Liberty, Technology and Growth: Perspective on Estonian Economy

by Rok SPRUK

What do ABBA and Estonia have in common? Not very much everyone would say. But one of the most tremendous music groups in the 20th century and a Baltic tiger share equally tremendous success. As a music group, ABBA had a great manager Jaan Manitski, a Swede-Estonian who was, later, a director of privatization and a foreign minister in the government of Mart Laar. Once he explained his purpose of participating in politics: “I left politics after all Estonian enterprises were privatized.”

Estonian economic policy has several times been harshly criticized by the IMF and the Western countries, most notably Germany and France. The latter expressed concerns about Estonian tax policy complaining about unfair tax competition by defending Franco-German hungry tax and consumption appetites and attack Estonian flat-rated corporate income tax with an aim to attract the inflow of foreign investors. Nevertheless, France and Germany both break the Maastricht criteria, leaving the budget deficits and public debt away from the control which other nations have to obey. For example, the IMF criticized Estonia’s exit from ruble zone in 1992 and several measures introduced to boost economic growth and GDP convergence. Situated on the periphery of Europe, Estonia offers very much to learn in the field of economic and structural policy.
The State of World Liberty has declared Estonia as the freest country on earth. As personal freedom and economic liberty go hand in hand, Estonia has several times expressed a concern over a hidden EU danger of possible tax harmonization and increased GDP spending. The most obviously hidden EU danger is a high tariff wedge which undermines trade openness and competitiveness of product markets. It should be noted that any kind of particular tariffs or quotas is a given subsidy to domestic companies which produce similar products or services as the competing company abroad. Further, subsidy is cumulated at the expense of consumers simply because in a competitive equilibrium, companies are using a bottom-line incentive to provide the best quality at the lowest price by constantly fighting the cost-push shock. Tariff or quota as a subsidy, distorts the behavior of a competitive equilibrium setup by consumer claims and supply-side of the economy. In a traditional equilibrium relation, the supply curve jumps up and the net effect is the increase in price per unit of product which final consumers have to pay. In addition, Estonia has established one of the most competitive trade regimes in the world by slashing the tariff rate to a rock-bottom level. After joining the EU, the country was forced to accept the “majority rules of the game” and thus adjust to common weighted EU tariff rate. Not surprisingly, the level of trade freedom shrank rapidly as Table No.1 shows.

Table No.1: Trade Freedom in Estonia
Year                    Trade Freedom Score
1995                                     92
1996                                     89
1997                                     89
1998                                     98
1999                                  100
2000                                 100
2001                                 100
2002                                 100
2003                                   99,2
2004                                   99,2
2005                                   99,9
2006                                   77,4
2007                                  76,6
100 means the highest possible score in trade freedom while 0 means that trade freedom does not actually exist
Source: Heritage Foundation

In relation to corruption perception, one of the most striking reform acts by Laar government was the banking reform. As in every communist country, banking system was marred by political authorities exercising banking system as an agent to finance political projects on behalf of benevolent central planning. Mart Laar and his team supported the bankruptcy of the banks supposedly owned by mafia. The administration also supported the de facto lustration of communists from key government positions. Corruption Perceptions Index has ranked Estonia 24th in the world according to the frequency and existence of corruption which puts Estonia in a position of the best former communist country in perceiving corruption. Corruption itself has a strongly negative side-effect on the functioning of the economy. The most frequent effect is the loss of confidence in commercial contracts as corruption practice supports the uncertainty about enforcement of the contract in free-exchange agreement.

According to Fraser Institute’s Economic Freedom of the World, Estonia is the 12th freest economy in the world surrounded with one of the most flexible access to sound money, dynamic business sector and low regulation of getting credit. A stable stance of vibrant Estonian market further support the research conducted by the World Bank named Doing Business where Estonia ranks 17th in the world, having some troubles in the labor market with hiring and firing rules which undermine the overall productivity growth which is essential to higher and sustainable economic growth. A report on Estonian economy in 2005 notes the rapid expansion in loans supply after further introduced measures to foster the liberalization of the financial sector together with institutional development which further contributed to getting higher credit ratings of the major Estonian banks. As one of the most confidential indicators of Estonia’s rapid financial sector is the rate of securities market capitalization which has grown at an incredible pace. 

