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Estonia's star shines in debt crisis - but for how long?

A poster informing Estonians about the adoption of the euro adorns a bus stop in this photo from last December.


By some measures, tiny Estonia is Europe's model of a successful economy: a rock-bottom debt load of 6.7 per cent of GDP (compare that to Greece's 152 per cent), employment growth of 7.7 per cent year-over-year, and a second-quarter GDP growth of 8.4 per cent.

But those gains represent a long journey back to pre-recession levels after a very steep dive. The country's pro-market agenda has led it to keep its debt down at all costs, forcing other measures to plummet. Estonia's unemployment rate in the second quarter of 2011 was 12.8 per cent, a big labour gain from 2010's average of 16.9 per cent -- but still far higher than the 4.7 per cent unemployed in 2007.

Of course, all this is in the shadow of Estonia's decision to adopt the euro, the country's biggest economic move since gaining independence 20 years ago after the collapse of the Soviet Union. Estonia joined the shared currency in January, after years of running a tight fiscal ship to meet membership requirements.

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But membership comes with a cost, as profligate European countries are discovering. In a common currency, you can't devalue your way back to prosperity. A brutal internal austerity program is about the only option -- and one that mature Western economies may not have the stomach to impose.

Greece and Italy, now seen to be dragging their heels in implementing austerity, have suffered more than if they had begun dealing with their debts in the early days of the recession, as Estonia had. Ireland's borrowing costs have fallen dramatically since the summer, while it continues pledging billions in government cuts.

Estonia is small, with a population of only 1.3 million. The bear of Russia looms to its east, Scandinavia beckons across the Baltic Sea to its north and west, and Eastern Europe sits to its south.

The Baltic country's gross domestic product was $19.8-billion (U.S.) in 2010, making the economy a little more than half the size of Nova Scotia's. Its economy is boosted by strong electronics and information technology sectors. Ties to Finland and Sweden dominate Estonia's foreign trade, representing half of its trade in the euro zone.

The recession hit Estonia hard, and it's still working to dig itself out. Standard and Poor's noted the country's ability to bounce back in a review of its banking sector published last week.

"After contracting by nearly 14 per cent in 2009, the Estonian economy demonstrated exceptional flexibility in implementing fiscal consolidation measures while remaining the EU's least indebted nation," the rating agency said, predicting the country would see 4 per cent annual growth over the next four years.

Despite this flexibility, returning to the heights of the pre-recession boom years will be a major challenge. The International Monetary Fund predicts Estonia's real GDP won't return to 2007 levels until 2014.

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"The [European debt]crisis leaves a legacy which makes it impossible for the [Estonian]economy to grow using the same pattern as in the past," according to an OECD paper from June.

Much of the pre-crash boom came from investment in sectors such as real estate and construction, where there is now much less demand, according to the OECD economists. Future growth will require an increase in exports -- but with other countries struggling, the IMF predicts that path will be difficult.

Estonian President Toomas Hendrik Ilves is optimistic.

"Our flexibility and desire to cope with the difficulties allow us to feel a bit more secure in the cur­rent situation, where the economic future of Europe and the U.S. involves an alarming amount of uncertainty and fear," he said in a statement.

Some worry the cyclical unemployment could become structural. Forty-five per cent of the unemployed have been out of work for more than a year, and that doesn't include thousands that have given up looking for a job.

Even while employment was high, Estonia had some of the lowest per-capita GDP in Europe. The situation hasn't improved.

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To keep its slim debt figure, Estonia slashed away at its public work force, wages and pension benefits.

Health care was hit, including many other government services. The country runs an efficient, single-payer health-care system and out-of-pocket fees help top up funding. Unfortunately, the payments can create a serious problem with the country's many low-income households, according to OECD economist Zuzana Smidova.

The health care system has increasingly relied on user fees, pushing some households "into poverty."

"[Out-of-pocket payments]raise issues of accessibility of care, which can have an impact on the general health status of the population," Ms. Smidova writes, noting that patients who delay treatment may develop much more serious -- and expensive -- problems later on.

Still, in the context of Europe and the shockwaves of austerity, perhaps Estonia's problems don't seem so bad. The country has made a virtue of taking some pain now to prevent future fiscal agony. It's a gruelling lesson that, for Greece, Italy and others, may have come too late.

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About the Author
Assistant editor, Ottawa

Chris Hannay is assistant editor in The Globe's Ottawa bureau and author of the daily Politics newsletter. Previously, he was The Globe and Mail's digital politics editor, community editor for news and sports (working with social media and digital engagement) and a homepage editor. More

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