Transition in Estonia

by Hanna Sanchez
by Darman Lopez

by Frank ONeill
by Jill Snoddy

   

Estonia's Economic and Political Transitions 

Written By: Hanna C. Sanchez

 

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As the Soviet Union gradually came apart, Estonia was among the countries that moved towards sovereignty and a market economy.  Both the political and economic transitions were slow and came accompanied by relatively unavoidable problems for the country; however, Estonia's independence was finally regained.  Estonia was the only country of the Soviet republics to have experienced independence, and this period lasted for twenty years during the interwar years.  Furthermore, Estonia's close relationship with Finland and its consciousness of Western political culture aided its shift away from the Soviet culture.  The Baltic states also witnessed the experiences of the central European countries gaining their independence from the Soviets, the part of Europe that the Baltics were historically and culturally a part of.

The country shifted from a one-party system to pluralism in 1988.  A significant factor in re-establishing political awareness among the Estonian citizens was the ability to participate in the first multi-candidate elections on the national level in 1989.  The idea of independence grew increasingly popular in Estonia.  As Moscow gave an ambivalent response to a proposed economic reform plan, it became evident that the central government was unable to enact true reforms and the citizens lost confidence in the system.  The other two Baltic nations, Latvia and Lithuania, were the victims of a violent and bloody crackdown of the Soviets on reformers in January 1991.  Estonia was spared this, and a Committee of National Salvation was not introduced by Soviet supporters in Estonia mostly as a result of the strength of the resistance in Latvia and Lithuania.  The possibility of a military suppression reinforced the resistance in Estonia.  Furthermore, a visit by Boris Yeltsin to Tallinn provided much support for their independence movement and confirmed the right to self-determination of the Baltic countries.  A coup in August 1991 led by the hardliners in Moscow against Gorbachev provided an unexpected and final push toward restoring independence for the Baltics.  The failed coup discredited those who were supposedly the strongest supporters of the tightly controlled central government, and this aided in speeding up the decentralization of the Soviet Union as well as its subsequent fall.

Among the former Soviet countries, Estonia was the first to develop a new constitution and to hold post-Soviet elections.  Its constitution, adopted in June 1992, was formulated with Western models as examples.  The state assembly was developed to be a single chamber parliament that was granted political supremacy by the new constitution.  An immediate concern in the realm of foreign policy for Estonia was its relationship with Russia, notably the continuing yet decreasing presence of former Soviet troops in the country.  However, Russia was experiencing its own dilemmas of transition, including an internal power struggle among the leadership and the instability of the government.  This made it difficult to restructure its relationships with the former Soviet republics. 

                     Estonia's foreign policy after its Soviet years can be described as multilateral, as the primary strategy has been to form a broad range of international relationships.  This would serve the purpose of eliminating Estonia's necessity of a bilateral relationship with Russia.  The country has been working towards this goal by joining international organizations, such as the Conference on Security and Cooperation in Europe, the Council of the Baltic Sea States, and the Council of Europe. 

 Among the domestic issues that Estonia must handle, ethnic relations have been a significant issue.  This is particularly important considering the prominent Russian population within Estonia and some violent ethnic conflicts in other former-Soviet countries.  However, Estonia has been able to handle its ethnic questions non-violently, having a political culture of a non-violent nature.  Estonia also has a less volatile ethnic combination compared to countries such as Yugoslavia as there are no deep historical ethnic conflicts within Estonia.

While all of the former Soviet republics were faced with the task of moving from a centrally planned command economy to a market economy, the Baltic states possessed an advantage over the others in that it was more West-oriented historically and geographically.  During Estonia's period of independence in the interwar years, the country had the chance to experiment with creating a market economy.  Estonia and the other Baltics also maintained the highest standards of living among the Soviet republics during its years of integration into the Soviet Union.

Estonia was also the first of the former-Soviet republics to introduce its own currency in June 1992, the kroon.  This led to the start of diversifying the country's economic relations, specifically with countries other than Russia.  It also spared Estonia from the problems of the ruble's inflation.  Estonia declared all other forms of currency illegal, despite the International Monetary Fund and western experts advising otherwise.  Fortunately, taking this risk proved to be the right choice as confidence among investors increased and capital flowed into the country.  Aiding its foreign policy goal of lessening its dependence on a relationship with Russia, the introduction of the kroon and abandonment of the ruble resulted in Estonia ending its almost complete dependence on trade with the former Soviet Union and the successor states.

