Estonian economy – implications of “smallness” Eve Parts (PhD) University of Tartu, Estonia NBSS Economic Workshop, Reykjavik, November 18, 2011

Structure of the presentation Estonia’s basic economic decisions in 1990s Characteristics of “smallness” in case of Estonia (as defined by the World Bank) Future economic prospects

Basic economic decision in 1990s Strict fiscal policy –Yearly balanced state budget Tight monetary policy –Currency board system Simple and clear tax system –Proportional income tax –Relatively low general tax level Balance between wage increase and productivity growth

Basic economic decision in 1990s Main purposes: –Economic and financial stability –Higher credibility FDI ! –Lower country risk ratings –… leading to faster economic growth Other outcomes: –Flexible labor market –… but still not enough restructuring …

Economic freedom 2011 (14.) Source:

Changes in economic freedom Joining EU Economic crisis

Characteristics of “smallness” Remoteness or isolation Openness Income volatility Limited diversification Access to external capital Natural disasters Limited public and private capacity Poverty and inequality

Remoteness or isolation ?

… are not the problem But Russian neighborhood is … –Communist past –Economic security (trade embargo in 1998) –Energy issues One of the (main) reasons to join EU and NATO

Openness – total trade (EX+IM) But (statistically), total effect of trade on GDP growth has been negative (-6% in 2006)

Limited diversification of foreign trade Main trading partners (2010) –Finland, Sweden, Latvia, Germany, Russia: 56.5% of total exports 57.3% of total imports –EU27: 67.6% of imports, 79.8% of exports –Euro area: 31.0% of imports, 37.6% of exports –Trade balance: negative with Latvia, Lithuania, Germany, EU27 and Euro area Principal exports: –Machinery and equipment, wood and paper, textiles, food products, furniture, metals and chemicals

Size and importance of export sector 1% of largest exporters gave about 46% of total export in % of largest exporters – 72% of total export 10% of largest exporters – 84% of total export BUT (manufacturing, average ): Export accounts for ~70% of Estonian GDP Exporting firms are much more productive: –22% higher TFP (total factor productivity) –58% higher sales per employee –53% higher value added per employee

Access to external capital Extremely important! FDI –FDI position 12.3 bn euros 2010 (4,3x increase since 2000) –Top investors: Sweden (35%), Finland (23%), Netherlands (9%) EU financial support (infrastructure development)

Current account balance (% of GDP) goods services returns transfers CA

Income growth and volatility GDP 1990 = GDP 2001 ? Pre-crisis volatility,

Convergence with EU (Real GDP per capita as % of EU15 average)

Real versus nominal convergence (Real GDP per capita as % of EU27 average)

Boom and crisis: GDP2009~GDP

Productivity and wages (% as compared to the same period in previous year)

Employment and unemployment

Other vulnerabilities? Possibility of natural disasters? Emigration …

Future economic prospects (Estonian Development Fund) Main problem of Estonian economy: low value- added production structure Possible solutions: –Moving ahead within or between value chains –New business areas with greatest growth potential (global as well as local/regional) –Exploring new markets Solutions might be (largely) outside the economy –education, migration, values, …

Additional statistics (%) Real GDP growth Inflation (CPI) Unemployment GOV/GDP Public debt/GDP