Some Insight Views into the Macroeconomic Performance of the Estonian Economy in 1989-1997.

 

Raul Eamets

Tartu University Faculty of Economics

Lossi 3-303, Tartu, Estonia

E-mail: eam@cie.ut.ee

 

Radical reforms in Estonia started in 1987-88 when a group of economists and politicians debated the idea of economic autonomy (IME in Estonian). This idea developed into proposals for economic and social reforms and a movement called 'the parade of sovereignty' by M. Gorbachev, the initiator of perestroika in the former Soviet Union (FSU).

In 1990, an important change occurred in the strategic aims of the reforms in Estonia: economic autonomy, which had formerly been the priority, was replaced by the goal of political independence or the task of re-establishing independent statehood in Estonia. The new target for economic reforms became the restoration of a market economy. The transition to a market economy was supported by the re-establishment of independence (August 1991) and the introduction of Estonia's own currency (June 1992).

The process of establishing economic and political independence and market relations had been under way for seven years. Characteristic features of Estonian reforms have been radical and rapid introduction of market oriented institutions accompanied by high social costs (EAS; 1995)

1.1. Background and general developments

Before economic reforms the industrial sector in Estonia was characterised by:

1) a high degree of concentration, with about 20 per cent of all enterprises producing about two thirds of total industrial output,

2) a heavy reliance on inputs imported from the rest of the former Soviet Union,

3) Estonia's dependence on markets in the former Soviet Union.

Estonia stabilised its economy in much less favourable conditions than those of most CEE states and Russia. First, Estonia experienced larger terms of trade shocks, due both to a high dependence on energy imports and to relatively lower energy prices which prevailing in the FSU compared to CEE1. Second, as a small country, it was more affected by the collapse of trade which hit all economies in transition (again Russia would have been least affected). Third, in spite of having been relatively reformist and within the FSU, Estonia probably inherited more distorted economy than, say, Poland or Hungary, which had introduced some market elements during the previous decades. Almost the only sense in which the Estonia had better initial conditions was their start from a position of zero foreign debt, as Russia took over all of the foreign assets and liabilities of the FSU (Hansson; 1997).

The Estonian economy was, naturally, part of the economy of the Soviet Union and, thus as mentioned before, tightly connected with the raw material and product markets of the former Soviet Union. The transition period problems characteristic to the Estonian economy were similar to the problems of the other former Soviet Union command economies (See also Eamets, R. 1994, pp. 60-63). Briefly, these common characteristics were as follows:

1. The orientation of the economy to the former Soviet Union.

As has already been pointed out, the Estonian economy stemmed from the Soviet economic system. As a result, many enterprises found themselves in serious economic difficulties in the early 1990s. This was due to the fact that contracts with Russia were no longer in effect since the other party failed to fulfil its responsibilities. Furthermore, the goods of Estonian enterprises could not be sold since they could not withstand competition with those produced in West Europe. At the same time the Central Bank of Russia had frozen money transfers of Estonian enterprises which brought a wave of bankruptcy among Estonian companies. In addition to the general economic disorder and loopholes in the legal system, contracts were also often refused for political reasons. During the years 1992-1997 Estonia restructured its foreign trade, orientating its towards western markets however, some industries, like agriculture and fishing are still dependent on Russian market. This caused deep crises in these industries when Russia suffered economic depression in 1998.

2. Economic recession.

Partially due to the factors pointed out in the paragraph above, the Estonian economy faced a deep crisis in 1990-1992. For instance, in September 1992 industrial production was 64% of that in September 1991. During the same period labour productivity decreased 26.6%. On the basis of these data, it can be assumed that enterprises fictitiously held a high number of employees who were paid wages even though there was no work to be done2. There is also some evidence of economic recession caused by Russian crises in 19983.

3. Allocation of labour to industries did not match with demand of market economy.

Following the norms of Soviet central planning, several heavy industries were built in Estonia which operated on imported raw materials and the production of which, as a rule, was exported to Russia. In most cases heavy industry was imported its labour force. Employment in agriculture was influenced by collectivisation. Estonian agricultural production had a clear Soviet orientation in order to supply other Soviet provinces nearby with foodstuffs. Since income in agriculture was higher than the average in the republic, the number of people employed in agriculture was relatively high.

Thus, the employment structure in Estonia is not a result of natural (market oriented) development but rather an artificially shaped one proceeding from the economic needs of the former Soviet Union.

4. Surplus of jobs.

One of the characteristics of the Soviet Estonian labour market was the so-called surplus of jobs, or, in other words, a labour shortage. This was a artificially created situation typical of the entire Soviet economic system. What were the reasons given for the surplus of jobs? The Swedish economist S. Oxenstierna has summarised the reasons for the surplus of jobs offered by Soviet economists as follows: artificial labour shortage; low labour discipline; low production discipline; wrong investment policy; too many workplaces; irrational use of the labour force; poor financial situation of the workers and workers' dissatisfaction with their present state (Oxenstierna, S. ,1990).

 

1.2. Developments after economic reforms (after 1992)

The recent macroeconomic performance of Estonia can be described by the following general indicators:

Drastic changes in the Estonian economy took place in 1992. In June Estonia introduced its own currency: the Estonian kroon which is pegged to the German mark (1 DEM = 8 EEK). It created a completely new environment for business activities and is considered to be the start of serious economic reforms in Estonia.

