Estonia – The Return of a Baltic Tiger?

February 6, 2010

by Andreas Hoffmann*

The new member states of the EU were hit hard by the current crisis. Especially the former Baltic tigers (Estonia, Latvia, Lithuania) have seen a tremendous decline in GDP. While our economies face difficulties to cope with a decline of about five percent of the GDP, they lost 10 to 15 percent. In my opinion, Estonia is the most interesting of the three as it chose a distinct way to deal with the crisis.

Like many economies, Estonia saw an artificial boom driven by cheap credit rates until the latest crisis. From 2003 to 2007 growth rates reached up to 12 percent. At the same time wages grew rapidly. Huge current account deficits reflected the increase in wages, influx of capital and the credit boom. However, unlike most other economies and even though it lost by two digits, Estonia managed to keep the budget relatively balanced in the current crisis. Estonia was even able to contribute to the IMF-program for its formerly “growth mate” Latvia. What is the reason behind it?

With a tradition of a fixed exchange rate to first Germany and now the euro area, Estonia has been waiting to enter the euro area as soon as possible. Even though the boom brought about real convergence as the GDP per capital caught-up with the former EU-15, nominal convergence was out of sight. The credit boom fuelled inflation, not only in real estate prices but also in consumer prices. Nominal and real convergence did not go hand in hand. This caused a problem in not fulfilling the Maastricht inflation criterion, necessary to introduce the euro.

Thus the Estonian government reacted in a way to the current crisis that should bring tears of joy into the eyes of any free market economist: First, they did everything to hinder a devaluation of the Estonian kroon, as a relatively stable exchange rate to the euro is a prerequisite for euro introduction. Secondly, they did not overspend. Instead they cut wages heavily with the fall in per capita GDP – even in the public sector. And third, unlike most economies, Estonia did not sacrifice economic freedom for crisis management. Instead, officials wait for the crisis to heal the market. At the same time lower spendingĀ is assumed to bring inflation down. The crisis is seen as a chance to (readjust and) fulfill the Maastricht inflation criterion, which was impossible during the boom period.

Thus, as Estonia allowed for an adjustment process, malinvestment from the previous boom should be dismantled soon. This should bring about lucrative future investment possibilities in an economy with solid macroeconomic fundamentals, a high degree of economic freedom and prospects to enter the euro zone. At the moment interest rates are much higher there than in the euro area and a credible fixed exchange rate assures against depreciation. These facts should attract new investors. Therefore it is likely that we soon see the return of at least one Baltic tiger.

*Andreas Hoffmann is visiting the Department of Economics, New York University from the Institute for Economic Policy, University of Leipzig during the current academic year. He is a Bradley Fellow and a Fellow of the Friedrich Naumann Foundation. Some of his work can be found here.

7 Responses to “Estonia – The Return of a Baltic Tiger?”


  1. I’ve been to Estonia twice and followed it for some years. The Estonians are an amazing people, committed to free-market principles and tough and determined in pursuit of goals. The government officials I met were also very professional.

  2. Andreas Hoffmann Says:

    Indeed, therefore I think Estonia is a good case study of whether free-market economics works in a small emerging market economy.

  3. zpv Says:

    I dont fully understand what happens at the expense of capital inflows. They will find crude oil? And by what means they can keep the fixed exchange rate? Their generally economics model – bying german auto on Sweden credit is not stable.


  4. I am an estonian, but we also follow global markets quite thoroughly. And we surely do live in interesting times – some parts of marcroeconomic books will be re-written in the future.

    Estonia has taken a rather different crisis-management approach than Western world (US, Western Europe et al) – no government stimulus, very low government debt (only around 10% of GDP) and no bailouts. Therefore the steep GDP drop in 2009 (around -15%), if US would have no stimulus or bailouts, the GDP would be surely negative as well.

    I think that Estonia has taken the quick and painful way, whereas a lot of countries have gone the route which may be more painful in the end – big budget deficits must be paid back at some point (probably higher taxes globally).

    I was really negative about Estonia’s outlook in 2006 (as you all know, that is not a popular thing to do), the economy overheated badly. But the normalizing process has been very effective after that, gross wages have dropped around -20%, asset prices around -60%. That surely is not a pleasant process but it is helping to restore Estonia’s competitive advantage.

    The recovery will probably not be not that quick in Estonia, the normalizing process is still ongoing and unemployment has reached 15%. But looking at the macro picture, Estonia looks pretty good (should I use the term “sane” here?) compared to most of the World.

    If anyone has more detailed questions you can drop me an e-mail kristjan-at-tarkinvestor.ee


  5. P.S. If you look at Greece right now – they will have to go the same route as Baltic countries did, “Internal devaluation” is the name of the game. Having witnessed it with my own eyes, it is not a nice process. But if the economy had overheated badly (that happened surely in Baltics and in Greece as well), all the options left are from category “not pleasant”.

    There was a high amount of sceptisism about the process in Baltics, but so far it has worked. One reason behind it could be that Baltic countries have had quite tough times during last 50 years, after the Soviet occupation this crisis really is a walk in the park. So people are used to radical changes and have taken salary cuts really well.

    If I read the news about Greece and how people blame the government, lot’s of strikes and nobody willing to make sacrifices – I’m not sure this will work there …


  6. I was living in Estonia for a while, from 2005 to 2008. It is great country and great people, well educated and polite.
    I am quite sure that Estonia is going to overcome the crisis in a very good way for the following reasons :
    – They knew the true socialism under the Soviet regime, they are well aware of the cost of such disastrous economy ( we in italy are not aware …)
    – They are well educated, everyone speaks english
    – They are in a great geographic location, just in the middle of suck big “lake” as the Baltic Sea
    – They have a very low inhabitant density
    – They are not burdened of such huge “old” social debt like the old western economy
    – The crisis will open their eyes against the fake western free economy before they will be grasped

    I think that if Estonia continue the real anticrisis economy which already started and improve his relations with Russia then it will really become the Tiger of the Europe!

    I am confident that Estonia will be successful

    Buona Fortuna Estonia!!!

    Antonio Manno


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