In recent years, quite a lot of article threw an eye upon the so called Estonian high tech boom which triumphed in the latest E-voting where 70 percent of all voters voted online. By 2010, E-voting shall be an equally accessible public service in an information society in Estonia. The high tech boom which sparked in Estonia has also left signs in a vibrant economy using ICT as a comparative advantage ahead of regional and global competitors. One of the high-tech success stories is Skype, the provider of digitalized internet phone calls, which was originally founded by a Swede, Niklas Zennström and a Dane, Janus Friis. In a vibrant technology sector, innovation-supported high tech venturing soared in the time when international tech firms firmly settled in Tallinn which is full of Cybercafés on every corner offering tourists a remote stay in the Silicon Valley of the East. In fact, the high tech boom of Estonian markets has gone hand in hand with a strong core cooperative relationship between a dynamic business sector and research-supported university sector. A recent case has been the initiative launched by Tartu Science Park called Regional Innovation Strategies for Cluster Internationalization and Competitiveness. In addition, strong economic performance of Estonia has been further confirmed by Lausanne-based IMD where the country was ranked 20th in 2006, the highest rank after 2002.

Equipped with an iron will and free-market engine of a roaring Baltic tiger, Estonia has given a lot of positive energy to the world. The country pioneered flat tax revolution which took effect on January 1, 1994 when the rate was set at 26 percent. Since then, the rate was slashed all the way to 22 percent. Corporate profits tax was abolished, except for dividends that are taxed as personal income at the flat rate. Baltic Business News has confirmed that Estonian policymakers agreed on the reduction of flat-rated income tax from current 22 percent to 18 percent. On a conference organized by Finnish EVA Business and Policy Forum, Andrus Ansip, Estonian prime minister promised to lift Estonia into the group of the wealthiest countries in the EU further by cutting the flat tax rate to 12 percent. The latter could dramatically boost Estonian global competitiveness together with sound structural policy (labor market reform) and measures introduced to accelerate GDP growth.

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Rok SPRUK is a classical liberal economist. His fields of work are macroeconomics, economic growth, tax reform, international economics and international competitiveness. In the area of business Rok is focused on strategic management, financial markets, business models and innovation. He lives in Slovenia where he studies economics and business. You can send Rok an email to rok.spruk@gmail.com or you can visit his blog entitled Capitalism & Freedom

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Stane sa Tomanová najväčšou reformátorkou v dejinách?

Podľa ministerky práce Viery Tomanovej by mal byť druhý pilier dôchodkového sporenia dobrovoľný. Výborný nápad. A čo tak zdobrovoľniť aj prvý pilier? Ak by teta Tomanová pokračovala v rozvíjaní tejto myšlienky rušením povinného prispievania do štátnej diery, má šancu presláviť sa ako najreformnejšia ministerka na tomto poste a vo svete vôbec. A ani by o tom nevedela.

Úradnícke výškové plánovanie

Výškové budovy – u nás často neopodstatnene nazývané mrakodrapy. Môže slobodná spoločnosť akceptovať obmedzovanie ich výšky, alebo umiestnenia?

„Tak tedy má nám "vzrůstat" Praha do výšky či nikoliv? To je jedna z bouřlivých otázek dneška, která se objevila v souvislosti se zveřejněním záměru jedné developerské firmy vystavět v Holešovicích dva „minimrakodrapy". Nejvíce je na celé diskusi zajímavé to, že se téměř všichni zabývají hlavně tím, zda li je vůbec vhodné, aby se výškové budovy v Praze stavěly. Nikdo ale nemá starost o to, jak je absurdní, že si soukromý investor nemůže sám od sebe na svém pozemku postavit to, co uzná za vhodné. Neboli, že tímto centralisticky-socialistickým "výškovým" plánováním dochází principiálně ke stejnému omezování vlastnického práva jako třeba u regulace nájemného.“

Viac v článku Tomáša Munziho na stránkach Liberálního institutu.

