The Curious Case of Estonia: Where Austerity Works

After a deep contraction, one small Baltic nation cuts spending and wages to regain competitiveness.

Winter in Tallinn, Estonia, June 25, 2006
Winter in Tallinn, Estonia, June 25, 2006 (David Jones)

The Economist has a good story about tiny Estonia, which is turning out to be a textbook example of how austerity works to regain competitiveness and economic growth.

The small Baltic nation, which joined the euro this year, implemented “shock therapy” liberalization after the Soviet Union collapsed in 1991 — and prospered because of it before it felt the effects of the global economic downturn, starting in 2009.

Estonia maintains a flat income tax rate, low corporate taxes and few barriers to international investment and trade. It has performed particularly well in finance and information technology and built strong trade relations with Finland, Germany and Sweden.

The recession was painful. Estonia’s economy contracted by as much as 14 percent in 2009, but it is showing signs of recovery. Its growth rate was 8.5 percent in the first quarter of this year, the highest in the European Union.

Estonia also boasted the biggest drop in unemployment, from almost 19 to under 14 percent.

It has the lowest debt in Europe, equivalent to just 6.6 percent of gross domestic product, prompting the Fitch rating agency to raise the nation’s creditworthiness to A+ status recently.

Recovery

Growth in exports and industrial output reflect in part soaring sales of the country’s largest exporter, The Economist argues: the mobile phone manufacturer Ericsson. “But the recovery is broader based.”

Eva-Maria Ounapuu of Joik, which makes “simple, Nordic, minimalist” cosmetics, says the recession made consumers turn to local products. Now that this market is “all but saturated,” she is starting to export.

Estonians saw their wages cut and jobs disappear at a staggering pace in recent years, but the recovery is just as spectacular.

The government cut spending and raised the value-added tax from 18 to 20 percent to immediately mend its deficit. Two short years later, the central bank already worries about overheating.

Little wonder that The Economist believes the nation of 1.3 million “shows not only the virtues of flexibility and austerity; it also gives heart to Latvia and Lithuania,” two Baltic neighbors that are pursing similar policies.