While Estonia was successful with its new currency and gradual decline of its economic dependence on Russia, the country still experienced economic problems.  In both the industry and agricultural sectors, output fell during the first years of independence.  This resulted in an apparent disparity in wealth and income, although the decline was largely acknowledged as a necessary evil of the transition to a market economy.  Although the problems of transition cannot be completely avoided by any country, Estonia's relatively small population and area have contributed to making the process less painful.  The country faced the rather difficult responsibility of reassuring foreign countries as well as investors that the government of an independent Estonia is committed to reform and to competitive markets.

Estonia's economic transition was aided by its large amount of mineral resources.  Its ties to Finland played a significant role as well.  As a result of its historical development with the influence of the Hanseatic League, Estonia along with Latvia have a stronger mercantile tradition.  There has also been a higher level of private economic activity, possible resulting from cultural reasons and confidence in the country.  Estonia and its two Baltic counterparts will likely have to experience growth rates comparable to those of newly industrializing countries in Asia for decades in order to attain economic levels and standards of living similar to those of countries around them, particularly towards the west.  Among Estonia's advantages over other former Soviet republics in its transition to a market economy are its relatively small size, diverse economy, mercantile traditions, and its access to Western Europe and its markets.

Bibliography

Adirim, Itzchok.  "Realities of Economic Growth and Distribution in the Baltic States".  Journal of Baltic Studies.  Vol.19 No.1, 1988, 49-59.

Mockunas, Jonas.  "Transitions to Market Economies: Scenarios from the Baltic States".  Australian Journal of International Affairs.  Vol. 47 No.1, 1993, 31-46.

Raun, Toivo U.  ""Post-Soviet Estonia, 1991-1993".  Journal of Baltic Studies.  Vol.25 No.1, 1994, 73-80.

Raun, Toivo U.  "The Re-Establishment of Estonian Independence".  Journal of Baltic Studies.  Vol.22 No.3, 1991, 251-257.

Report on Ardo Hansson's

"The role of International Trade in the Transition Process of Estonia"

by Darman H. Lopez

 

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This is a report based on two papers written by Ardo Hansson. Hansson is a research fellow at the Stockholm institute of East European economics at the Stockholm School of economics, he is also an Economic Adviser to the government of Estonia; and Member of the board of the Bank of Estonia. I will summarize Hansson's points on Estonia's strategy of transition. I will focus on Hansson's points on Estonia's success as well as transition difficulties. Hansson suggests that "of all the states to emerge or re-emerge from the former Soviet Union (FSU), Estonia (pop. 1.5 million) has arguably pursued the most successful economic reforms". In 1992, inflation was 953% this figure in 1993, has been reduced to 35.7%. The Soviet Ruble in 1992, was dropped and converted to the Kroon, which was rigidly pegged to the D-mark in June 1992. Today its value is 12 times more then the Ruble. Foreign reserves have trebled to 377 million USD, or around 4.5 months of Import coverage . Official unemployment, which obscures some hidden joblessness, is still only 2.1% of the labor force. Around 50,000 private firms have been established, of which 6,000 have foreign capital participation (p.1).

Estonia is the smallest country in Eastern Europe and the CIS, she suffered greatly after the collapse of existing foreign trade links with the Former Soviet Union and CMEA. International trade reforms in Estonia have been consistent and comprehensive. In 1991, foreign trade with the FSU and CMEA was 95%, in 1992, it fell to 47%, and in 1993, it dropped again to 32%(p.1).

Positive developments in trade began as a result of tight fiscal policy and highly liberal foreign trade policy. Estonia's foreign trade policy began with removal of export taxes and import tariffs. Taxes remain only on antique art. Import tariffs are only on luxury goods (cigarettes, alcohol, cars, yachts and furs) and doe not protect important industries. Agriculture products do not have export or import restrictions. Almost all quotas and other quantitative limits have been removed. Estonia has pursued free trade agreements (FTAs) with her neighbors and major trading partners. Thus in 1993, one-quarter of trade is with the Baltic States, Finland is 1/3 of Estonia's trade, replacing 19% of Russia trade and becoming her major trading partner. Germany and Sweden each account for about 9-11% of Estonia's foreign trade (p.2). Estonia has sought to undertake a rapid free trade policy and rejecting the traditional slow mutual phasing out of tariffs.