Statism Aside: Government-Backed Economy Does Not Work

by Rok SPRUK

One of the greatest philosophers of all time, a Nobel Prize winning economist Friedrich August von Hayek once wrote that coercion implies the control of human life and inevitably leads to forced government intervention, redistribution of wealth and income and a reduced degree of personal liberties. Hence, Professor Hayek wrote that we shall never see a free society if government and the privileged few, mostly interest groups, would still exercise the means of coercion and control. There are several countries that went from rags to riches and became a global success stories. Ireland, once a third world country, became the second richest economy in Europe in less than a century. The »Irish miracle« of an economic supply-side powerhouse is also a proven case study of supply-side's success which is in principle based on Say's law which means that free exchange agreement is possible if one is able to sell before someone is able to buy. Critics of supply-side economic policy approach claim that Ireland sustained its economic model on the basis of natural circumstances and subsidies from European Structural Funds.

Thus, a lot of those critics propose the application of direct government subsidies and handouts to businesses to support growth and welfare while keeping a nearly confiscatory corporate tax wedge and steeply progressive taxation of marginal income. The tragedy of Airbus is a case study of the abovementioned tactics and strategy. Strong government interference, coercive role of trade union intervention, and ownership role resulted in the downfall of Airbus. Thinking about positive role of the government in the business sector is an illusionary servitude. When strategic managers develop a dynamic business model they consider several factors extending from information asymmetry, cost-benefit analysis, value-chain, risk management, innovative capacity to the ways of how to efficiently reach the targets wanted wheatear it be the combination of market share, business excellence and strong growth (star companies). In case of government handouts to businesses in the form of subsidies or ownership, strategic stakeholders undermine the previously mentioned areas as they mostly consider the political business goals (Airbus) though they are almost everywhere out of reach.

In Slovenia, the government intervention and handouts to businesses have a strong tradition marred by an explosive trade union demand pressures. When Slovenia gained independence, the level of economic freedom reached he lowest rate among transition countries. Even Belarus, the cradle of Soviet-style economy, had had a greater degree of economic freedom. The edifice for success in the range economic freedom is not very difficult to understand the establishment of the rule of law, sound protection of property rights and the privatization are several major components of economic freedom's invigoration in transition countries. In Slovenia, we had neither. The rule of law and the protection of private property rights have been accompanied by a corrupted judicial system while the privatization of state enterprises has been minor. Almost 90 percent of the big companies were left partially or wholly in government hands through the capital ownership of government funds, namely KAD and Sod. Thus, the private sector comprises only 65 percent of the GDP which is one the lowest rate of private sector economy/GDP among European countries. Sole government activities compose 35 percent of the GDP. In comparison with European competitors, Slovenian public sector is among the least efficient, taking input-output efficiency into account. According to Economic Freedom of the World (Fraser Institute), Slovenia has the second biggest public administration, after Sweden. An exponentially growing size of the public administration negatively affected the business environment. Obscene bureaucracy and a huge size of public administration externally distort decision-making in the private sector and, hence, increase the size of the compliance costs where extensive tax reports compose the major part. Historically, the government ownership of big companies caused the external pressures on economic policymakers. Slovenia is an economy largely dependent on international trade. Export presented 70 percent of the GDP in the early period of 2007. in 1991, the hyperinflation from Yugoslavia was inherited and policymakers decided to depreciate the currency several times in order to boost the export growth which resulted in a growing size of excess money supply leading to higher inflation. After the independence, the IMF recommended Slovenia to fix the exchange rate while the central bank didn't have enough currency reserves to fix the exchange rate. Instead, the central bank depreciated the exchange rate and conversely supported export sector at the expense of higher inflation and increased import prices.

