štvrtok, apríla 26, 2007

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.

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