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Bank of Estonia: More stable environment would help revive growth

Euros. Source: (AFP/Scanpix)

The Estonian government should support economic growth and competitiveness by making the business environment as stable as possible, as frequent changes in the tax system with short reaction times have increased uncertainty, the Bank of Estonia said.

Growth in the Estonian economy picked up at the end of last year, and the revival continued in the first months of this year. The economies of most partner countries have improved and foreign trade activity has increased, which has benefited Estonian exports and through that economic growth, the central bank said in an overview of the economy.

The volume of goods exports increased at the start of this year at a rate that meant that further market share was gained in external markets, confirming the competitiveness of Estonian production output. However, the market position that has now been taken is no guarantee of success for exports or of economic growth in the years ahead. This would require companies to keep increasing their competitiveness. It matters for raising competitiveness and for economic development whether companies can reorganize their production in a way that makes it possible to keep raising pay for staff, the bank said.

The competitiveness of the Estonian economy is dependent on the ability of companies to deploy limited labor resources more efficiently. Confidence indicators for the private sector show greater optimism about the near future and companies are looking to recruit additional staff, which predicts an increase in output volumes.  

The problem is the shortage of suitable labor, which has caused the number of vacancies to increase for some time, and the shortage of labor is becoming more of a restraint on growth in the economy. As the number of people in employment is close to the maximum it can reach, further growth in the economy will need to be based on the internal development of companies or the reallocation of labor from companies and sectors with low productivity to more productive ones. In both cases, more investment than at present will be required.

Investment remaining at a low level threatens the recovery in economic growth. Corporate investment has been in decline for four years, making it harder for growth in the economy to increase. To some extent, there are objective reasons for the low level of investment activity, such as uncertainty about the recovery in demand in foreign markets and the under-utilization of existing resources, but investment by companies in Estonia has now fallen below the EU average if taken as a ratio to value added.

The Bank of Estonia said that this is a poor outcome for a country where production capital per employee from investment remains markedly below the levels in more developed countries. Catching up with the income level needs the amount of capital in the economy to be increased notably faster than it has been so far, and investment to be made in leading technologies.

The government should support economic growth and competitiveness by making the business environment as stable as possible. Investment by companies depends on certainty about the future, which in turn depends on trust in economic policy, including tax policy. Frequent changes in the tax system with short reaction times have increased uncertainty however, and this is confirmed by the steadily deteriorating opinion that companies have of the tax environment, the central bank said.

When the labor market is likely overheated and there are no major obstacles to growth for companies focusing on the domestic market, as has recently been the case in Estonia, long-term growth will not benefit from demand being stimulated with a government budget deficit. At a time when labor is becoming more expensive and more scarce, that could actually make it harder to maintain and increase competitiveness.

Editor: Aili Vahtla

Source: BNS

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