DIVERSITY IN THE CONVERGENCE PROCESS OF ACCESSION COUNTRIES

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ESTONIAN ECONOMY CURRENT SITUATION
AND FUTURE DEVELOPMENTS Urmas
Varblane University of Tartu
DIVERSITY IN THE CONVERGENCE PROCESS OF ACCESSION
COUNTRIES   Urmas Varblane University of Tartu
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Structure of presentation

• Why Estonian economy entered into world economic
  crisis with its own crisis?
• How Estonian economy is adjusting? Firms,
  households and goverment.
• Which are the major strategies of firms to
  improve their competitiveness?
• Estonia after the crises?

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Estonian economy entered into world economic
crisis with its own crisis in 2008

• Engines of growth were exhausted
• External financing deviated economy toward
  internal market (construction, trade, nontradable
  services)
• Export still labour intensive - low value added
  intermediate products dominating in Estonian
  exports - structural change slow
• Labour costs growing faster than productivity
• Labour productivity level several times below the
  EU-15 average

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Productivity (value added per employee) and real
wage growth in Estonia 2004-2009 (y.o.y.bases)
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Economic crisis has assymetric results
Industrial production - annual change August
2009 compared with the same month of the previous
year
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Real GDP quarterly growth (, compared with the
same quarter year ago)
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Which countries are hit most seriously by the
world economic crises?

• Small domestic market and very open economies
• With high external debt
• With very high foreign trade imbalances and
  balance of payment deficit
• Depending heavily on export of natural resources
• Whose major trading partners were hit severely

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Impact of the world economic crisis on the
Estonian economy

• World demand is weaker
• Threat of growing protectionism among trading
  partners
• General credibility of Central and Eastern
  European countries among politicians and
  investors is going down rapidly
• Foreign funding is much more limited (on the
  household, firms and country level)
• Domestic demand is weaker as well
• Competing devaluations from trading partners

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Economic decline in Estonia is serious (real GDP
growth between 2004 and 2009)
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Dynamics of world GDP during three crises
and how Estonia behaves in the current crisis
Estonia 2007100
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Unemployment during three crises and how Estonia
behaves in the current crisis
Estonia 2008-2009
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What is needed in Estonian economy?

• Credibility (Estonia is looked among the other
  CEE and Baltic countries, devaluation
  expectations)
• Funding (banks more conservative, need to find
  new investment areas less trade, construction
  )
• Markets (new markets, new segments on old
  markets)
• Ideas, knowledge (fresh ideas, change of business
  models, diverse knowledge base, new generation of
  top managers)
• Stabilisation of labour market to keep labour
  for the future growth

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Monthly growth of the stock of households and
firms loans (billions EEK)
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Major change in economy- need to learn living
according to the ability to earn

• On all levels
• Government budget cuts, reduction of public
  sector employment, better and faster use of EU
  funds, some support schemes
• Firms - costs reduction, restructuring, further
  internationalisation
• Households - consumption reduction, savings

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Estonian current account deficit ( of GDP)
Q2-2009 Current account 4.9
Current account has improved extremely
rapidly adjustment mechanism of the currency
board system
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Estonian foreign trade is stabilising (?)
Compared to June 2008 exports decreased 13 and
imports 29 Compared to May 2009 exports
increased 17 and imports by 19.
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Dynamics of industrial output and retail sales in
Estonia 2005-2009 8 ( change y.o.y bases)
Industrial output Comp. with previous period
Ministry of Finance, 2009
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First round of adjustment in Estonian firms

• SURVIVAL!
• Radical correction of expenditures
• Input prices were falling (fuel, raw materials,
  labour, services)
• Management processes improved
• Sudden need to restructure and make changes,
  which were not implemented during good times
• Easier for firms, which started changes earlier

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Which are major strategies of firms to improve
their competitiveness?

• reduce costs - improvements in process
  management organisational innovation
• increase of sales (or currently softening of the
  fall) internationalisation cooperation with
  partners
• change of products or services differentiation
  product/service innovation
• replace labour with capital - investments
  reduction of labour intensity
• 5) change of the position in global value chain

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Measures used by managers in Central and Eastern
Europe (Roland Berger, March 2009)
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How Estonian firms are seeing their sources of
competitiveness?

• Closeness to the major markets
• High flexibility
• 1) small and frequent deliveries
• 2) fast adjustments to the change in demand
• 3) ability rapidly rearrange production lines

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Upgrading strategies in global value chain
RD Center
Branding

• Value added

Marketing Center
Design Center
Manufacturing Center
OperationCenter
RD Design Engineering Manufacturing Operation
Marketing Sales Services
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What is needed for the Estonian economy?