 

Table 1.1. Estonia: Key Economic Variables

 

05/98

05/97

Average of last 12 Months (05.97-04.98)

Prices

     

1.1. consumer price index

1.004

1.02

1.010

1.2. producer price index

0.997

1.024

1.005

1.3. export price index

0.982

1.005

1.003

2. Foreign trade (EEK mn)

     

2.1. exports

3 123

2 569

2 874

2.2. imports

4 615

3 956

4 384

2.3. net balance

-1 492

-1 387

-1 510

3. Budget (EEK mn)

     

3.1. central and municipal budget revenue

1 700.7

1 378.7

1 564.4

3.2. central and municipal budget expenditures

2 285.4

1 422.8

1 487.9

o/w social welfare

937.3

728.1

749.5

Economy

262.6

313.7

309.2

public administration

162.9

201.1

164.2

4. Population growth

     

4.1. births (live)

1 004

1 110

1 028

4.2. deaths

1 441

1 512

1 591

4.3. natural increase of the population

-437

-402

-563

5. Number of unemployed and unemployment rate

     

5.1. number of registered unemployed (end of month)

18 769

20 515

18 640

5.2. total number of unemployed job-seekers per month

31 984

36 454

32 616

5.3. registered unemployed (% of the working-age population)

2.1

2.3

2.3

5.4. unemployed job-seekers (% of the working age population)

3.7

4.2

3.8

5.5. unemployed job-seekers (% of the employed and job-seekers)

4.8

5.4

4.8

Source: Bank of Estonia

 

1.2.1 Inflation

The Estonian Government and Bank of Estonia have close co-operation with the IMF and the framework of economic reform has been worked out with advisors from the IMF and IBRD. Most open sector prices were liberalised in Estonia in 1991-1992 and the monthly inflation rate declined from 20 per cent in the summer of 1992 to 6.6 per cent in September 1992 and to 1.7 per cent in May 1993.

Annual inflation has been brought down from near-hyperinflation in 1992 (annual rates of 953% in Estonia, 959% in Latvia, and 1163% in Lithuania) to 10% in 1997 (14%, 8%, and 10%, respectively). This is in contrast to the CIS, where inflation remains much higher4.

The persistence of relatively high inflation can be traced to several causes

a) Money supply is related to the increase of foreign reserves of the Estonian Central Bank. Due to the Currency Board system the money supply will increase automatically when foreign investments, foreign loans etc. increase.

b) Because Estonian kroon exchange rate is fixed with DEM the PPP (Purchasing Power Parity) principle influences the price level. In situations where we don’t have trade barriers the price level of imported goods (mostly from Finland, Sweden and other Western countries) pushes up our domestic price level.

c) Prices in non-tradable goods are not completely liberalised while the tradable sectors are opened to foreign competition since the start of currency reform. If we analyse different components of inflation we can see that it is mostly price increases in the non-tradable sectors (electricity, public transportation, housing etc.) that leads to high inflation in Estonia.

1.2.2. Output decline and employment

Poor starting conditions led to greater falls in output than in most CEE states (Table 1.2.). The cumulative fall in measured GDP from 1989 to 1996 was about 31% in Estonia, 48% in Latvia and 58% in Lithuania. Falls in agricultural and industrial output have been even greater. This contrasts with a cumulative GDP increase of 4% in Poland, and declines of 14% in Hungary, and 11% in the Czech Republic5. By OECD estimates, all of the Baltic States had restored growth in 1996 (Table 1.3.), with the higher Estonian rate partly reflecting the fact that it turned around first.

Dropping economic output is typical of the early transition period. According to Allen (Allen, 1992) the main sources of output decline, common to transition economies, are as follows:

1) The implementation of structural changes. The experience of the IMF has shown that deep structural adjustment is almost invariably accompanied by a certain retrenchment in production.

2) The shift from the pattern of holding stocks of input as a precaution against disruptions in supply to holding stocks of output so that customer demand may be met. This is a fundamental part of the process of transition from a supply-constrained to a demand-constrained economy. As it occurs, it inevitably causes output losses as firms run up against the demand barrier for their production.

3) The decline in output has been partly explained as the result of a breakdown of plan discipline. While the planned economy did not work well, its elimination has made the co-ordination of economic activities more difficult. This is a temporary phenomenon.

There are many other possible explanations to economic decline in transition. some have argued that the magnitude of the decline has been overstated by official statistics , either because their coverage excludes all or part of the growing private sector (Berg and Sachs, 1991) or simply because, beginning from an initial situation of widespread shortages, standard price and quantity indices generally overstate the drop in output and the increase in the price level associated with price liberalisation ( Osband, 1992). Such explanations do not , however, claim that the decline in output is entirely an artifact of official statistics.

Some observes have viewed the output decline as being related to the price shock that followed economic liberalisation. This demand-side view would argue that the decline in real wages, money, and credit is associated with the inflation depressed domestic absorbation and thereby contributed to the decline in output.

(Borensztein, Ed, Ostry; 1995)

Other demand-side effect might include high real interest rate and change in foreign trade (collapse trade relations with CIS countries in the case of Estonia for example).

