World Bank: Estonian Way a 'Very Expensive Model'
With Estonia showing signs of economic recovery and on the verge of entering the Eurozone, it's tempting to point to the country as a model of success. But top World Bank officials, speaking to ERR News in Riga, warn that serious risks still lie ahead.
Pin-ups are all very well but they have a nasty habit of doing things that make you want to take them down again - just ask Naomi Campbell.
So while Estonia is currently enjoying supermodel status among the advocates of flat tax, austerity and the Eurozone, it could still potentially ruin things if, like Ms. Campbell, it starts to confuse projected images of perfection with rather more mundane reality.
Nevertheless, the way Estonia tackled the global economic crisis is drawing attention from some influential figures including the World Bank's director of Central Europe and the Baltics, Peter Harrold. Joining World Bank President Robert B. Zoellick on a visit to Latvia August 12-13, Harrold told ERR News he had asked his colleagues to write a comparative piece of analysis on the three Baltic countries.
“What I think I will get, which is not a banal conclusion but is a very straightforward conclusion, is that initial conditions are fundamental,” he said.
“You had Estonia going into this crisis after several years of very prudent fiscal policy deriving from their utter determination to become a Eurozone member as soon as possible and consequently with a pretty strong fiscal reserve, and having dealt with many of these fundamental questions already.”
“When Latvia was looking to reform its health sector, what did it do? They went to have a look at Estonia. Education reform has been in place for some time so a lot of those questions of the fundamental adjustments they dealt with earlier. “
While crisis can itself be a reason for a country to pull together, Harrold believes Estonia's determination to adopt the euro come what may served a similar purpose.
“Crisis is often the thing that generates something like this. Alternatively it can be national unity around a particular policy goal that can energize you. That was the case in Estonia, which had a national consensus around the desire to enter the euro – a very fundamental thing and of course a huge victory.”
“They have had a massive, unambiguous endorsement of their entry at a time when you would expect the European Central Bank and European Commission to be very cautious about letting new countries in. In the case of Estonia it was 'Absolutely, come in guys, you're very welcome.' They have the single strongest fiscal position of any country in the EU.”
However Harrold admits that doing things the Estonian way is “a very expensive model” and was born more from necessity with a dash of common sense and good luck than any genius plan – particularly as the pegged exchange rate left very few options open apart from cutting to the bone.
“If in Europe fiscal policy is your only instrument, do it right and in the good years put aside something for the bad years because you haven't got many other instruments to use. You can't depreciate. Poland could depreciate and use the exchange rate as part of their adjustment mechanism. Romania could use the exchange rate, Hungary could use the exchange rate. But none of the Baltic countries could.”
Estonia's “initial conditions” were better, so its exit from recession is proving to be slightly quicker. But a 14 percent GDP contraction in 2009 is still huge by any measure, and as London-based Capital Economics pointed out on August 12, there are still some concerns in international markets over how permanent some of Estonia's reforms will prove to be.
“Despite the massive fiscal consolidations that have already taken place, further cutbacks are likely to be needed over the coming years as government spending continues to adjust to the new reality of much smaller tax bases. Note that in Estonia, around two percent of the cuts enacted to bring the fiscal deficit below the three percent of GDP Maastricht limit last year were temporary in nature,” said David Oxley, analyst for the macro economics research firm Capital Economics.
“Domestic demand will remain under pressure, and in no position to drive the economies forward once the industrial rebound fades,” he warned.
And while the World Bank's Harrold identifies Estonia as the pin-up model for economies in Central and Eastern Europe, he has a warning for any country that thinks it can revert to business as normal in a post-crisis world.
“Everyone knows the patterns of growth that we saw in 2004-8 have gone,” he says. “The future will be different: technology led, innovation led, export led. It will be about productivity, not about how fast can we expand domestic demand using foreign capital.”
Harrold's boss, Robert B Zoellick, preferred a more exotic pin-up when asked by ERR News what regional countries had learned from the crisis.
“You have to keep additional elasticity and flexibility because changes in the international economy could hit you very hard. Take Singapore: it had a very severe downturn like Latvia and it's now had a pretty good upturn, so there are lessons we can learn from small open economies working off of trade from around the world,” Zoellick said.
Editor: By Mike Collier