• Credibility for the outside world (Estonia is
  looked among the other CEE countries, devaluation
  expectations )
• Ideas (fresh ideas needed how to change existing
  businesses and launch new diversity of knowledge
  base, new generation of managers)
• Funding (banks more conservative, previous areas
  of investments like real estate, trade etc. not
  attractive, own resources are scare)
• Markets (new markets, new niches on old markets)

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What is needed for Estonian economy

• Credibility for the outside world
• Estonia is looked as one among others in Central
  Eastern Europe /Baltics
• Good solution before entering Eurozone hard to
  find
• Hard to differ which are arguments in favour
• a) Rapid stabilisation of current account
• b) Public sector debt very low
• c) Government is able to reduce costs and cut
  state budget
• d) Reserves collected during good times

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Cost of insurance against government default
sharp rises indicate lack of confidence
Credit default swap on 5-year government bonds
2 January 2008 16 March 2009
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What need to be explained to foreign experts

• Small economy is easier to restructure
• Labour market is flexible and nominal wages could
  be reduced and general reduction of price level
  is possible
• Devaluation of Estonian kroon is not miracle
  structural change is needed
• Estonian kroon is covered with hard currency much
  better than expected (compulsory reserves by
  central bank 15 , reserves of currency board,
  liquidity agreement with Swedish Central Bank)
• Estonian government is able to manage budget
  deficit

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What is giving devaluation of Estonian kroon?
Import needed to produce export goods (raw
materials, semi-final products, machinery,
equipment)
Loans of Estonian households and firms in total
234 billion Including. 201 bn. nominated in
euros
Estonian exports (estimation in 2009. ca 100
billion EEK
Estonian households and firms savings In total
130 bn including 56 bn. in euros
growing commitments,
inflationary pressure
postponement of moving to euros
credibility???
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What is needed for the future growth?
Foreign private funding (foreign direct
Investments, loans)
Savings and domestic capital
State funding (budget with EU structural funds
loans)
Export capacity improvements Work with
foreign investors
Development of fields with strong multiplier
effect
Dealing with social problems
New entrepreneurship support
Growth of export earnings New foreign investments
Activate domestic market oriented industry and
services
Maintain labour force, improvement of
capabilities
New firms (knowledge intensive)
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What is improving during the crisis in Estonian
economy?

• Growing competitition between different suppliers
  
• Motivation to rething business models -all is not
  automatically for sale anymore
• Motivation to learn marketing, management
  models, technologies
• Quality of goods and services important again

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What is improving during the crisis in Estonian
economy?

• Cost advantage restored partly helps to compete
  with devaluating economies (Russia, Poland,
  Sweden )
• a) reduction of labour costs
• b) reduction of energy and fuel
• c) lower prices for other major inputs
• Attractiveness to foreign tourists may improve
  again

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Labour cost advantage still exists
Estonia 2007. average costs 6.2 EUR
Estonian labour market could demonstrate
flexibility downward adjustment wages is
possible
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Average hours worked per employee 1990-2005
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Forecast about the recovery of world economy
(GDP growth, WEO, 2009)
Recovery of world trade hopefully helps Estonia
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Scenarios for the future -(Roland Berger, 2008
november)
or maybe W
v
Type of change
U
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World markets slowly improving - some green
shoots around the world (Wescott, end of June,
2009)
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Confidence among Estonian firms and consumers
Expectations are improving
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GDP growth and confidence index in Estonia
1995-2009
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Conclusions - Estonia after crises?

• GDP is lower and external financing as well
• But Estonia is coming out of the crisis still
  with very low public sector debt
• No need to increase taxes
• Cost competitiveness partly restored and
  productivity increased
• Labour in short run available for growth
• In positive case the joining with Eurozone
  succeeds and it provides credibility
• Improvements of country risk ratings, cheaper
  funding, improved image
• New round of investors shifting activities out of
  Scandinavia

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Public sector debt
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Public intervention into banking sector
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Conclusions - Estonia after crises?

• Estonia should use the crises in order to improve
  the competitiveness of the economy
• In the context of falling labour costs exists
  threat to avoid major changes in the business
  models of firms
• Cheaper labour enables to produce again labour
  intensive but relatively low value added products
  and services
• Long run change oriented behaviour is needed (new
  products and services, new position in global
  value chain, new strategic partners, new market
  niches, new entrepreneurship among graduates from
  universities)