The negative side-effects of government ownership of companies has been thoroughly experienced in the case of Slovenia. In 1991, when the economy launched the metamorphosis from Soviet-style to free-market economy, the human capital stock was marred by the lack of knowledge-intensive managerial company reform strategies and employee knowledge (that could be enriched by foreign direct investment) coupled with the edifice of economic nationalism. In this respect, the real sector was inefficient in meeting the global market competition and thus it undertook structural features in a direction of firing the employees with insufficient knowledge. The government intervened and offered those employees early retirement schemes instead of education. On other hand, the government initially complicated the laws surpassed by the parliament that regulated the foreign investment entry. Consequently, Slovenia has one of the lowest foreign investment penetration rates in the EU. In search of non-market utility many technologically redundant employees chose early retirement instead of going back to school. The fatal consequence of such features was the growth of »young pensioners« which has increased exponentially. Today, the age of retirement entry in Slovenia is the lowest in the EU which increases long-term demographic risk as the birth rate is minimal and flows of immigration heavily regulated.

What about the dynamics of the business sector. The growth of productivity of export sector is growing too slowly and the business models are largely old-fashioned, not following the trends and challenges of innovative and growth-supporting strategies to absorb the competitive advantage of a small and open economy. Recent studies have shown that Slovenian labor productivity is in some cases six-times slower than the average EU15 labor productivity. The lack of productivity in wholly or partially government-owned industries emerges from the lack of sufficient capital and technology equipment brought by foreign direct investment such as greenfield or brownfield investment. The growth of productivity is usually hampered by government interference and employment regulation also on behalf of trade union pressures respectively.

Another reason why the performance of state-driven economy is miserable lies in the fact that the cooperation between the university system and business sector is linked very weakly. In Slovenia, there is a large monopolistic state university sector and no private university that could openly compete with government universities and find the incentives to link the bridge between the economy and university sector. In practice, disastrous consequences of monopolized regional universities are seen in a very low growth of services related to trademarks and patents. After postponing the industrial restructuring, Slovenian economy remained, after Poland, the second biggest share of industry in the GDP. Those industries (steel, leather) are facing a huge labor-cost competition from developing economies such as India and China. In advanced economies, enterprises such as Levi's completely abolished the industrial production on the native location and moved it to the countries with a largely smaller labor cost burden. Levi's, for example, focused on trademark development and design that bring the greatest output share per unit of product. On the road to economic growth, the investment in R&D is one of the foremost determinants of human capital creation but this also requires the adjustment of knowledge sector (universities and research institutes) to innovation flows. In other case, higher R&D spending is an »outlay in the black hole«. The fact that research and education quality of Slovenian university achieves a low international level is seen on the Shanghai Academic Ranking where none of Slovenian universities is among top 500 world academic institutions according to the number of highly cited articles (SCI), staff quality and several other factors determining the quality of academic environment. In Slovenia, there're only 3 highly cited scientific articles per 1000 inhabitants which is the third lowest ranking in Europe, only in front of Turkey and Portugal. The outcome of weak cooperation between the university-research sector and the economy is seen in the export structure of Slovenia's economy where the share of high-tech products is on the lower bottom-line among the EU economies. The education system from basic to secondary level is marred by government intervention. The system includes very unproductive education with no correlation with growth and dynamic challenge in a modern information society. According to OECD's Literacy in the Information Age, 80 percent of adult population in Slovenia is functionally illiterate, i.e. knowledge-fatigued to solve contemporary complex problems in a modern information society which also means not knowing how to calculate the savings for the old age.

The final impact of a statist influence in the economy is reflected in the aggregated level of international competitiveness pertaining to each economy. In recent years, Slovenia has dropped on nearly every scale measuring international competitiveness. IMD's World Competitiveness Scoreboard shows a very weak rule of institutions and law, a low performance of government policies, globally uncompetitive business sector and above all – a heavily regulated labor market. The rigidity of the labor market has also been displayed by the Index of Economic Freedom issued by Heritage Foundation in Cooperation with Wall-Street. Fraser Institute's Economic Freedom of the World ranked Slovenia in the group of authoritarian countries such as Tanzania and Uganda. The analysts at Fraser Institute exposed a growing size of public administration, a rigid labor market, state-dominated and highly concentrated banking and insurance sector. The latter is, of course, essential to capital formation and venture funds creation which improve the access of investors to capital and financial markets to sustain growth and entrepreneurial dynamics.