Estonian External financial policy and strategy of transition:

Macroeconomic and fiscal policy have been important in encouraging the reorientation of Estonian trade. First, the convertibility of the Estonian current account, capital account and a credibly fixed exchange rates have helped the initial stock of foreign reserves. Second, the gold reserves worth USD 100 mm which were deposited in the West before the Soviet occupation were returned to Estonia. Finally, Estonian initial policy of protectionism from an undervalued exchange rate, coupled with the other reforms has redirected her trade from East to West (p.5).

Tight monetary and fiscal policy were used to ensure the convertibility of exchange rate. The "currency board rule" allowed the Bank of Estonia to issue money which is not backed by foreign reserves. Estonia's balanced budget meant that the government could borrow from the bank to smooth seasonal changes. A a result of these policies domestic "demand barrier" was removed. Inflation was low thus firms were able to move out from weak domestic demand to new Western markets.

The Estonian Kroon which is credibly pegged to the D-mark, has allowed exchange rate risk to be relatively low towards Western currencies, and high relative to the Russian Ruble. As the Ruble was depreciating at a variable rate, this increased trade with the West. Undervaluation made exports attractive, encouraging firm producing low quality goods to seek western joint ventures. The current account convertibility and fast payments in hard currencies eased the financing of trade with the West at a period when Ruble payments took months.

The macroeconomic and exchange rate policy allowed the economy to stabilize. In the short-run, the distorted official prices inherited from the planned economy induced Estonian reformers to seek temporary protection. Protection was accomplished through depreciation of effective exchange rate. This policy will be later reversed by "deprotection" when exchange rate willappreciate. This policy is preferable as the exchange rate protection because initial undervaluation will unlike the indirect protection of high tariffs erode over time. The reason for using tariffs as a "corrective policy" was outweighted by two important considarations. First, tariffs go against the law of comparative advantage, and tariffs would be based on false premises, as across the board tariffs would move prices even further from reform levels. Second, protection leads to corruption as the politically best organized rather than the most needy receive tariffs.

Tariff policy is bad because government officials are intellectually and technically ill-equipped to identify market failures and because they are demoralized and often corruptible. Hence, corruption creates dependence on tariffs making their removal very difficult. Hansson suggests that while undervaluation of currency has been formally criticised, there is a good deal of evidence that it was a successful policy in countries like Czech Republic, Baltic States and Poland which combined undervaluation with macroeconomic stabilization. These countries have been able to maintain low unemployment, high enterprise profitably, balanced budgets and foreign accounts. On the other hand countries like East Germany and Hungary that combined appreciated real exchange rate with macro-stringency have not performed as well (p.3-7).

Work Cited

  • Hansson, Ardo., "The role of International trade in the transition process". Prague, 29th -30th January 1994. P1-7.

Estonia's Economic Transition from Centralized Economy to a Market Economy

 by Frank ONeill

 

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During Estonia's history as Soviet Satellite, the people of Estonia suffered a great deal socially as well as economically. During the mid 1980s, relations were dangerously tense between the Estonian people and Moscow. In the midst of ever growing shortages of food, services, and other products, Moscow acted to relieve the economic stagnation with the implementation of the Perestroika plan. However Mikhail Gorbachev's Perestroika plan (a program of economic, political, and social restructuring) became the unintended catalyst for the downfall of totalitarian regime and the rise of Estonian independence.

