis Dombrovskis on 9 June secured proposals for even tougher spending cuts amounting to 500 million lats ($9.92 million). This follows demands from international lenders, including the International Monetary Fund (IMF) and the European Union, for state budget cuts to be reduced by an additional 10%.

Andres Borg, the Swedish finance minister, welcomed the news and - while attending a meeting of European finance ministers in Luxembourg - made clear what he expected of his Latvian colleagues: "We are pleased with a more responsible fiscal policy from Riga...now we need equally strong credibility. (The Latvian government) must do exactly what they say and the effects must be exactly what they say."

The comment is revealing. For the background to Latvia's present troubles is the national story of an economic tiger overestimating its strength and catching pneumonia; and a regional story about cross-Baltic ties, and Sweden's renewed role in an area it once dominated.

The breakers

In a recent walk through Stockholm's Old Town, I noticed a window-display where a copper-engraved map from 1635 showed a Baltic region where Swedish possessions stretched all along the coastline. One of them is Livonia, a territory now divided between Latvia and Estonia, which spent decades (1629-1721) under the Swedish crown. 

Indeed, Sweden has been a strong regional power in the Baltic Sea area for centuries. During the 17th century, it was military power that allowed kings and queens in Stockholm to rule Riga and other cities on the sea's eastern shore. Swedish power in the region passed to Russia after the battle of Poltava in 1709, but now - after its three states regained independence after the fall of the Soviet Union, then joined the European Union in 2004 - Sweden is back.

In global terms, Sweden does not qualify even to be part of the Group of Twenty (G20); but regionally, it exerts a large economic influence. Swedish banks dominate the financial markets of Estonia, Latvia and Lithuania - and exposed these countries' vulnerability as the financial crisis accelerated throughout 2008. In Latvia, for example, these banks' excessive and irresponsible lending fuelled unsustainable private consumption and property prices. Now, the economy is in freefall.

The Latvian government has ruled out devaluation of its currency - a decision that is provoking great political controversy. Instead, it is - after an agreement with the IMF, the European Union and individual countries such as Sweden - pursuing a strategy of reduced domestic consumption and cuts in state expenditure amounting to 40%.

The consequences for Latvian citizens are dramatic. The trade-union confederation LBAS estimates that average wage-rates will decline from €500 ($700) a month to €340 ($480), just above the subsistence minimum. It is no surprise that teachers and other groups are taking to the streets to protest.

A success-story has turned to a crisis whose reverberations can be felt across Europe. The previously fast-growing Baltic economies are falling into recession. Only Latvia has so far received financial support from the IMF, but the situation of Estonia and Lithuania is serious too - protests against reductions in public expenditure have also been held in Tallinn and Vilnius.

True, Latvian politicians themselves bear a large responsibility for allowing the financial bubble to expand out of control. But the course of the crisis - especially the intense negotiations taking place in late 2008, when the banking system in Latvia was on the verge of collapse - suggest that the failures of consultation by international lenders, including Sweden, contributed to the fall.Among openDemocracy's articles on the global financial turmoil:

Ann Pettifor, "The week that changed everything" (22 September 2008)

Fred Halliday, "The revenge of ideas: Karl Polanyi and Susan Strange" (24 September 2008)

Rein Müllerson, "The world after the Russia-Georgia war" (5 September 2008)

Godfrey Hodgson, "The week that democracy won" (29 September 2008)

Grahame Thompson, "Deglobalising the crisis" (3 October 2008)

Will Hutton, "Wanted: a fairer capitalism" (6 October 2008)

Avinash Persaud, "Europe's financial crisis: the integration lesson" (7 October 2008)

Paul Rogers, "A world in flux: crisis to agency" (16 October 2008)

Andrew Dobson & David Hayes, "A politics of crisis: low-energy cosmopolitanism" (22 October 2008)

Ann Pettifor, "Beyond the triple crisis: a green new deal" (27 October 2008)

Simon Maxwell & Dirk Messner, "A new global order: Bretton Woods II...and San Francisco II" (11 November 2008)

Andre Wilkens, "The global financial crisis: opportunities for change" (10 November 2008)

Paul Rogers, "A world in the balance" (13 November 2008)

Krzysztof Rybinski, "A new world order" (4 December 2008)

The deal-makers

An IMF team headed by Christoph Rosenberg visited Riga in mid-November 2008 to negotiate a deal with the Latvian government. The Swedish magazine Affärsvärlden reported that the team initially argued for devaluation of the lats. But the European commission would not allow any change to the currency regime, if Latvia had any hope of becoming a member of the eurozone within a few years.

