Estonia: Economy

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 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 joined the European Union (EU) in 2004. It adopted the euro as its currency and became the 17th member of the euro zone on January 1, 2011.

Estonia began to adopt free-market policies even before it declared independence from the Soviet Union 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 and in 1994 implemented a flat tax for income. Tax evasion is now relatively low by regional standards.

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.

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. 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 14.3% in 2009. Estonia's economy began growing again in the fourth quarter of 2009, and in 2010 the economy continued to recover with growth of 2.3%. The pace of recovery quickened in 2011 driven largely by exports, with final GDP figures expected to show growth over 7%. Unemployment dropped dramatically in 2011; however, long-term unemployment remains a concern, with nearly half of all unemployed persons out of work for over 1 year.

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 (roughly 10% of total energy consumption) from Russia. Alternative energy sources such as wind and biomass make up about 9% of primary energy production. An undersea electricity cable inaugurated in December 2006 allows Estonia to trade electricity with Finland. Estonia and Finland are due to complete a second undersea cable in 2014.

In 1999, Estonia joined the World Trade Organization, adding to its previous membership in the International Monetary Fund (IMF), World Bank, and the European Bank for Reconstruction and Development. Estonia's final decision to join the EU was conditional on the outcome of a national referendum, which was held in September 2003 and returned a large majority in favor of membership. Estonia joined the Schengen zone in December 2007. In May 2007, Organization for Economic Cooperation and Development (OECD) ministers invited Estonia to begin accession discussions; Estonia completed the accession process to the OECD in December 2010.

Foreign Trade
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 include Sweden, Finland, Germany, and others in the West. Russia's share of Estonia's trade is approximately 10.4%.

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.

According to National Trade Data, total U.S. exports to Estonia in 2010 were $188 million, forming about 1% of total Estonian imports. Principal imports from the United States were computer and electronic products; chemicals; machinery; transportation equipment; and wood products. Estonian exports to the United States were around $698 million in 2010 (3.8% 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 computer and electronic products; petroleum products; chemicals; electrical equipment; and optical, medical, or precision instruments.

Sources:

CIA World Factbook (April 2012)
U.S. Dept. of State Country Background Notes ( April 2012)

Glossary