Table 1.2. GDP levels in selected transition economies (1989=100)

Country

1991

1996

% change

(1996 compared

with 1989)

Czech Republic

80

89

-11

Hungary

82

86

-14

Poland

84

104

4

Slovakia

79

90

-10

Bulgaria

74

68

-32

Romania

75

88

-12

Russia

71

51

-49

Belarus

87

63

-37

Ukraine

79

42

-48

Estonia

73

69

-31

Latvia

61

52

-48

Lithuania

51

42

-58

Source: Allsopp, C., Kierzkowski, H. (1997)

Table 1.3. GDP growth rates in most Central and Eastern European countries

Country

1996

1997

1998

Bulgaria

-9.0

-6.0

2.0

Czech Republic

4.4

0.9

1.7

Estonia

4.0

9.0

-

Hungary

1.0

3.0

3.9

Latvia

2.8

4.0

-

Lithuania

3.6

4.0

-

Poland

6.1

5.6

5.4

Romania

4.1

-4.0

1.0

Russia

-4.9

0.5

3.0

Slovakia

7.0

5.0

4.5

Slovenia

3.5

3.5

4.0

Ukraine

-10.0

-4.0

-

Source: OECD, from Transition , World Bank Newsletter, vol. 8, no.6, December, 1997

Supply-side view would characterise the output decline as resulting from the increase input prices (energy, oil). After price shock country like Estonia faced with new relative price structure and one would expect that, over a period of time, resources would flow towards sectors whose relative output prices had risen and away from other sectors. Comparative advantage would imply that, if the country faced world market prices for its inputs and outputs, resources would move towards those sectors where comparative costs were lowest, thereby increasing the value of goods and services. During transition period, when factors will be allocated, structural change might be associated with output decline.

A very high growth rate in 1997 indicates that the Estonian economy has almost fully recovered from previous supply shocks and high growth rates have caused discussion in the local media about the overheating of the Estonian economy.

According to preliminary data of economic performance in 1998 the growth of GDP will slow down. The main reasons are the financial recession caused by stock market crash in October 1997 and the crises in the world financial markets. The Russian economic collapse of summer 1998 has also contributed to the slow down of Estonian economy.

The fall in GDP has not led to high unemployment. Unemployment in Estonia has increased gradually, and there has been no explosion of unemployment, including social disturbances, massive unemployment etc In the second quarter of 1997, the unemployment rate was 10.9% in Estonia. Open unemployment was around 5%. The main reason for moderate unemployment growth is a sharp drop in labour force participation. Other factors include initial exchange rate undervaluation (which helped to maintain average enterprise profit rates), relatively flexible labour markets, low unemployment benefits, and net emigration to the FSU.

In the following, we shall take a look at the changes in employment in Estonia as compared to changes in other Eastern European countries. We have used the respective labour market databases of the OECD (OECD, 1997).

We have observed Estonia’s closest neighbours Latvia and Lithuania, our companions on the way towards the European Union - Hungary, the Czech Republic, Poland, and Slovenia, and from the so-called second division of EU accession of Eastern Europe we have observed Romania. When possible, we have also used the results of the Russian labour force surveys (the database has, however, its shortages).

If we start with agriculture, we can say that Estonia is strongly on her way towards the employment structure characteristic of the more developed countries of Europe (see Tables 1.4 and Figure 1). In comparison with our closest neighbours, agriculture in Estonia has undergone the largest decrease in employment. The number of employed persons in 1996 as compared to 1992 has decreased by 55.7%6.

Table 1. 4. Employment change by industries in the three Baltic states , 1992-1995 for Estonia and Latvia and 1993-1996 for Lithuania %

Industry*

Estonia

Latvia

Lithuania

Agriculture

-55,7

-11,3

10,1

Mining

-27,2

-25,0

-41,7

Manufacturing

-14,7

-41,6

-42,2

Electricity

-8,8

54,5

38,7

Construction

-39,3

-45,4

-29,7

Trade

15,4

7,3

16,3

Transport

5,3

-1,9

-23,5

Finances

14,9

-9,4

0,9

Health care

-5,4

11,3

3,6

Public administration

7,9

n.a.

37,9

Other services

-8,9

-33,0

-10,7

Total

-15,7

-14,9

-10,6

* According OECD classification: Agriculture includes fishing, trade includes hotels, finances includes real estate and business services, health care includes education

Sources: Estonian labour force survey, OECD data, Lithuanian Statistical Office, own estimations

 

During the same period, employment in agriculture in Latvia has decreased by 11.3%7 and in Lithuania it has increased by 10.1%. This tendency is the result of the quick restructuring of agriculture in Estonia, by means of shock therapy8. Another question is how strong and effective are the new economic structures (mostly small farms) that replaced the former system of collective farms. The low employment in agriculture in developed countries is based on high effectiveness, while in Estonia we are simply dealing with decreases in production. If we look at the share of employment in agriculture (together with forestry and fishing), in 1996 it was 10.0%. This is more or less at the same level as Slovenia and Hungary (in the case of Slovenia we have used the data of the II quarter of 1996).

 

Figure 1

 

 

 

 

 

 

 

Sources: Estonian labour force survey, OECD data

 

Figure 2

 

 

 

 

 

 

 

 

 

 

 

 

Sources: Estonian labour force survey, OECD data.

 

The largest decreases in employment in manufacturing during that 4-year period have taken place in Latvia and Lithuania. In Estonia, the decrease in employment in manufacturing has been substantially smaller - 14.7% (see Table 1.4). On the other hand, a smaller decrease means that Estonia has a larger share of employment in manufacturing from total employment than the other Baltic countries. As far as employment in manufacturing is concerned, Estonia is comparable to Poland and Hungary in a term of total share of employment in manufacturing.

The fastest increase has taken place in the trade (including hotels and restaurants). In Estonia, the increase in employment during those 4 years was 15.4% and the share of employment in 1996 was 16.0%. Other Eastern European countries observed here are at about the same level, except for Lithuania, Poland, and Romania.

