Estonia: The Euro Dream (Part I)

By Henri Erti. Originally published on 2012/07/24

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.

All Hail Austerity

A solemn contraction in global economic activities resulted in egregious crisis in the credit markets, which inexorably spread also to the Baltic States and especially to Estonia. However, such ominous financial Armageddon was avoided by implementing prudent, yet flexible macroeconomic policies, which relied heavily on the philosophy of laissez-faire and favorable tax-codes, which attracted foreign capital and consequently, boosted economic growth. As a result, an expansion in domestic demand, driven by increases in medium wages (864 euros), exports have been growing quarterly according to the 2011 IMF report on the Estonian economy.

While the majority of the EMU economies had a meager GDP growth due to the crisis, the Estonian GDP recorded an average 7% growth per year during 2000-2008. Furthermore, the debt to GDP ratio is circulating around 6%, which may seem a sporadic number for most economies in Europe. Admittedly, such numbers can be attributed to the austerity programs implemented by the Estonian government, which has been successful in promulgating mutual responsibilities during rather harsh cuts on public goods and services.

Keep the Government Out

Such growth is remarkable when considering that the Estonian subjugation under the Soviet Union ended merely a decade before the beginning of the Baltic economic triumph. Nationalist advocates draw causality from the tough Soviet era where people survived rigorous times by ignoring the shortages of everything and focused on creativity and survival. Such natural erudition enabled people to acclimatize to the new economic crisis and exhibit pragmatism during such serious strife.

Without disregarding the efforts of the Estonian people or underestimating the abhorrent times of the Soviet Union, the current Estonian economic paradigm is unlikely to be caused solely by the Estonian “spirit”. A more tangible explanation might be the system of low, flat rate taxes, especially the 21% income tax. Unlike in many Scandinavian economies where progressive taxation is favored, Estonian tax-code espouses its citizens to increase their employment or entrepreneurial inputs, which in return is not penalized through higher taxes. Subsequently, companies are given inducements to expand their businesses by eliminating corporate income taxes from reinvested profits. With such benign tax-policies, Estonia has liberalized its economy and, therefore, attracted a great deal of foreign direct investments to further drive more sustainable fiscal policies.

Strong ties with Scandinavian Banking

Second reason for the booming economy prior to 2009 is the Scandinavian-connected banking in Estonia and strong trade relations with Finland and Sweden. Estonian banks have the privilege to obtain access to relatively cheap credit from the strong Swedish economy, which naturally has not suffered drastically from the submersion of the Euro zone credit crisis. As a result, more than 90% of the banks operating in Estonia are under the ownership of Scandinavian banks. Consequently, these banks are adequately capitalized, meaning that banks’ funds are highly protected from contagious credit-crunches or liquidity issues. Furthermore, the interbank financial market is relatively small, which eliminates the problems of one bank being spread to another.

Albeit the Estonian economic triumphalism is evident, the success can be highly perfidious. The government’s decision to implement harsh austerity policies after a robust economic growth was not a popular decision. Government jobs were eliminated, wages were cut up to 30% and access to credit became more difficult. Regardless, it must be noted that the Estonian economy grew the second fastest of the EU in the fourth quarter. Only Latvia had higher growth rate with 5 % and given their trade relations, both countries are able to benefit from their mutual success.

As the austerity debates rage in Brussels, perhaps the Estonian experiment can bring about a change in the current futile status quo and eliminate the divisive block between EU countries.

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