Despite the political rethorics, the command economy doesn't work as I have tried to demonstrate it above. If it worked, the economy of Soviet Union, Yugoslavia or North Korea would flourish. The major objection to free economy and private ownership of individual resources lies in the fact that the proponents of command economy and confiscatory taxation deny the prosperity and individual and economic freedom to successful people who accumulated the wealth from productive behavior – risk-taking, work and entrepreneurship.
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Rok SPRUK is a classical liberal economist. His fields of work are macroeconomics, economic growth, tax reform, international economics and international competitiveness. In the area of business Rok is focused on strategic management, financial markets, business models and innovation. He lives in Slovenia where he studies economics and business. You can send Rok an email to rok.spruk@gmail.com or you can visit his blog entitled Capitalism & Freedom
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Pascal Salin: Capitalism is the only moral system

Extract from an interview with French economist Pascal Salin in TREND:

You came to Bratislava to give a lecture on capitalism - the most ethical system. How would you explain your views to those who consider profit immoral?

Profit is the consequence of a system that acknowledges and protects ownership rights and the freedom to conclude contracts. Someone who founds a company, concludes contracts with employees, purchasers and so on. This is a fair system as the employees receive their agreed wages. And if there is a residual difference between production costs and income – i.e. profit this belongs to the owner - the person who decided what to produce, entered into agreements with other parties, and so on. The profit is fully legitimate and there is no reason to redistribute it. What I do not understand is that something called national income should be redistributed. There is no such thing as national income, the only income is personal income. So we have to be careful with making such general statements.


A socialist would object that some things like healthcare are not a product.

You know, health care concerns individuals and that is how you should approach this issue. I do not know how it is in Slovakia, but in France you often hear politicians mentioning public health, but I do not know what this means. The public does not have health; only individuals do. Using the public and its interests as an argument is the result of the collectivization of healthcare. It is always easier to solve a problem by decisions made by competent people rather than by incompetent ones. And capitalism due to its close relation to ownership educates competent and responsible people who are aware of the impact their decisions have on their property. In a public system, people act irresponsibly because the fate of decision makers is independent from the fate of the property they decide on.

(Pascal Salin have held the lecture within Conservative Economic Quarterly Lecture Series organized by Conservative Institute)  

Trade Protectionism = Racial Discrimination

By Rok SPRUK

Swedish economist and the recipient of the Nobel prize in 1973, Gunnar Myrdal once wrote that from all experiments, central planning is the best approach to be applied in developing countries on their path towards prosperity. The so called central planning approach included a tight policy of protectionism in all fields including high tariffs and import quotas. As today’s trade protectionism is deeply entailed in the African and mostly totalitarian countries, their achievement in past decades has been miserable, facing a low level of GDP, the lack of institutional stability and a very weak structural performance in an international perspective. Ad hoc critics of the free-market economics and economics in general have blamed “unrestricted entrepreneurial capitalism” to be the main reason why third-world countries are still waving in the spiral of economic deadline. However, a serious and thorough economic analysis of the situation shows quite the opposite results.

First, there is a question of institutional performance and stability. Recently, International Private Property Index has shown that the measured protection of private property rights is the weakest in predominantly totalitarian third-world countries such as Ethiopia and Bangladesh. The weakness of the institutions is the first step on the way to miserable economic performance. The institutional protection of private property rights pertains the issues such as the protection of intellectual property, trademark protection, patent strength, copyright piracy, registering property, access to loans, corruption level, judicial independence and political stability. The performance of the third-world countries is very weak in this respect as international studies and research observations have shown. It takes years to register a property and start to run a business. In Haiti, for example, it lasts 683 days before your property is sufficiently registered. As the institutional efficiency is low, the underground economy is widespread and so is the economic performance harshly undermined.

The central-planning approach further focused on trade protection of the economies in the early transitional passage. It was said that the best way for those countries to achieve high level of GDP is to “repeat the development path exercised by Western countries.” High level of trade protectionism is among the foremost reasons for a very low level of GDP as the entrepreneurs in those economies have been deprived from gaining access to international product and financial markets.