Compared to other Baltic countries, employment in banking (together with real estate and business activities) has increased greatly in Estonia. During 1992–1996 the increase in Estonia was 14.3%, while Lithuania has retained her level and in Latvia employment has decreased by 9.4%. At the same time, the share of employment in banking in Latvia was 6.5% and in Estonia 6.0%. Thanks to the fast increase in the field of finances, Estonia has gained a certain advantage as compared to her neighbours. This is shown by the intervention of Estonian financial institutions on Latvian and Lithuanian financial markets and by the fact that stock exchanges in Riga and Vilnius are influenced on Tallinn Stock Exchange. An earlier development in Estonia also means that financial crises are likely to occur earlier in Estonia and after a certain period in Latvia and Lithuania9.

In conclusion, we can say that the share of employment in service sector is largest in Hungary, next come Estonia and Latvia. Estonia is closest to Hungary, as far as employment structure is concerned (see Figure 1). The share of employment in primary sector from total employment is 11.4% in Estonia, while the same share in Hungary is 9.3%; the share of employment in secondary sector is 32.1% both in Estonia and Hungary, and in the service sectors 56.5% and 58.6% respectively.

If we compare Estonia to the developed countries in Europe, we can see that the share of employment in primary sector is even smaller there. In Denmark, for instance, the share of employment in primary sector in 1994 was 5.1 %, in Holland 4.0%, in Italy 7.7%, in Germany 3.3%, in Finland 8.3%, in Sweden 3.4% (see Figure 2).

 

1.2.3. Fiscal policy

A balanced budget has been one of the foundations of the economic policy of newly independent Estonia.

However, current Estonian conventions are different from international practice and we do not use terms such as overall deficit or financial deficit. Figuratively speaking, Estonia uses what could be called a ledger book system, where revenues and expenditures are always equal

According to international practice, the overall deficit is equal to the net volume of the loans taken by the general government (central government including the local governments and off-budget funds) which is necessary for balancing the difference between revenues with expenditures and loans given to the non-financial system. The overall deficit is not affected by onward government lending to banks, but among the factors having an impact on the deficit are loans to structures not in the financial system. The latter are necessary in cases when companies do not possess sufficient credibility to receive loans on their own. Since loans to non-financial system structures affect the overall deficit very differently from country to country, the term financial deficit is widely used. It means the overall deficit without the non-financial-sector loans. The role of such loans can be insignificant. For example, when the Maastricht Treaty says that the budget deficit must not exceed 3% of GDP in the EU states, it is referring to the financial deficit.

In Estonia, however, the distribution of such loans in the first years after the restoration of independence was the primary reason for the deficit. Apparently, this fact contributed to the wrong impression that the overall deficit has secondary importance in fiscal policy, because the loans to producers were "not proper public sector expenditures" from the view of national accounts. Since the Estonian government loan policy is only a few years old, the costs of servicing debts are not comparable to the size of the overall deficit (interest is expected to remain at about 0.5-0.6% of GDP).

In the last two years, the EU budgetary policy, reflected by a primary deficit, has been successful in terms of reducing the overall deficit. Estonia has experienced the opposite process: expenditures and investments, not the costs of servicing earlier debts, have increased the overall deficit.

The budget deficit of the Estonian government has been both positive and negative in the 1990's, going by international measurement standards. Even though the size of the deficit has been conservative (from 1993-1996 the size of the average deficit in the EU countries was reduced from 6.2% to 4.4%), it is still larger than the optimum 1% of GDP. In addition, the fact that vernacular terminology ignores international nomenclature can hurt foreign investors' confidence, especially if the government proclaims that the budget is balanced when actually the overall deficit has been growing rapidly over the last few years. (Saarniit, A.; 1997)

The deficit of the general government in 1996 was contained to EEK 811 million (1.5 percent of GDP). This deficit was larger than in 1995, reflecting difficulties early in the year in mobilising revenue, as well as higher infrastructure investment; at the same time, the general government continued to generate public savings on the order of 3 1/2 percent of GDP. Fiscal performance in the first half of 1997 has been better than anticipated, as a result of stronger-than-expected economic growth and improved revenue collection; there are indications that this good performance has continued during the third quarter. These developments, together with the one-off transfer to the government in July 1997 of accumulated profits of the Shipping Company (in anticipation of its privatisation), will result in the general government registering a surplus of about EEK 280 million (0.4 percent of GDP) this year, considerably better than initially projected. Excluding this profit transfer, the overall deficit is projected to be about EEK 120 million (0.2 percent of GDP) (Memorandum of Economic Policies; 1997),

 

1.2.4. Foreign trade

One of the characteristic features of the republics of the USSR were their very open economies. At the end of 1980’s, average weighted share of total trade as a per cent of GDP was 29% in the USSR, compared to the average 23% in EC countries. However, excluding Russia from the statistics, the average unweighted share reached 47% of GDP, including 64% in Estonia and 55% in Latvia and Lithuania. (Kuddo; 1997)

Estonia's share of foreign trade with industrial countries, which was negligible in the beginning of 1990's, increased to nearly 50 per cent of total trade by the third quarter of 1992.

In 1992 radical changes in the structure of Estonian foreign trade took place. The following Tables, 1.5. and 1.6. demonstrate that in 1991, the main trade partner of Estonia was Russia. Their share of total imports was 45.9 per cent and from total exports 56.5 per cent.

