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Estonia - Economy

With just 1.3-million people, Estonia is one of Europe's smallest countries, but it was one of the worst hit by the global economic crisis. In the two years after the 2008 financial crunch the economy contracted by 20 percent. Estonia is considered one of the most liberal economies in the world, ranking 14th in the Heritage Foundation's 2011 Economic Freedom Index. Its 2011 score was 0.5 points higher than in 2010 due to significant improvements in Estonia’s monetary and labor freedoms. Hallmarks of Estonia's market-based economy have included a balanced budget, a flat-rate income tax system (the first in the world), a fully convertible currency pegged to the euro (until 2011, when Estonia adopted the euro), a competitive commercial banking sector, and a hospitable environment for foreign investment, including no tax on reinvested corporate profits (tax is not levied unless a distribution is made).

Estonia began to adopt free-market policies even before it declared independence in mid-1991 and has continued to pursue reform aggressively ever since. For example, the government set privatization as an early priority and has now completed the process of putting most major industries in private hands. After independence the Government of Estonia took steps to simplify the tax system. Tax evasion is now relatively low by regional standards. Income tax is levied at a flat rate, a principle supported by the major parties except for the Center Party, for which a progressive tax system remains a keystone policy. An integral part of Estonia's transition to a market economy during the early 1990s involved reorienting foreign trade to the West and attracting foreign investment to upgrade the country's industry and commerce. In 1990, only 5% of Estonia's foreign trade was with the developed West; 87% was with the Soviet Union, and of that, 61% was with Russia. Estonia's main foreign trading partners today are Sweden, Finland, Germany and others in the West. Russia's share of Estonia's trade is less than 10%.

The introduction of the Estonian kroon in June 1992, with only U.S. $120 million in gold reserves and no internationally backed stabilization fund, proved decisive in stabilizing foreign trade. For stability, the kroon was pegged by special agreement to the deutsche mark (DM) at EKR8 = DM1 and later to the euro. The new Estonian currency became the foundation for rational development of the economy. Money began to have clear value; the currency supply could be controlled from Tallinn, not Moscow; and long-term investment decisions could be made with greater confidence by both the state and private enterprise. The central bank is independent of the government but subordinate to the parliament. In addition to its president, the bank is managed by a board of directors, whose chair is also appointed by parliament.

The fall of the Soviet Union and the rapid contraction of Estonia's market to the East during the early 1990s caused Estonia's economy to shrink 36% from 1990 to 1994. But economic reforms in Estonia and the ability of its economy to reorient toward the West allowed Estonia's economy to pick up beginning in 1995. Driven by liberal economic policies and fiscal discipline, the Estonian economy grew quickly, at an average annual rate of 8% from 2000 to 2007. The recent global recession struck early in Estonia with the bursting of a large real estate bubble in 2007. GDP fell by 5.1% in 2008 and 13.9% in 2009. In 2010 the economy started to recover with growth of 3.1%.

Estonia's liberal economic policies and macroeconomic stability have fostered exceptionally strong growth and better living standards than those of most new EU member states. After enjoying 8% average annual GDP growth since 2000, the economy started to show signs of cooling in 2007, followed by a sharp drop in GDP during the global recession. Estonia's economy began growing again in the fourth quarter of 2009 and saw modest growth through 2010. Although unemployment is currently 14.4%, the Estonian Government kept budget deficits low.

Estonia is the poorest member country to adopt the Euro, but its debt and deficit levels are among the lowest in the bloc. Estonia successfully joined the euro zone on January 1, 2011. Estonia became the 17th member of the euro zone. Estonian officials said switching to the Euro marks the end of its struggles. The country had been in a deep recession since 2009 when economic output dropped by 14 percent. The government said that it hopes to encourage investors by assuaging fears of devaluation in its currency. Analysts say that the switch also topped off the country's drive for integration with the West, away from the influence of Moscow. Meanwhile an anti-Euro campaign continues in the country with opponents claiming, in a statement, that Estonia was, "getting the last ticket for the titanic." Nobel Laureate economist Paul Krugman claimed, in a blog, that Estonia's switch to the Euro was at a high cost to the country's economy.

The economy benefits from strong electronics and telecommunications sectors; the country is so wired that it is nicknamed E-stonia. Bars and cafes across the country are typically equipped with wireless connections. Skype, designed by Estonian developers, offers free calls over the Internet to millions of people worldwide. Tourism has also driven Estonia's economic growth, with Tallinn’s beautifully restored old town a major European tourist destination.

Estonia is a net exporter of electricity, using locally mined oil shale to fire its power plants. However, it imports all of its natural gas and most petroleum (roughly 30% of total energy consumption) from Russia. Alternative energy sources such as wood, peat, and biomass make up about 9% of primary energy production, and Estonia is developing wind farms for clean, renewable energy. An undersea electricity cable inaugurated in December 2006 allows Estonia to export electricity to Finland. Estonia and Finland plan to complete a second undersea cable in 2014.

Estonia is part of the European Union, and its trade policy is conducted in Brussels. By the late 1990s, Estonia's trade regime was so liberal that adoption of EU and World Trade Organization (WTO) norms required Estonia to impose tariffs in certain sectors, such as agriculture, which had previously been tariff-free. Openness to trade, rapid growth in investment, and an appreciating real exchange rate resulted in large trade deficits from 2000 to 2008.

Estonia's economy benefits from its location at the crossroads of East and West. Estonia lies just south of Finland and across the Baltic Sea from Sweden, both EU members. To the east are the huge potential markets of northwest Russia. Estonia's modern transportation and communication links provide a safe and reliable bridge for trade with the former Soviet Union and Nordic countries. Many observers also see a potential role for Estonia as a future link in the supply chain from the Far East into the EU.

Estonia's business attitude toward the United States is positive, and business relations between the two countries are increasing. The primary competition for American companies in the Estonian marketplace is European suppliers, especially Finnish and Swedish companies.

Total U.S. exports to Estonia in 2009 were $123 million, forming 1% of total Estonian imports. Principal imports from the United States were machinery; photo, medical, or surgical instruments; electronic equipment; and aircraft parts. Estonian exports to the United States were around $439 million in 2009 (3.9% of total exports), making the U.S. Estonia's third-largest export market after the EU and Russia. U.S. imports from Estonia are primarily mineral fuels and oils; electronic machinery; games and sports equipment; and photo, medical, or surgical instruments.

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Page last modified: 06-11-2012 17:15:22 ZULU