Estonia’s Astonishing Development

by Andreas Hoffmann

Intellectual Takeout’s Luis Pablo has published a nice piece on Estonia’s astonishing development. You can find it here. He attributes this development to Estonia’s “market-oriented reforms” during the 1990s. Importantly, Estonia has sticked with the “market-oriented” approach. I suggest that this persistence might help explain why the country has fared better than most other countries following liberalization.

The author neatly summarizes the development Estonia has taken on the whole. He attributes the success to the liberalization efforts and “market-oriented” reforms during the 1990s:

From day one, the new government committed to undertaking market-oriented reforms that laid the foundations for a successful transition from socialism to capitalism. The political agenda included monetary reform, the creation of a free-trade zone, a balanced budget, the privatization of state-owned companies, and the introduction of a flat-rate income tax.

The result:

Today, Estonia is considered a high-income country by the World Bank, and it is member of the EU and the Eurozone. The purchasing power of Estonians has increased 400 percent over the last two decades despite the severe impact the 2008 financial crisis had on the Baltic economies. In addition, life expectancy has moved from 66 years in 1994 to 77 years in 2016.

Estonia is ranked among the top countries in terms of economic freedom. Government finances are healthy as shown by the fact that public debt is only 9.5% of GDP.  In terms of the labor market, Estonia’s unemployment rate is 5.3%, well below the EU average. Finally, its efficient and attractive corporate tax system (undistributed profits aren’t taxed) has placed Estonia as a worldwide center for high-tech companies, boosting foreign investments and economic growth.

Liberalization certainly put Estonia (and other former transition economies) on the right track. But the 1990s are long gone. New politicians came to office. And the economy got hit by a severe crisis every now and then. There were time and reason to move away from the 1990s approach. It is rather impressive that Estonia did not.

Take for example the recent 2008 financial crisis.

Like many countries, Estonia saw an artificial boom driven by cheap credit rates between 2003 and 2007. Growth rates reached up to 12 percent prior to the crisis. At the same time wages grew rapidly. Huge current account deficits were a reflection of substantial increases in wages, a great influx of capital and the credit boom. Then the financial crisis struck the country.

Sounds familiar? However, unlike most other governments and even though the economy lost by two digits, Estonia continued to, by and large, follow the “market-oriented” approach prescribed to in the 1990s.

Remarkably, Estonian governments managed to keep the budget relatively balanced during and after the crisis. When the crisis hit, the government did not (over)spend but allowed individuals to sort things out. Wages fell rapidly with the fall in per capita GDP – even in the public sector. Estonia was criticized for this on many occasions but withstood the general call for government interference in markets. Economic freedom was not sacrificed for crisis management and short-term success.

I believe that this rather unusual persistence in pursuing a “market-oriented” agenda even in times of crisis is important in understanding why Estonia fares so well. In economies with credible institutions guaranteeing a high degree of economic freedom and solid macroeconomic fundamentals, economic prospects tend to be bright.

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