The Swedish government reaffirmed the "no" in contacts with the IMF. Swedish banks had made substantial profits from their activities in the Baltic states, but now feared big losses if the value of their loans decreased as a result of devaluation.

There is a Swedish domestic dimension here. Also in November 2008, Sweden's finance minister Anders Borg was busy rescuing the banks from the downturn in the economy at home. Documents I have obtained suggest that the minister's civil servants were also calculating the consequences of devaluation in any of the Baltic states for the Swedish economy. 

The IMF's Christoph Rosenberg told Swedish daily Svenska Dagbladet: "There was a risk that a devaluation would also ‘infect' other countries in the region. In addition, Latvia, the EU, Mr Borg and the banks wanted to avoid it. The Swedish government knows that the Baltic states are important both for the banks and for the market value of the Swedish banks."

Anders Borg himself claims that Sweden only helped Latvia to keep the currency regime it wanted. It is true that high-level Latvian politicians have fought hard to rule out devaluation.

But it is unfortunate that the Swedish government did not talk to other people in Latvia who could have given better advice and input about what was happening in their country. There were no serious discussions with trade unions, employers' federations or the municipalities, even though these three social partners had developed an alternative to the Latvian government's economic policy.

The main elements of the IMF support-package for Latvia were agreed at a meeting on 10 December 2008 at Arlanda airport, near Stockholm. "We support the programme and have gone through it, though roughly", said Anders Borg at the time. It included €7.5  billion ($10.6 billion) worth of loans from the IMF, the EU, and the Nordic countries; in return, the Latvian government agreed to substantially reduce public expenditure and to increase indirect taxes such as VAT.

European Union finance ministers kept up the pressure. Latvia should "rigorously implement public-sector nominal wage reductions", Anders Borg and his colleagues told the Ecofin meeting on 10 March 2009. The ministers "invited" the Latvian government to fully implement the budget cuts - an offer it could hardly refuse. But the ministers did not address any of the social consequences of budget cuts, or the fairness of a package that hits poor people hardest.

Egils Baldzens, the vice-chairman of Latvia's trade-union federation, offers another perspective on these events. "We have the most unequal society in the EU", he says.

Baldzens believes that budget cuts in education and healthcare cannot be the heart of the strategy to solve the crisis. The cost of defending the currency regime is too high, he says. In the present situation, devaluation might be necessary.

Egils Baldzens - whose bookshelf is decorated with gifts from Swedish trade unions, but who has seen no interest from the Swedish government in dialogue with Latvian trade unions or other social partners - thinks that resistance to devaluation comes from "those countries that have high investments in Latvia". But the present policy will lead to even greater losses, he says. This opinion is now supported by many Swedish economists, who argue that devaluation could lead to a quicker recovery.

The tensions

Latvia and the other Baltic states are important countries that have much to contribute to Europe - culturally, politically, economically. But this potential will be strangled by dogmatic economic policies from European Union governments that deepen rather than ameliorate the current crisis.

There is an additional danger: increased tensions between the Latvian-speaking majority and the Russian-speaking population. "The sense of belonging to Latvia has never been very strong among Russians-speakers", says Nils Muiznieks, a prominent social scientist and a former Latvian integration minister. "During the economic crisis it will become weaker; it will throw back our efforts at integration a few years".

Nils Muiznieks, talking in his office at the University of Latvia, tells me how the closure of Russian schools because of the budget cuts will probably lead to protests; how rising unemployment will hit the minority hardest; and how agreement by all main parties to implement the IMF agreement will give opportunities to more extreme political forces.

People in Latvia are well aware of Russia's policy towards former parts of the Soviet Union. The Kremlin could make use of the present situation, says Muiznieks: "There is one looming factor, in Estonia as well, and that is Russia. I think it makes it easier for Russia to meddle. Russia has a policy of trying to win the hearts and minds of Russian-speakers here."

A strong and enduring foreign-policy goal for Sweden and the EU has been to prevent conflicts between the majorities in the Baltic states and the Russian-speakers. During the present financial crisis, such considerations seem to have been forgotten. In Stockholm, saving the banks was more important than contributing to further integration through a socially responsible economic policy.

I believe that the Swedish finance ministry and the European commission made strategic mistakes in their policies towards Latvia. They should have consulted with a larger part of the Latvian society, not just with government and financial institutions. The crisis in the Baltic states should now be a priority for Sweden's prime minister Fredrik Reinfeldt and his European colleagues. Whether Stockholm likes it or not, the issue will figure prominently on the agenda of Sweden's European Union presidency that begins on 1 July 2009.

It is not too late for Sweden to recall the role it has played in the region for centuries: and to act as a friendly neighbour showing solidarity, rather than the equivalent of a colonial power. Latvia has seen enough of those.