Assume there’s an economy. Probably the most common goal of the economic policymakers is to let the economy grow and thus to ensure the conditions needed for productive behavior to flourish. In every economy, dynamic entrepreneurial sector is the basis for high growth and reducing unemployment. Enterprises cannot compete internationally if the system of tariffs and quotas does not allow them to buy very much needed capital equipment and technology to run a business and trigger the productivity level. As the import of business tools become steeply difficult, the probability of buying the wanted technology and other means of production legally comes to the minimum. Consequently, if the entrepreneurial sector is destined to search the domestic market to buy the wanted, then it can hardly find the right information about more productive technology offered in the international markets. As oppressively developed countries are mostly factor-driven economies, the products and business services are almost non-existent or large monopoly structures dominate the domestic market. Extracting from the fact that high import quotas indirectly raise the price of foreign products, the innovative capacity can hardly find its place. The consequence of such policy chains several reactions: (1) the outburst of the informal sector and (2) the lack of entrepreneurial dynamism as enterprises in certain country cannot spillover competitive advantages and buy the products needed to operate to increase the productivity and the quality of products offered in the market. if there is any successful enterprise, the system of high import quotas negatively affects the competitive pricing and consumer prices. Protectionist trade policy doesn’t affect the number of jobs but the fields in which individuals may work. If protectionist policy practice increases the number ob jobs in the import sector, it decreases the number of vacant jobs in the export sector, i.e. in the sector which produces exchangeable goods but they cannot be exchanged because they are more expensive because of the system of high tariffs and quotas. At last, the export is the price the countries pay to import goods from abroad. If trade barriers decrease the price of imported goods, then those barriers also lower the value of exported goods. As the products thus become uncompetitive in the international markets, the long-run effect is higher unemployment as the export sector is unable to cover-up the losses and this inevitably leads to fewer jobs.

As the economies in the third world countries have insufficient capital equipment and technology, the entrepreneurial sector cannot absorb the advantages and gains from the international trade. Coupled with explosive government intervention, a weak rule of law and miserable education conditions, the effect of abovementioned trade policy increases the convergence gap as well as it denies consumers a market product choice.

The critics of the liberalization in the third-world countries are focused on the repetition of thoughts that foreign direct investment is a bad option for the nations in transit. The net effect of foreign direct investment is clearly visible. New investors bring new capital, technology and equipment in a country and they need a labor force to run the production. As a matter of fact, laborers in that precise country gain as they get a job. Their standard of living would be much lower if the investment flows were heavily restricted. In fact, there’s a question disliked by many; what do you consider better? An employed person in the factory, receiving a payment for taking part in the production process or a person seeking a better way of living in the street through criminal while being unemployed?

In the end, the implications of protectionism are unimaginable. The denial of access to international market results in the demolition of entrepreneurial sector which cannot sustain its competitive advantages and is thus forced to walk on water with seeking supply-chains on domestic markets only. Financial protectionism is equally painful. In the age of globalization, the market business is becoming more integrated and companies from all over the world are in the need of funding in order to support the growth agenda. Chicago economist, Gary Becker once brilliantly captured the essence when he told the real meaning of protectionism: trade protectionism is equal to racial discrimination.

Staunch trade protectionist policy is definitely one of the reasons why third-world countries haven’t achieved very much progress in the previous periods. Hence, the establishment of high quotas and tariffs raised the price of the most demanded goods in the market. The course of protectionism negatively affected the efficiency and openness of capital markets. Discretionary right to setup such system resulted in a prolonged period of economic contractions and spinning crisis. In such an environment, education enrollment and the investment barriers resulted in a low-paced growth and structural crisis in which the free exchange mechanism is unreasonably blamed for.

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Rok SPRUK is a supply-side economist and a classical liberal. He lives in Slovenia where he studies economics and business. His fields of professional interest and research are economic growth, international economics, macroeconomics, tax reform, international competitiveness, free trade and globalization. In the field of business he is focused on strategic management, financial markets, business models, marketing and innovation. Rok works for economic freedom, individual liberty, free enterprise and a free society. His ideas, writings and observations are posted on his blog Capitalism & Freedom. You can contact Rok by sending an email to rok.spruk@gmail.com
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