Two options for Estonian economy: slow fadeout or risky development

The following are extracts from Kattel’s opinion article.

There are two events that do not depend on us, but will shape our future for the next five years and beyond: Europe’s capacity to handle its debt crisis and the Ukraine crisis. The combined impact of these two events will keep our economic growth at a minimum. We need to get accustomed to the current situation with low productivity and wages. This is the new normalcy.

Estonia should not be too optimistic about the outcome of both events. As for Ukraine, Russia is obviously out to restore its multipolar world, but because it remains too weak, especially economically, it is likely to remain a drawn-out conflict.

The West is not accepting Russia’s ambitions in the Crimea and Ukraine, but is not willing to confront Russia which keeps sanctions and insecurity.

This means that the Estonian economy will continue stagnating in the newt couple of years.

Because of its small size, the Estonian economy has been growing for the last twenty years because of external stimulus. These include foreign investments and the growth of exports to Scandinavian countries.

The problem is that there will be fewer external stimuli in the future that is available for Estonia, especially when the EU aid that has been flowing into Estonia dries up.

Five problem areas

There are five bigger problems that Estonia is facing.

First, the manufacturing industry – Estonia’s largest employer – must notably increase its productivity.

Secondly, Estonia must develop and implement a comprehensive industrial policy which is based on R&D, and notably increase R&D funding, both private and public.

Third, the service sector which is another large employer is being held back by low wages which is mainly paid for by tourists.

Fourth, whereas the median wage is at 750 euros, it is difficult to expect domestic consumption to drive the economy over a longer period.

Fifth, marginalization of peripheral areas which is already putting medium-sized towns at risk which will face problems if some larger plant closes doors and are already suffering from domestic migration.

The solutions to all these problems need long-term vision and determined cooperation between the state and other sectors, to say nothing of resources.

As for resources, we need to start better using internal resources such as public procurements or investments of pension funds.

This implies that we need to reform our tax system because at present poorer pay more which is not solving the problem of low-earners, on the contrary.

High labour taxes are not attracting anyone to create jobs in marginal areas, to say nothing of massive hiring of R&D people in Tartu or Tallinn.

Whether we want it or not, the state must seriously consider the possibility of issuing government bonds although it will increase government debt.

So the nation is facing two challenges: on the one hand, migration will continue as long as wages remain low; on the other hand, the state needs funds for investments, but growing government debt will increase instability.

The choice is ours – slow fadeout or risky development.