Table 1.5. Estonian import by main trade partners

Country

1991

1992

1993

1994

1995

1996

1997

Finland

2.0

22.6

27.9

29.9

36.9

35.7

33.9

Sweden

0.8

5.9

8.9

8.9

8.9

8.6

10.0

Germany

0.8

8.3

10.8

9.9

8.1

8.9

9.6

Russia

45.9

28.4

17.2

16.8

14.2

10.1

7.5

Holland

0.1

1.8

3.6

3.1

3.3

3.5

3.8

Latvia

5.1

1.7

2.3

1.5

2.9

3.3

3.5

Denmark

0.1

1.7

2.6

2.6

2.7

2.7

2.9

UK

0.1

1.6

1.5

2.1

1.6

2.1

2.2

Lithuania

6.3

3.6

3.3

2.6

2.0

2.1

2.0

Ukraine

7.9

3.2

1.6

1.7

0.9

1.4

0.9

Other

30.9

21.2

20.3

20.9

18.5

21.6

23.7

Total

100

100

100

100

100

100

100

Source: Estonian Statistical Office

Dramatic changes in foreign trade took place in the second half of 1992 after the introduction of the Estonian national currency. One important reason why trade with the former Soviet Union has decreased is the financial difficulties at CIS countries. The Estonian national currency was internally convertible but Russian roubles were not. This generated additional problems in financial transactions and most deal with the former Soviet republics are made in hard currency. Secondly, money transfers were carried out very slowly and the inefficient banking system causes a lot of payment problems.

All this led to a very rapid reorientation of Estonian foreign trade. In 1997 the biggest trade partners were Finland, Sweden, Russia and Germany.

In 1997, special exports and special imports10 amounted to 28.8 billion and 46.8 billion kroons, respectively, and the trade deficit was 18.0 billion kroons. Compared to 1996, special exports in current prices increased by 35.6%, special imports by 35.1% and the foreign trade deficit by 34.2%. The foreign trade deficit decreased slightly against special exports in 1997, amounting to 62.5% (63.2% in 1996)11.

Table 1.6. Estonian export by main trade partners

Country

1991

1992

1993

1994

1995

1996

1997

Finland

2.3

21.2

20.7

17.8

23.3

20.8

20.5

Sweden

0.5

7.7

9.5

10.8

11.8

13.2

18.2

Russia

56.5

20.8

22.6

23.1

16.3

14.1

9.8

Latvia

7.7

10.6

8.6

8.2

7.5

8.2

9.2

Germany

0.2

3.9

8.0

6.8

7.3

7.3

7.3

Lithuania

3.8

1.5

3.7

5.4

4.5

5.2

5.0

UK

0.1

0.9

1.4

2.8

3.3

3.6

4.3

Denmark

0.1

2.4

2.4

3.4

3.3

4.0

4.2

Ukraine

12.9

6.9

3.6

3.1

3.2

4.0

3.5

Holland

0.3

5.1

4.0

3.2

4.4

3.3

3.5

Other

15.6

19

15.5

15.4

15.1

16.3

14.5

Total

100

100

100

100

100

100

100

Source: Estonian Statistical Office

General exports amounted to 39.3 billion kroons in 1997 and general import share 59.4 billion kroons while the trade deficit amounted to 20.1 billion kroons. Compared to 1996, general exports increased by 57.4% and general imports by 54.2%. The high growth rate of general exports and imports can be attributed to changes in the customs regulations under which merchandise stored into customs warehouses for long periods (up to one year) has to be recorded from 1 October 1996. (Neumann, 1997)

Despite the fact that the deficit in foreign trade increased we can say that a positive aspect is that the biggest share in imports consists of different capital goods (machinery and equipment). That allows us to look to the future rather optimistically, because the increase of imported capital goods may transfer, in the long-run, into an increase in productivity of the Estonian export sector. From the other side if we look at the share of transport facilities in total imports, then the growth in 1997 was almost 100%. This imported articles consists of private cars as well. The boom of car consumption was closely related to the fast increase of the stock exchange and the banking sector12. After the sock exchange collapse and crises in banking in 1998 the boom of buying new cars slowed down as well.

Table 1.7. Import and exports by commodity groups, million EEK (1997)

 

Import

Export

Change

Change

Item

%

(compared with 1996)

%

(compared with 1996)

Foodstuff

12.7

19.4

16.2

4.0

Mineral products

8.1

18.5

6.5

10.1

Chemical products

12.1

25.4

10.5

14.1

Clothing, footwear

11.0

19.4

17.5

25.1

Timber, paper, and products thereof

4.6

29.2

14.1

55.3

Non-precious metals and metal products

8.2

36.7

6.9

49.8

Machinery and mechanical equipment

25.4

51.1

14.0

89.1

Transport facilities

10.8

99.7

4.8

21.1

Furniture, sports requisites, toys etc.

2.6

22.6

6.1

26.7

Other manufactured goods

4.5

19.2

3.4

43.6

Total

100.0

35.1

100.0

35.6

Source: Estonian Statistical Office

 

 

1.2.5. Balance of payments

At the end of 1997 the overall balance of the Balance of Payments was positive. That means the reserves of the central bank increased. The financial account was in surplus while the Current Account was negative. A more negative trade balance was balanced by an increase in the service balance. The nominal increase in the trade deficit was more than 65%. The trade deficit constitutes 13% from GDP and this ratio is enormously high even for a developing country. One-fourth from the current account deficit was caused by an income balance deficit (- 2 046.7 mill EEK). While income earned by Estonian residents abroad was roughly the same as in 1996, the income of non-residents earned in Estonia tripled. Fortunately one-third of this income was reinvested into the Estonian economy through foreign direct investments (FDI).