The implementation of the Perestroika took place as part of the Soviet economic reformation. Its impact on the Estonian economy was perceived by Estonians to be detrimental in many ways. As specified by Moscow, new phosphorite mines in Northern Estonia were to be opened in order to stimulate the Estonian economy and increase employment within the Northern communities. However, mining in the Northern territory of Estonia would not only have had catastrophic ecological effects but it also encourage another influx of migrants and with them further economic troubles. These new proposals, following a series of previously unsuccessful polices, further infuriated the Estonian people and stimulated a widespread mobilization against the Soviet intervention in Estonia. In response to their anger, the people of Estonia organized several large scale protests, the first of these protests occurred on August 23, 1987: radical Soviet opponents in Tallinn organized the first grand scale political demonstration. Following demonstrations encouraged the spread of free political and economic ideals. These ideals developed rapidly throughout the Republic, and the society became further organized around them.

During a union conference in early April 1988, a program of action was presented: extending Estonia's economic and political rights, halting the immigration flow, and cultural independence. The Popular Front was soon founded on April 13, and the Estonian population was engaged in

withdrawing from the Soviet totalitarian state. By the end of 1989, the USSR Congress Peoples Deputies, as well as the Estonian Supreme Council, declared null and void the protocols to the Hitler-Stalin pact and the decisions which incorporated Estonia into the USSR.   Slowly yet in a step wise fashion, Estonia gained independence from Moscow: the Estonian police and the basis for the defense forces were formed, payments into the USSR State Bud-get were cut down, and an economic border was established. Co-operation between the Baltic States greatly increased and the Council of the Baltic States was established to further the developments of routing resources and goods. The transition to a market economy began, prices were liberalized, many small enterprises were privatized, and farms established.

With the reorganization of the infrastructure, the same goods produced in the Soviet centralized economy soon became far more internationally competitive and profitable under the market economy. "The Government of Estonia is fully committed to free market policies. This

strong commitment has made economic development and reforms irreversible (Vilo, 1994)." Theses strong ambitions to revert back to the once strong market economy are evident in the Estonian economic policy: liberal trade agreements and high property privatization. The existence of low or absent tariffs on trade allow the small nation to remain competitive in the international market place were industries and workers must be constantly in step with newly emerging technologies. Furthermore, the privatization of property accelerated at an alarming rate in the mid 1990s. With the ownership transition of property and capital from government to citizens, as well as the establishment of radically new private companies, Estonia demonstrates a triumphant return to a democratic political environment and a prosperous market economy.

References:

Christopher, P. (1995) Socialism After Communism: The New Market

Socialism, The Pennsylvania State University Press.

Kyn, O. (2000) Home page. Apr 22.

http://econc10.bu.edu/copy_of_econsys/Lecture_Notes/len1_frame.htm

Stidelsky, R. (1995) The Road from Serfdom: The Economic and Political Consequences of the End of Communism, Penguin Press.

Vilo, J. (1994) Business and Economy: Doing Business in Estonia,

                  http://www.ibs.ee/ibs/Economics/business1.html

 

Introduction to Free Market Economy in Estonia

By Jill Snody

 

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Estonia has the distinction of being the first state to transform to a market economy. With this transformation came the adoption of a new currency, public elections for President and members of Parliament, and the creation of a new Constitution. Because of it's geographic location between Western Europe and Russia, Estonia is an important link in the transportation of goods throughout the world. Trade routes are prosperous, and in the period since the fall of Communism, these routes have at times kept Estonia ahead in terms of growth (Estonian Economy, October 97).

Under the Soviet system, Estonia, which was forced into the Union in 1940, had a diverse economy. This would later prove to be a great advantage, because its wide base of knowled~e helped Estonia adapt to the market system.

Estonia has always been a culturally homogenous population, and during the recessions of the 80s in the Soviet Union, Estonians began to voice their nationalism and desire to leave the Soviet Union. In November 1988, Estonians got their wish and were declared sovereign. This meant that Estonia had to start over, and started the tasks of rebuilding the Estonian state and democratic institutions, and restoring a free-market economy (Estonian Investment Agency, 2).

They did this by first establishing a new currency, the Kroon. After the successfiil implementation of this monetary policy, privatization began with the selling of state owned enterprises. These acts increased the GDP and decreased the inflation rate and continue to do 50 year after year. The government tries to stay out of most management issues and prefers instead to trust the market without its interference. This liberal economic policy expedite reforms and policy changes and improve efficiency in the country.

