tutor2u | Estonia - Growth and Development

Study Notes

Estonia - Growth and Development

Level:
A Level
Board:
AQA, Edexcel, OCR, IB

Last updated 22 Mar 2021

Estonia is the smallest of the Baltic countries but one that has gained a growing profile internationally partly because of her emergence as a leading country in information technology and commitment to free market principles and a small government sector.

Basic Background on Estonia

  • Population: 1.1 million
  • Capital city: Tallinn
  • GDP: $22.2bn in 2011
  • Produces 0.04% of the world's GDP
  • Estonia places 34th among 187 countries in the international Human Development Index
  • Estonia is a land of islands – there are 1,521 islands in total
  • In 2012 73% of Estonia's total trade in goods and services was with EU member countries.
  • Estonia's main trade partners are neighbouring countries Finland, Sweden, Russia and Latvia.

From the early 1990s onwards Estonia was a transition economy after the break-up of the old Soviet Union. Transition economies are engaged on a long-run process of reform that takes them away from a system of central planning towards a free-market or mixed system.

Estonia is widely regarded as a success story in the transition process. By the turn of the new century Estonia was a fully-fledged market economy – a necessary condition for a nation that wants to join the EU single market. This happened in May 2004 when Estonia joined the EU along with nine other countries – including Latvia and Lithuania, Cyprus and Malta and five central and Eastern European countries Poland, Hungary, the Czech Republic, Slovenia and Slovakia. Bulgaria and Romania joined the EU in a further wave of EU enlargement in 2007.

Growth and Competitiveness

Estonia has a good record in lifting itself up the rankings on international competitiveness published annually by the World Economic Forum.

  • Overall: 33/144 countries
  • Ease of doing business 24/144
  • Infrastructure: 44/144
  • Macroeconomic stability 20/144
  • Labour market efficiency 10/144
  • Technological readiness 25/144
  • Innovation: 30/144
  • Trade Tariffs: 6/144
  • Internet access in schools 2/144
  • Government debt to GDP: 6/144

In the 2013 league table, it was placed comfortably higher than Ireland (29th) Italy (43rd) Portugal (45th) Spain (36th) and Greece (90th). Estonia has one of the best records in the world for the number of new business start-ups per head of population. It has a high web penetration and strong standards of technical education in schools. Market-based supply-side policies aim to develop new areas of competitive advantage.

For example, Skype is based in Tallinn and runs on software written by Estonian software engineers. Play Tech is another Estonian success story; it is the biggest maker of gambling software in the world! Estonia's largest exporter is Ericsson, the Swedish company with substantial inward investment in Estonia. Tehnopol Research Parkis Estonia's largest technology hub housing cutting-edge companies like Modesat, which is developing a communications technology to make it possible to introduce ultra-high-speed broadband on jets and high-speed train.

Foreign direct investment has been important to Estonia as a growth strategy. The Estonian government offers a zero rate of corporation tax (a tax on profits) for re-invested profits from overseas investors. The policy seems to have worked. The total stock of FDI in Estonia in 2006 was 9.6 billion Euros (compared to a GDP of Euro 13.4 billion). Annual inward FDI peaked at Euro 2.5 billion in 2007 before falling during the crisis. But the total FDI stock reached Euro 14.3 billion in 2012 (GDP in 2012 was Euro 17 billion) and FDI per capita reached a record of Euro 11,000.

Growth Strategies – Free Market / Private Sector Principles

Estonia is lauded by supporters of free-market economics for a strongly pro-private sector approach to growth and development. The key characteristics of their reforms have been:

  • 1.A belief in free-market principles and a small state sector
  • 2.Commitment to a highly open economy with strong trade and investment integration with neighbouring countries
  • 3.Conservative fiscal policy rules including a commitment to running a structural budget surplus
  • 4.Target of maintaining a low or zero government debt. Estonia does not currently issue long-term government bonds
  • 5.Latterly, the government has introduced some ambitious environmental / sustainability aims (covered in more detail in the final extract)
  • 6.Strong support for e-commerce both in commercial markets and also at government levels

Estonia and Flat Taxes

In 1994, Estonia became the first country in Europe to introduce a flat-tax regime. Latvia and Lithuania followed suit in 1995, Russia in 2001 and the Ukraine in 2003. After an initial flat-rate tax of 26% in 1994, by 2009 Estonia had reduced personal and corporate taxes to 21 per cent with a zero tax for reinvested profits.

Government Debt Private Sector Debt Credit Rating
Data for 2012 % of GDP % of GDP
Estonia 6.1 94.8 AA-
Latvia 42.2 107.0 BBB
Lithuania 32.5 48.3 BBB

Estonia has an exceptionally low level of gross government debt. The National Debt is the accumulated level of money borrowed by the state and financed through the issue of bonds. Estonia currently has no need to issue new long-dated government bonds and it is has seen their sovereign debt credit rating from agencies such as Fitch and Standard & Poor's improve. Estonian government debt has not exceeded 7% of GDP since 1995.

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