But there are some tendencies in the Balance of Payments that might cause some problems in the future. The structure of FDI has changed during 1996-1997. If in 1996 the amount of FDI in the balance of payments constituted 1 329.9 mill EEK, then in 1997 the total amount of direct investments was 1 812.9 mill EEK. At the same time the amount of portfolio investments increased from 1 784.4 mill EEK to 3 663.3 mill EEK. This means that a decrease in FDI has transferred to an increase in portfolio investment. The cause of the switch from direct to indirect investments, may originate from exhaustion of one-time prospective FDI-projects in combination with attractive rates of return on portfolio investments. From a long-run economic perspective, the increase in portfolio investments, as opposed to foreign direct investment, may impede the transition process, because the transfer of know-how through FDI is diminished.

Finally there is an automatic stabilisation process which will help to balance the overall balance of payments. Because of the currency board system, the Estonian Bank does not have the right to increase money supply without increasing central bank reserves. In the Estonian case, we can see that the crises in financial market has already caused sharp increases in interest rates. Increase of interest rates has caused a decline of aggregate demand (because both consumption and investments have declined) and also it means that the inflow of foreign capital has slowed down. Money supply has declined as well. Attractiveness of the Estonian economy has decreased. All these factors together have caused a decline of imports of goods which may balance the trade deficit. If this will continue in long run then the Estonian economy may enter to deep economic depression.

 

Table 1.8. Balance of Payments in Estonia in 1996 and 1997 (million EEK)

Item

1996

1997

Current Account

-5 108.5

-8 452.1

Trade Balance

-12589.8

-16 470.8

Merchandise: export f.o.b.

21 531.8

29 059.5

Merchandise: import f.o.b.

-34 121.6

-45 530.3

Services: net

6 245.0

8 465.9

Services: credit

13 352.8

18 349.2

Services debit

-7 107.8

-9 883.3

Income: net

-26.2

-2 046.7

Income: credit

1 352.5

1 562.1

Income: debit

-1 326.3

-3 608.8

Transfers: net

1 210.1

1 599.5

Official transfers

1 005.3

1 320.6

Private transfer

204.8

278.9

Capital and Financial Account

6 596.4

11 477.0

Capital Account

-7.8

-2.0

Financial Account

6 604.2

11 479.0

Direct Investment

1 329.9

1 812.9

Portfolio Investment

-1 784.4

3 663.3

Other investment

3 489.9

6 002.8

Monetary authorities

-220.8

-302.6

General government

333.9

-397.7

Banks

2 336.4

4 195.8

Other sectors

1 040.4

2 507.3

Errors and omissions

- 259.5

-253.6

Overall Balance

1 228.4

2 771.3

Reserve Assets

-1 228.4

-2 771.3

Source: Bank of Estonia

 

1.2.6. Monetary policy and currency reform

Estonia was the first country of the FSU to leave the rouble area. Currency reform based on the currency board system was introduced in mid 1992. The Estonian kroon is fully (100%) guaranteed by the Bank of Estonian’s foreign reserves and the Estonian kroon is pegged to the German mark at a rate 1DEM=8EEK.

“..A currency board is a monetary authority that issues notes and coins convertible into a foreign "anchor" currency or commodity (also called the reserve currency) at a truly fixed rate and on demand. An orthodox currency board typically does not accept deposits. A currency board can operate in place of a central bank or as a parallel issuer alongside an existing central bank; cases of parallel issue have been quite rare, though.

As reserves, a currency board holds low-risk, interest-bearing bonds and other assets denominated in the anchor currency. A currency board's reserves are equal to 100 percent or slightly more of its notes and coins in circulation, as set by law. A currency board generates profits (seigniorage) from the difference between the interest earned on its reserve assets and the expense of maintaining its liabilities - its notes and coins in circulation. It remits to the government all profits beyond what it needs to cover its expenses and to maintain its reserves at the level set by law. An orthodox currency board has no discretion in monetary policy; market forces alone determine the money supply” (Schuler; 1998)

In Estonia The Bank of Estonia is responsible for maintaining the Currency Board system. Due to limits on the use of monetary policy instruments the main tools are regulations for commercial banks and supervision of commercial banks. The primary goals of the Bank of Estonia are as follows:

1.To maintain the value of the Estonian kroon and ensure its high quality in performing the functions of money.

2.To improve the safety and stability of the Estonian banking system.

3.To enhance the development and efficiency of the Estonian financial system, particularly payment and settlement arrangements.

4.Meeting the currency needs of the public.

Estonia is characterised by the convertibility of their national currencies. Estonia has abolished all limits on capital movements and foreign exchange accounts.

Given the small size of the Baltic economies, their openess, and their will to reintegrate into the world economy, strong international competitiveness was regarded as crucial for economic stabilisation and growth. It was not clear whether this could be best achieved on the basis of fixed or flexible exchange rates. On the one hand, high inflation and the Baltic countries’ exposure to external shocks would have suggested the adoption of flexible exchange rates. On the other hand, the Baltic states were vulnerable to severe rigidities inherited from the Soviet command economy. Minimum wages and other nominal wages and social benefits were closely linked to price increases, resulting in strong inflationary inertia which, in turn, was intensified by high inflationary expectations reflecting past experience. To break the momentum of inflationary expectations, an anchor was needed, - an argument for a fixed exchange rate regime. In addition, fixed exchange rates have the advantage of imposing monetary discipline, an important concern given the legacy of uncontrolled credit expansion under Soviet planning. (Cornelius; 1995)

The Baltic currencies have undergone significant real appreciation since the start of monetary reforms in June 1992. Measured in US dollars, the level of the CPI had by June 1995 grown 4.5 times in Estonia, 5.6 times in Latvia, and 5.8 times in Lithuania. This translates into average annual increases in dollar prices of 65% in Estonia, 78% in Latvia and 80% in Lithuania. Yet, in spite of massive real appreciation, exports have expanded rapidly.

