Transition   Privatization   



Privatization in Estonia

by Darman Lopez


Introduction and Background
Estonia has one of the best privatization records among the Baltic States. By the end of May 1994, an estimated 50% of stated-owned enterprises and business units have been transferred to private ownership or control. Estonian ownership transfer is taking place in a reformed macroeconomic environment (Nellis p. 7). Inflation has been reduced from 953% in 1992 to 35.% in 1993 (Hasson p. 1). The GDP decreased by 14% in 1991 and by 15% in 1992. In the second half of 1993 the decline stopped, a arise of GDP by 4-6% and an increase in volume of industrial output of 6% is predicted for 1994. (Vaino p. 3). Estonian privatization started in early 1991, the law of property reforms was passed when she was still part of the Soviet Union. After the collapse of the SU the economic reforms really began. During 1993, the privatization process was in full force when other laws such as: law on land reform, law on real estate, bankruptcy law and Law on securities where adopted and now serve as a legal basis. Enterprises are sold on auctions and on tenders. The method of international tenders was chosen to attract foreign investment. The first international tender was announced in November 1992, offering 38 enterprises for sale and in 1993 three additional tenders were undertaken. This includes national tender for agriculture enterprises. Together these four tenders offered 155 companies for sale to investors (Vaino p. 4)


Key institutions in the privatization process.
With the adoption of the Privatization Law in June 1993, the State Property Department and the Privatization Enterprises were united and the Estonian Privatization (EPA) was founded. The EPA is a government institution that administers the privatization process. The EPA privatization process has adopted a range of divestiture methods aimed at putting assets into the hands of those with the incentives and skills to use them wisely. I will focus on the Estonia's two primary divestiture paths: The sale of firms through tender bidding and the voucher program (Vaino p.5). These two processes receive the most attention of her privatization reforms, I will highlight John Nellis Views on these two divestiture methods, he is an economist form the Private Sector Development Department of the World Bank.

The Estonian Privatization Agency describe, that the tender process is based on the privatization of medium-size and large firms thought to be of interest to foreign and domestic investors. A tender is public and any one may bid. However the conditions for bidding are based on an evaluation criteria: First, a bidder is expected to present a concise and realistic business plan with a projected proposal for at least three years. The plan must include the type of product or service, the goals of the business and the ways of achieving them. Second the investor must have employment guarantees, promising to maintain employment for a minimum of three years or to create jobs for workers in downsized enterprises. Finally, a investor must guarantee a maintain a significant level of investment in purchased enterprises for a minimum of three years (Vaino p.6).


Tender success and enterprise debt.
There have been four tenders conducted by May of 1994, two of the four are large textile and furniture producing companies. The four tenders have generated 63.4 million in sales proceeds. Buyers have contracted to invest more than $30 million in the privatized firms and guaranteed more than 14 thousand jobs. Between 30 to 50 % of sales through tenders have gone to foreign investors, or to domestic purchasers with foreign partners or foreign financial backing. However Nellis suggests there are problems with enterprise debt. The revenues being generated by sales of enterprises are not sufficient to cover the debts and liabilities of the privatized firms.

The government has begun to clear some inter enterprise debt by introducing improved accounting methods. However other options are under discussion for example the creation of a consolidation bank based on the Czech model to excise much of the bad enterprise debt of the banking system and replace it with government bonds. Nellis describes at this point bankruptcy laws in Estonia are aimed solely at protecting creditors: "there is nothing like Chapter 11 provision allowing debtor a chance to restructure. Dirty games have occurred as there is a weakness in the courts and there are no government agency monitoring bankruptcies. Creditors inflate claims many times in the weeks between the announcement of bankruptcy process" (p. 8-10). Nellis suggests it is important that the government force creditors to absorb some of the losses, this would send a strong signal that the government will not bail out creditors and hence boost the credibility in her reform process.


