Estonia: The Euro Dream (Part II)

Originally published on 2012/07/27

The Estonian dynamic and vibrant economy has survived the Euro crisis with remarkable resistance and recorded robust economic growth in times of looming austerity and monetary stagnation. This is the second and final part of Henri Erti’s analysis of the economic situation in Estonia.

Euro’s Poster Child?

Albeit the fact that the Estonian economy has been one of the strongest in the EU zone during the financial crisis, many economists have been castigating such robust growth and rendered the Estonian success fallacious. Perhaps the most prominent economist to denigrate the Estonian austerity policies -by warning us of its pernicious character- has been none other than Paul Krugman.

Despite Krugman’s analytical and empirical claims, his aspersions did not receive favorable support in the global economic and political arena. The Estonian President Toomas Ilves responded to Krugman’s solemn accusations with a rather evocative manner in his Tweeter account. Even though it was palatable for President Ilves to defend the Estonian austerity policies publicly, it would be hasty to disregard Paul Krugman’s thoughts on such crucial topic. Especially given his credentials in the area of Keynesian economics. Admittedly, and even more so unfortunately, the IMF 2011 report on the Estonian economy vicariously illuminates Krugman’s latent doubts on Estonia’s Euro miracle

Krugman’s Challenge

While strolling around the streets of Tallinn, one can witness the economic growth of the former USSR state simply by observing the amount of new businesses and luxury cars appearing in the urban facade. The scenery slightly resembles any other big city’s lifestyle, where people wear designer clothes and sit in fancy street-cafes, sipping macchiato. In some areas, a few Ferraris and luxury Lexus cars epitomize the success of the Estonian’s rapid economic growth. How can professor Krugman postulate that such growth was not only ambiguous, but also fugacious?

In his New York Times blog “Estonian Rhapsody”, Paul Krugman argues that although Estonian economy is growing and recovering, the current performance is not, in fact, close to the 2007-08 years when the recession began as a result of the housing bubble. Due to the remarkable economic performance before 2007 -which was fueled with low-interest rates, increasing FDI and growing consumer demand (see Estonian Dream Part I)- the Estonian economy flourished to the point of over-heating. One would hope that the Estonian leaders have learned from such ebb. However, according to the IMF 2011 report, an approximately quarter of mortgages are in negative equity. This situation can be detrimental for a stable long-run growth because the health of the Estonian banks, and hence the assets of individuals, depend primarily on house price increases. Furthermore, the banking sector’s profits have been increasing since the second quarter of 2010, but still remain well below their pre-crisis levels.

IMF on Estonia

In 2009 the Estonian GDP contracted 13.9 %, which is significant and hazardous for such a small emerging economy. This particular number has been a pivotal point for Krugman and his claims. Albeit the fact that recovery and growth have been astonishing by every measure, they have not exceeded the level achieved during the pre-crisis period. Therefore, all the fuss about Estonian austerity policies being the panacea for EU crisis and the favorable appraisals that justify this claim reflect the overestimation of these policies and the fact that other variables have been egregiously ignored.

The IMF 2011 report reveals accurate data on the performance of the Estonian economy. For example, the level of unemployment does not deserve a positive public appraisal. The unemployment rate has fortunately declined from its 18.3 % peak in 2010 to 13 ¼ percent in 2011. However, such high rate contradicts the increasing consumer demand, which relies on more disposable income of consumers deriving from employment. In addition to the high unemployment rate, the average income in Estonia in 2012 was 859 euros. On top of such relatively low average wages, inflation is one of the highest in Europe. Hence, expensive goods, such as food and energy, have diminished the purchasing power. Taking into consideration such numbers, Paul Krugman is entitled to be dubious and to question whether the austerity policies deserve the credits and headlines it has received from the media.

The author serves as the EST Ambassador to Croatia and Interim Ambassador to Estonia.