The Estonian banking system was in crisis at the end of 1992. Banks failed to carry out their creditors orders. At the end of 1992 the three biggest commercial banks were placed under moratorium by the Bank of Estonia. Later the biggest commercial bank - Tartu Commercial Bank was liquidated. The bank's property was sold at an auction on 15 January. The other two banks placed under moratorium by the Bank of Estonia in November, were merged by January 1993. After the banking crisis The Bank of Estonia strengthened is supervision activities and tightened regulations concerning the capital adequacy ratio, banks' minimum capital requirement etc. As a result, these measures together with general economic developments, helped to rationalise the banking sector. In 1991 there were more than 40 commercial banks, however the number declined to 11 by the end of 1997.

The Bank of Estonia adhered to its commitment under the currency board. Although monetary aggregates developed broadly in line with program projections for most of 1996, the rapid growth of domestic bank credit to the private sector in 1996 and 1997, combined with continued balance of payments surpluses, resulted in money supply growth exceeding program projections ( money supply grew by 39 percent in the year to June 1997, compared with a program target of 29 percent). In order to limit the risks associated with rapid credit growth, the Bank of Estonia extended the coverage of the reserve requirement to include banks' net liabilities to foreign financial institutions from July 1, and raised the capital adequacy ratio from 8 percent to 10 percent as of October 1, 1997. (Memorandum of Economic Policies, 1997)

 

1.2.7. Privatisation

In 1991 Estonia passed the Law on the Privatisation of State-Owned Trade and Service Enterprises. This legislation was amended in early 1991 to permit the sale of all small enterprises, and by the end of 1993 less than 20% of all service establishments were state owned. In 1994 the rules of small-scale privatisation were relaxed further, permitting enterprises to be sold on a best-price basis.

The privatisation of large enterprises has been more complex. Various methods have been applied, such as auctions, employee buy-outs and direct sales of shares. Use of the bankruptcy law to transfer assets into private hands has also become increasingly common.

Advice and consultation on privatisation was requested from the German Treuhandanstalt, which had established a Treuhand-East European Consultancy branch in early 1992. The TOB was established to offer its experience to Eastern countries of the former Soviet bloc in their endeavours to transform their economies to Western market policies, with the centerpiece of this transformation process being the privatisation of enterprises, land, buildings and other nationalised assets.

In Estonia 676 companies out of the total 1,212 subject to privatisation have been sold or auctioned. The majority of them in 1992. The proceeds from the sale amounted to 29.3 million EEK (US $2.25 million). Estonia started with large-scale privatisation in autumn 1992. In December 23 the first large-scale international tender seeking private investors for state owned enterprises was closed. A total of 103 bids were received from around the world to submit offers for 38 Estonian enterprises. The negotiations with bidders began in January and by the end of May 1992 negotiations for 25 of those were concluded.

The 38 enterprises on offer represent industries in textile, footwear, machine building, furniture, electronics and other manufacturing. In May 1993 the Estonian Government approved a second list of 56 state companies to be offered for privatisation.

In 1993 three additional tenders were floated, including one national tender for agricultural enterprises restricted to Estonian purchasers. In March 1994 the Fifth International Tender was announced offering 49 enterprises and objects for investment. This regular pace then continued with an international tender offered about every 3 months. By the close of 1995 a total of 10 Estonian tenders floated 377 enterprises. A total of 426 contract sales have now been transacted, including whole enterprises, parts of enterprises and individual assets. This total virtually completes privatisation of large-scale Estonian industrial enterprises that are expected to be of interest on international markets.

In conclusion we can say that most economic activity in Estonia is now in the private sector and the process of privatisation, apart from infrastructure, is virtually complete. In 1996 the first big infrastructural enterprise - the national air carrier Estonian Air was sold. The privatisation of ESCO (Estonian Shipping Company) was completed in 1996 as well. The next step is to privatise infrastructural enterprises including Estonian Energy, Estonian Railways and Estonian Oil-shale Company.

The ownership of 472 enterprises and structural units sold from 1993 to 1997 for the total purchase price of 4,3 billion EEK has been transferred. Investments worth 4,3 billion EEK and jobs for 56 154 people have been guaranteed. The purchasers have assumed liabilities of the enterprises for a total of 2,1 billion EEK.

Table 1.9. Privatisation in Estonia

 

From total

Methods of privatisation

Industry (1991-1998)

80-90%

Small privatisation, tender, auction
Banks (1990-1997)

99%

Increasing share capital
Infrastructure (1997-2001)

10-25%

II tender, increase capital
Land ( 1993-2003)

5-8%

fixed. restricted and open auction

Source: Preliminary estimations of experts from Ministry of Finance

The following Table 1.9. presents some conclusions from privatisation in Estonia based on unofficial opinions of experts from Estonian Ministry of Finance. In Industry most of the firms are in private hands and banking is also almost completely privatised. Privatisation of infrastructure just started in 1997 and, therefore the share of the private sector is not yet very high (10-25%). Land reform is a bottleneck in Estonian ownership reform. Only 5-8% of total state owned land has been privatised. According to ownership reform 55-60% of total land is returned to former owners (restitution) and 85% is compensated with vouchers.