The voucher program and problems.
Vouchers are exchangeable for shares in privatized firms, in investment fund companies, residential housing and land. Nellis suggests, that there is a growing concern that the total supply of assets tradable for privatization securities will be insufficient to meet the demand. The supply will be insufficient even if the EPA intends to expand the sales of shares for vouchers. He writes that "the conventional wisdom on vouchers is that the value should be the same for all recipients and that they should be exchangeable only for shares in companies or in investment funds. The Estonian scheme deviates from both suggestions"(p.8). Each resident over the age of 18 receives national capital vouchers, with each voucher denomination at 300 kroons. The number of vouchers obtained varies. One voucher is gained for every year spent in school or work between January 1, 1945 and January 1, 1992. This rewards long term residents and native Estonians more than immigrants. The total value of this type of voucher is estimated at 12 billion kroons. A second instrument, the compensation voucher, is issued to person whose property was illegally expropriated, but cannot be returned. People who were deported during the Soviet era also receive compensation vouchers. These vouchers cover the total cost of the property at the time it was expropriated. The total value of compensation vouchers, most of which have not yet been issued, is 9.0 billion kroon. Thus the total demand for vouchers is estimated at around 20.5 billion kroon, or US$1.6 billion. Nellis suggest that, on the supply side housing will absorb about 6 billion kroons in vouchers, land 4.5 billion kroons, and enterprises 5 billion kroon, this totals 15.5 billion kroons leaving a surplus of artificial demand of over 5 billion kroons (p.8-9). At the end of May 1994, the Estonian government approved a bill allowing complete tradabiliy of vouchers among Estonian citizens and residents. Nellis point out that the Bank of Estonia suggests, "making vouchers tradable will not significantly or enduringly contribute to inflation. Vouchers have for some time been partially tradable; pensioners have the right to sell their vouchers and family members can pass their vouchers on to one another" (p. 9). In May 1994, on the open market the price of a voucher varied between 50 and 200 kroons; the official rate is set at 300 kroons (p.9).


Factors contributing to Success.
The success of the privatization process in Estonia is a based on four main factors: First good policy, by the termination of soft credits to enterprises, active implementation of the bankruptcy law (an estimated 300 bankruptcy proceedings dealing with state firms have taken place), a currency board system that links money creation to hard currency reserves and keeps inflation at modest levels, liberalized prices, and open trade regime, and the encouragement of foreign investment. Second good politics, leaders in have so far persuaded the public to tolerate the painful, temporary adjustments. Third good history, Estonia has had strong developed national and commercial traditions during her domination by the Swedes and Germans between the 13-16th century. Finally good geography, Estonia is a small country this is an important factor in her ability to gain quick control of her economy. However Estonia's most important feature compared to other Baltic States, is geographically she is the farthest form Russia. Estonia's location allows her to put Russia
behind her and take advantage of her geographic closeness to Scandinavian and Finnish markets and investors (Nellis p.8).

Work Cited

·         Hansson, Ardo., "The Impact of Recent Developments in Russia on The Economic Transformation of the Baltic States". Paris, March 24, 1994. P8-13.

·         Nellis, John., "Successful Privatization in Estonia: Unusual Featurs".

·         World Bank July-August 1994. P7-10.

·         Sarnet, Vaiio., "Estonian Privatization Agency". Estonia, May 1994. P1-10.



Privatization in Estonia 

by Erin Hubbard

Upon regaining independence from the USSR in 1990, Estonia quickly began preparing the economy for a market system. The first step in preparing for the new economy was private ownership, which would provide the incentives to producers and consumers, essential for a competitive and efficient market system. However, the privatization of state (public) property, which had been under Soviet control for the past fifty years, was to be a very complicated task.

On June 13, 1990 Estonia adopted the Property Law, the first of three laws laying the foundation for privatization. This law officially removed the state from its fifty-year monopoly franchise over property ownership and laid the legal foundation for transfer of property into the private sector. According to this law, private ownership rights could arise from various sources. You may be entitled to property that was previously owned by you or your relatives at the time of annexation. Also, you may be entitled to property that you had been working on over the past decade. In the case that property that you should have been entitled to was destroyed or given to someone else, this law ensured for compensation. In addition to individual ownership rights, this law also provided ownership rights to legal entities, and municipal and state governments.

The next law, adopted one year after the Property Law, was the Law on Principles of Property Reform. The intent of this law was “the restructuring of property relationships in order to guarantee the inviolability of property and free enterprise, to make good the injustices carried out the violation of property rights, and to create conditions for the transition into market economy.” The main issues under this law was the returning of property illegally confiscated by the Soviets to their legal owners or heirs and the transformation of currently state-held properties to local or municipal governments.

The third law aiding property transformation was the Land Reform Act. The intent of this law was “the rearrangement of property relationships related with land so that they will be based primarily on private ownership, honoring the continuing rights of former owners and the legally protected interests of the current land users.” This law included returning both urban and rural lands to their previous owners and dividing rural lands among competing claims. In addition, it required the privatization of land that was neither claimed by individuals nor retained by the government.

