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: http://www.heritage.org/Index/Country/Estonia

0102030405060708090

100

Ove

rall S

core

Busin

ess

Free

dom

Trade

Fre

edom

Fiscal

Fre

edom

Gov

ernm

ent S

pend

ing

Mon

etar

y Fre

edom

Inve

stmen

t Fre

edom

Financ

ial F

reed

om

Prope

rty R

ights

Freed

om F

rom

Cor

rupt

ion

Labo

r Fre

edom

Changes in economic freedom

64

66

68

70

72

74

76

78

80

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

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 ?

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)

0,00

5000,00

10000,00

15000,00

20000,00

25000,00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0,00

20,00

40,00

60,00

80,00

100,00

120,00

140,00

160,00

180,00

200,00

Value in current prices, mln EUR (left axis)

Share in GDP, current prices, % (right axis)

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 2009• 5% of largest exporters – 72% of total export • 10% of largest exporters – 84% of total export BUT (manufacturing, average 1995-2002):• 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)

-30

-25

-20

-15

-10

-5

0

5

10

15

1999 2001 2003 2005 2007 2009 2011* 2013*

% SKPst

Kaubad Teenused Tulud Ülekanded Jooksevkonto

goods services returns transfers CA

Income growth and volatility

GDP 1990 = GDP 2001

?

Pre-crisis volatility,

1996-2007

SKP reaalkasv võrreldes eelmise aasta sama perioodiga (%)

-2

0

2

4

6

8

10

12

14

I II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IVI II III

IV

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

SKP kasv, 1990=100

60

70

80

90

100

110

120

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

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

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Czech Republic Estonia Latvia LithuaniaHungary Poland Portugal SloveniaSlovakia Bulgaria Romania

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

Boom and crisis: GDP2009~GDP2005-2006

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

Employment and unemployment

400

450

500

550

600

650

700

1996 1998 2000 2002 2004 2006 2008 2010* 2012*

tuhat inimest

0

3

6

9

12

15

18%

Hõivatud Töötuse määr - RM prognoos detsTöötuse määr - RM prognoos aug Registreeritud töötus

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 (%)2006 2007 2008 2009 2010

Real GDP growth

10.1 7.7 -3.7 -14.3 2.3

Inflation (CPI) 4.4 6.6 10.4 -0.1 3.0

Unemployment 5.9 4.7 5.5 13.8 16.9

GOV/GDP 16.2 16.5 19.2 22.0 20.9

Public debt/GDP

4.4 3.7 4.5 7.2 6.7