Conclusion

In general we can conclude with following statements:

Finally one might say that despite of the fact that the Estonian economy has been considered as one of the most successful among CEE countries there are many economic problems that government must deal with. But there is no reason for deep pessimism and desperation, because due to the small scales the flexibility of economy, and political stability, Estonia hopefully will overcome all troubles in the future. Of course we must keep in mind that if the financial crises in Russia will continue in the long run and world market will not recover from financial shocks then there exist a real the possibility that Estonian economy may enter to deep economic depression in near future.

 

References

 

Allen, M.(1992) IMF-Support Adjustment Programs in Central and Eastern Europe, in Central and Eastern Europe: Road to Growth. moderator Winkler, G. , Washington, DC., Austrian National Bank 1992, pp.23-61.

Allsopp, C., Kierzkowski, H. (1997) The Assessment: Economics of Transition in Eastern and Central Europe Oxford Review of Economic Policy, vol. 13, No. 2, Summer 1997, pp. 1-32

Berg, A. and Sachs, J.D. (1991) Structural Adjustment and International Trade in Eastern Europe: the case of Poland, presented at the Economic Policy Panel, October 1991, Prague.

Borensztein, Ed, Ostry, J.D. (1995) Common Causes or Structural Adjustment? Output Decline in Eastern

Cornelius, P.K. (1995) Unemployment During Transition: The Experience of the Baltic Countries. - Communist Economies & Economic Transformation, London: IEA, 1995, Vol. 7, No. 4.

Dobozi, I. and Pohl, G. (1995) Real Output Decline in Transition Economies – Forget GDP, Try Power Consumption Data ! Transition 6 (1/2), 1995, pp17-18

Eamets, R. (1994) Labour Market and Employment Issues of Transition Economies: the Case of Estonia. Communist Economies & Economic Transformation , IEA, London, Vol. 6 No 1.1994, pp.55-73

Eamets, R., Philips K., Kulikov, (1997) D. Estonian Labour force Survey. Structural Changes on Estonian Labour Market in 1989-1994, Statistical Office of Estonia. Tallinn- Viljandi 1997

EAS (1995) Transforming the Estonian Economy, by Estonian Academy of Sciences (EAS) Institute of Economics, Tallinn, 1995

Gottvald, J., Pederesen J.P., Simek, M.(1994) The Czech Labour Market in Transition - A Descriptive Analysis of a Micro Data Set, CLS Working Paper 94–10, August 1994.

Hansson, A.H. (1997) Stabilization in the Baltic States, in Macroeconomic Stabilization in Transition Economies, ed by M. Blejer and M. Ðkreb, Cambridge University press, 1997, pp.256-280

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Labour Market Database 1990–1996.(OECD; 1997) No 1.OECD–CCET, Diskettes, 1997.

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Notes

1 Saavalainen (1995) reports that in 1992, these terms of trade shock were on the order of 10% Estonia, as compared to 3 to 5.5% in Poland, Hungary and Czechoslovakia.

2 For example people were sent to so called forced vacations. In western economic literature this is called labour hoarding.

3 When this paper was written there was not clear understanding yet, how deep will be the influence of the Russian crisis to Estonian economy as whole. World Bank lowered its prognoses to GDP growth to 2% per 1998

4 According to EBRD estimates average inflation rates in CIS was 33% (Transition,1997)

5 The increase in Poland reflects our choice of measurement period, which omits 1990, a year in which Polish GDP declined. In a recent paper, Dobozi and Pohl (1995) argue that official statistics may strongly overestimate the declines in output in the western FSU states, but be far more accurate in Eastern Europe. This is based on the assumption that electricity consumption is a reasonable proxy for the level of economic activity. In the Baltic States, electricity consumption has fallen by far less than measured GDP, suggesting that the gap between the Baltic states and CEE is smaller than appears.

6 If we look at the similar data of e.g. the Czech Republic, we can notice a similar decrease during the period 1989-1993 when employment in agriculture decreased by 31% (Gottvald, J., Pederesen J.P et al, 1994, p. 3). In general, we can say that the indicators of changes in employment during the same period in other Eastern European countries (except for Latvia and Lithuania) are not comparable to those of Estonia, since in most Eastern European countries the reforms started several years earlier.

7 in 1991-1995.

8 In addition to rapid decrease in employment, this also means a decrease in production.

9 E.g. the banking crisis of 1992-1993 and the stock market crash of 1997.

10 The international customs statistics uses two methods, the general trade system or the special trade system. The main difference between these two methods is that in the first case import into customs warehouses and re-export from there is taken into account, while in the second case it is not. The countries are free to decide which of the two methods to use. The Estonian customs statistics is based on the general trade system. Since Bank of Estonia collects and processes the foreign trade data for the purposes of drawing up the country's balance of payments and the balance of payments reflects transactions between residents and non-residents only, the system of special trade serves The Bank of Estonia needs better.

11 The export and import figures in this paragraph of foreign trade differ from the figures published by the State Statistical Office because the Bank of Estonia used the special trade system in its analysis. This means that special export does not include export of merchandise previously imported into customs warehouses or their use in provisioning sea vessels and aircraft. Special import does not include customs warehousing of imported merchandise, although import of merchandise from customs warehouses for free circulation and processing has been included.

12 It was relatively easy to buy with leasing new cars because the interest rates were low.