Estonian economy – implications of “smallness”

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

2. 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

3. 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

4. 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 …

5. Economic freedom 2011 (14.)Source: http://www.heritage.org/Index/Country/Estonia

6. Changes in economic freedom Joining EU Economic crisis

7. 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

8. Remoteness or isolation ?

9. 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

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

11. 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

12. 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

13. 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)

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

15. Income growth and volatility GDP 1990 = GDP 2001 ? Pre-crisis volatility, 1996-2007

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

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

18. Boom and crisis: GDP2009~GDP2005-2006

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

20. Employment and unemployment

21. Other vulnerabilities? • Possibility of natural disasters? • Emigration • …

22. 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, …

23. Additional statistics (%)