With these laws in place, Estonia began the methods and procedures necessary to carry them out. After defining and identifying all state-owned property subject to privatization, the Estonian government began handing out privatization certificates to all permanent citizens. The number of certificates received by each individual depended on age, the number of years he worked in the country, and the number of compensatory payments the state owed him. These certificates could be used to buy housing land, a small enterprise, shares in a large joint-stock company, or saved in a bank. Although the system of handing out certificates seems to be a fair way of handling privatization, there have been several accusations of corruption, favoritism, and covert arrangements, which is clearly inevitable in this type of system.

An additional, and perhaps more fair way of privatization was through the use of international tenders beginning in 1992. This method can be described as “offering state-owned enterprises to private sector investors through the use of advertised international tenders.” Because these tenders comprised of a large block of shares, this method greatly contributed to large-scale privatization, which was actually not started until August 1992. The first international tender, comprising of 38 enterprises, was offered on November 17, 1992 and closed only a month later to promote high speed large-scale privatization. The tenders continued to be offered every three months, and by 1995 ten tenders with 377 enterprises had been sold. By 1996, large-scale privatization of Estonian industries was virtually complete (Wolfe, 1996).

Although privatization was slow at first, it has been relatively successful since about the time that large-scale privatization started. The best indicator of privatization efforts can be seen by Estonia’s growth rate of GDP. Between 1990 and 1993 Estonia’s growth rate was –9.7. However, this negative growth rate was inevitable with the new transition to market economy and was common to all FSU countries. Between 1993 and 1997 the Estonian growth rate was + 4.1 which was relatively high compared to other FSU countries, such as the Ukraine, Russia, and Moldova that were continuing to experience falling growth rates (Kolodko).

Estonia’s economic success thus far could not have been possible without privatization, as private ownership is the basis of a market economy. Although privatization is now complete, it provided the vehicle that lead to a competitive market economy, driven by incentives of consumers and producers. As indicated by Kolodko in his paper “Ten Years of Postsocialist Transition: The Lessons for Policy Reforms,” the GDP of free-enterprise Estonia should continue to rise in years to come. (Kolodko).


·         Kolodko, Grzegorz W. “Ten Years of Postsocialist Transition: The Lessons for Policy Reforms.” (30 April 2001).

·         Shen, Raphael, Restructuring the Baltic Economies: Disengaging Fifty Years of Integration with the USSR (Westport, CT: Praeger, 1994), 132-150.

·         Taagepera, Rein, Estonia: Return to Independence (San Francisco: Westview Press Inc., 1993), 182-183.

·         Wolfe, James W. “Privatization in the Former Soviet Union: The use of International Tenders.” Institute of Baltic Studies.1996. (29 April 2001).


Investment Opportunities, Economic Management, and Privatization in Estonia 

by John Koetzle

Estonia officially started the process of privatization in 1993. There are three main institutions that influence the economic management of the Estonian economy. The three main institutions are the Central Bank of Estonia, the Ministry of Finance, and the Ministry of Economic affairs. Each agency has a specific responsibility that has been delegated by the central parliament. There has been over 3000 legal acts passed that pertain to creating a legal framework suitable for privatization and austerity of the free market economy. The government's actual role is very limited in influencing macroeconomic policy. The Bank of Estonia is completely independent from the government and is not influenced at all by the parliament. 

The highest priority of the government is overseeing the sale of publicly controlled assets. Privatization The government agency that controls the process of privatization is the Estonian Privatization agency. The privatization process is considered a gradual one since in 1993 and 1994 only 54% of major retail stores were privately run. Thirty percent were jointly owned by the government and private owners and sixteen percent were still run by the state. This contrasts the big bang theory or approach towards privatization that had been advocated by Poland

The privatization of publicly owned assets is sold through three different methods. The methods are tender with preliminary negotiations, public auction, and public offering of shares. "The preliminary negotiations for tender are required in situations where complex due diligence is required and disputes about lost property rights and assets ownership occur." (Estonian Privatization Agency website) There the price is pre negotiated with these parties that claim right to publicly owned assets or property. 

The second method is public auction, which involves the sale of large enterprises that would not benefit by voucher sale of shares to Estonian citizens. These are typically firms that do not create public interest. If there is no public interest for these securities then there is no market for these securities and consequently no vouchers would be used. Typically foreigners buy these firms. "In 1994 alone these types of sales totaled upwards of 390 million croons."[Estonian Privatization Agency) 

The last method of privatization is through public sales of shares via a voucher system. The government distributes the vouchers in equal amounts to each citizen. The controlling interest held by majority shareholders is protected. The majority shareholders are usually management or an outside party and these shares are negotiated prior to the release of them publicly through the voucher system. Shares that can be allocated to the public are dispersed through vouchers. There is an auction to determine the final price of the securities. There are two types of bidders in voucher system of privatization. The two types are type 1 and type 2 bidders. Type 1 bidder doesn't have option to not buy shares if the price goes over the highest price he is willing to bid. For example if the bid goes way above what is willing to pay for a share of that enterprise he is still obligated to purchase some amount of shares at the equilibrium price. The equilibrium price is the price of the share when the bidding stops in the auction. In contrast to type 1 bidders type 2 bidders are required to disclose the highest price that he or she is willing to pay for that share and if the price goes above her ceiling price then she is not allowed to participate further in the bidding process.