Privatization was a major component of the transition in Estonia. It's main objectives were to ''increase effectiveness of economy, to foster competition and decrease monopolistic tendencies in the economy, to avoid the need for the state to subsidize enterprises, to attract foreign investment in order to achieve economic growth, (and) to generate revenues from privatization and to create additional ways to use privatization vouchers (securities)" (Estonian Investment Agency). The first areas of privatization were public utilities and land required for production purposes (EIA).

All privatization is carried out by the Estonian Privatization Agency (EPA). It has compiled a list of all available enterprises up for public sale and all legal entities--foreign or domestic--may participate in the purchasing for privatization purposes. Sales were done in several different ways, including public auction, money with preliminary negotiations, and public offer of shares in a company EIA).

Sales with preliminary negotiations were conducted when the sale involved a major industry in the economy or if it involved a service company in the public sector. For less complicated sales, a public auction was used. This would be beneficial because more people can bid on the enterprise and no previous requirements are needed for a sale to occur. ~a company is thought to interest many people from the community, a sale of public shares will take place, although they are admittedly only allowed a minority interest in shares. In addition, privatization vouchers may be implemented as a method of payment for any of the above types of sales. These government issued vouchers, since 1994, have been considered legal tender and freely tradable in Estonia (EIA).

Privatization began with seven pilot companies in 1991. These sales were primarily joint stock sales from the previously state owned enterprises. The majority of privatization on a large scale did not start until 1992, and by 1997, all enterprises had been privatized, with the exception of infrastructure, energy and alcohol industries, which remain under government control (EIA).

Estonia has been a trend setter for the rest of the New Independent States. Not all countries have been able to privatize industries such as transportation and major utilities with the success of Estonia. In general, the Soviet transition has been marked by quick privatization and trade liberalization, which sometimes lead to a recession and decreased growth in the MS. "Efficient, reliable and user-friendly infrastructure is a basic ingredient of a well-fbnctioning market economy" (EBRD's 1996 Transition Report). Infrastructure from the former Soviet Union is inefficient and lacks the environmental knowledge of conservation. This problem has had to be addressed by the new states during transition.

In general, the planned economy of the former Soviet Union lacked the understanding of efficient allocation. It was unable to coordinate its efforts into a smoothly run economic machine. This made it much more difficult to keep abreast of the technological advancements of the Western economies like the United States and East Asia. During the collapse, these deficiencies became quite clear as the Communist countries found themselves decades behind the production technologies of the west. In fact, in 1940, Finland and Estonia had the same level of GDP, yet Finland's GDP in 1992 was more than ten times that of Estonia. The Communist planning simply could not keep up with the productivity and growth rates of more open market economies.

"An important element of transition is to increase the types of savings instruments and institutions" (EBRD). Estonia has been very successfbl in the financial markets lately, and in fact Estonia has been called a "banker's heaven" (Estonian Economy September 1997). It's financial sector has seen swift growth and has a growth rate of 11% annually over six years.

Finally, there has been much bad press about the transition to market economies in the former Soviet Union. According to government statistics, the GDP dropped over 50% from 1989 to 1996. There are many reasons why this number is simply not true, including a tendency to exaggerate growth in the Soviet Union to flirther a political cause, an inefficiency in production, and a greater fall in investment than consumption. "Managers of state enterprises in the old Soviet Union routinely inflated their figures for output to earn themselves political favor. ..So a lot of what the GDP declined from may not actually be real" (OTN). Also, the increase in prices in 1992 when the market was liberalized, while appearing negative, actually eliminated queues, which is a definite positive repercussion. Prices are now determined by consumer demand and normal free market mechanisms, instead of the artificial demand imposed by queues.

Estonia has modeled its government on that of the United States, and they have experienced great success with it. There have been no ethnic conflicts, and they have 

experience a very harmonious and peacefi~l transition to the free market world. They have set the tone for many other nations to follow, and are important to the link between east and west, both geographically and politically.

References From the Internet:

1.  Economic Decline: not so bad as all that? (Out There News)

2.  EBRD'S 1996 Transition Report (http://iepnt. 1 .itaiep.doc.gov)

3.  Estonian Economy, September 1997 (from Estonian Foriegn Ministry)

4.  Estonian Investment Agency (http: /Iwww. eia. ee/factsheet/html)

 

 

 

 

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