Economic Institutions and Economic Management 
There are three main institutions that have influence on macroeconomic policies and management of the economy. The first institution is the Bank of Estonia. This is the central bank of
Estonia and it operates independently of the government. This is the most powerful institution in terms of the influence on economic policy. "It controls the issuing of currency, managing the state reserves of precious metal and hard currency, implementing monetary and banking policies and controlling credit policies. In addition to these responsibilities the Bank of Estonia oversees banking activity and records the Estonian balance of payments." (Investment Opportunities in Estonia 1994)

 The ministry of Finance is the next institution that influences macroeconomic policy. This institution acts conjointly with the Bank of Estonia and drafts the fiscal and foreign economic policies. "The reforms that are drafted are mainly budgetary expenditures and tax reforms. The agency also is in charge of formulating the credit policies and helps shape the regulatory system for economic activity." (Investment Opportunities in Estonia

The Ministry of Economic affairs is the agency that manages the economy. This agency has the least influence and just acts as a support function in drafting fiscal and regional economic policies. The agency acts similarly to beareau of labor and statistics and releases forecasts for economic performance and produces analysis on current economic conditions. The agency is also in charge of facilitating capital investment into the country through economic development programs and subsidization policies. The Ministry of economic affairs also coordinates tourism and consumer protection statutes. The last responsibility that the agency has is that there are in charge of intellectual property rights and patents. All patents in Estonia have to be registered with this agency. 

Monetary Policy and Fiscal Policy Like any economy that is in transition between a command economy and a free market economy the main concern of the Central Bank is inflation. Governments fear that with flexible prices because of previous market imperfections that prices will skyrocket. To stem this fear of inflation the Bank of Estonia has set up a currency board. The currency board has pegged the Croon to the Deutsche Mark at a rate of 8:1. The only concern that if the Croon is pegged to the Deutsche Mark there will be a run on the currency and people will trade their croons for Deutsche Marks which will lead to hyperinflation and devaluation. This has not happened because of consumer confidence in the Croon due to rapid expansion in GDP and a balanced budget that occurred in 1994. In 2000 GDP grew 6.5%. Another reason for not having a run on the currency is the sufficient reserves totaling 680 million Deutsche Marks. Inflation was only 3.1% in 1999. The currency board has proven to be very successful in stemming inflation. 

The recent fiscal policies are regarded as very conservative. The reason that they are conservative is to achieve their main objective of joining the European Union in 2003. They need to prove to the union that they have a stable currency, stable GDP growth and stable interest rates. The personal and corporate income tax rate was lowered in 1993 to 26%. This is well below the average of the tax rate of Western Europe and the United State. This has attracted many foreign investors and has increased direct net foreign investment because of the favorable tax conditions at the personal and corporate level. Interest rates have fallen to 8.6% from 16.3% in 1998. This lower of interest rates will help to improve domestic business investment because of the decrease in the cost of capital. This will increase the equity value of the firms leading to appreciating stock prices because of the decrease in the weighted average cost of capital of future cash flows. 

In the past five years 20 billion Kroons have been invested in the form of direct investment. In the last five years existing enterprises have invested 83 billion croons in the form of capital expenditures. Overall the economy is doing very well in Estonia and they have very good relations with the European Union and the United States. They are expected to join the union in 2003. The economy has been through a lot of structural changes in regards to the numbers of privatized enterprises. 

The government unlike Russia has a good legal framework that can support the free enterprise system. There are no problems with collecting taxes as of 2000 they only have a deficit of 1.2% of GDP and interest rates are at a record low of 8.3%. The method of privatization which is called gradualism worked very well and gave time for the people to adjust to the new economic system. Whether it would have been a better choice to make every organization private at once is remained to be seen. Poland has been very successful with that strategy. Estonia is doing remarkably well and poses a great opportunity for investors to enter that market. I think that they will continue to do well because of the conservative actions by the Central Bank and the strong legal framework that has been set up by the government.


Estonian Privatization Agency Investment Opportunities in Estonia 1994





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