Estonia has long boasted a robust economy driven by its impressive tech sector, but over the past year has had to deal with a disruptive energy crisis and the highest inflation in the eurozone.
Home to just 1.3 million people, Estonia has long punched above its weight economically. It has a higher gross domestic product (GDP) per capita – about 23,000 euros – than Portugal. Bolt and Wise are Estonian companies, and Skype’s software was developed by Estonians. Estonia has an ‘AA-’ issuer default rating from Fitch.
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In 2022, the sturdy foundations of its then-overheating economy were tested like never before as energy prices skyrocketed and inflation soared to the highest rate in the eurozone in August: 25.2 per cent. Purchasing power and private savings shrunk as consumption-based resilience faltered.
Dr Maryna Tverdostup, a labour economist researching Estonia at the Vienna Institute of International Economic Studies (wiiw), says, “If you just look at the numbers, it might look very pessimistic. The last quarter of last year, GDP declined over four per cent, and overall for the year it was over one per cent.”
“But,” she adds, “it’s not as bad as it may look”.
Dr Tverdostup says Estonia was one of the European economies least affected by the Covid-19 pandemic and performed well through the first two quarters of 2022. This initial strength has helped moderate the impact of shocks.
Estonia is the EU and global leader in digital public services. Estonians receive a state-issued e-ID that allows them to vote, pay taxes, and sign contracts online.
Estonia’s technological prominence is no fluke – it is the result of decades of state policy. Starting in the 1990s, the government earmarked one per cent of GDP to information technology development. The 1996 the Tiigrihüpe – Estonian for ‘Tiger Leap’ – initiative increased computer and network infrastructure across the country and expanded internet access to all Estonian schools by 2001.
It has successfully courted foreign direct investment by implementing a business-friendly tax system. There is a zero per cent income tax on all reinvested and retained profits and a 20 per cent flat tax for individual income – though there is currently a ‘tax hump’ in which the basic exemption gradually shrinks until it disappears at a monthly income of 2,100 euros. e-Residency allows non-Estonians to access the country’s e-services – including online tax filing – without gaining physical residency or citizenship.
The latest Emerging Europe IT Competitiveness Index ranked Estonia first in the region for its abundance of talent and business environment. Estonia has the most start-ups and unicorns per capita in Europe.
Shocks from the war in Ukraine
In 2021, Estonia imported 100 per cent of its gas from Russia. However, since Russia’s invasion of Ukraine in February 2022, Estonia has devoted the greatest share of its GDP to helping Ukraine of any country in the world and has hawkishly pushed the EU to cut its reliance on Russian fossil fuel. Estonia has imported almost no gas from Russia since April 2022, and a legally binding sanction took effect on December 31.
Households immediately felt the impact of skyrocketing energy prices. The Estonian government provided direct support to consumers struggling with energy prices but did not provide support to businesses. As a key cost rose for Estonian businesses, so did prices across the board.
Estonian Foreign Minister Urmas Reinsalu has repeatedly urged the EU to lower its price caps on Russian crude oil and liquefied natural gas (LNG), saying the cap proposed by the United States was not low enough to meaningfully impact Russia’s war effort.
Finland’s first floating LNG terminal became operational earlier this year and has begun supplying Estonia gas via the underwater Baltic connector pipeline. Estonia already had the second highest carbon dioxide emissions per capita in the EU in 2020, and its decision to restart the very shale oil power plants it was planning to phase out due to their inordinately high levels of pollution will set back its efforts to decrease its emissions.
Estonia’s actions to reduce emissions have included a high profile move to make all public transport in the capital of Tallinn free in 2013 and a new hydroelectric energy storage facility that will also support its move to become independent of energy from Russia. It hopes to use 100 per cent renewable energy by 2030.
Estonia has accepted the largest share of Ukrainian refugees in proportion to its population of any EU country. Refugees from the war in Ukraine now make up over four per cent of Estonia’s population, substantially raising the country’s labour force to compensate pre-existing labour shortages.
Dr Tverdostup, whose research focuses on immigrant integration and gender inequality, says that by the start of 2023, over 40 per cent of these refugees have been able to find work in Estonia – a higher percentage than in almost any other European country – thanks to their educational and skill background and knowledge of English and Russian.
Companies are increasingly feeling the consequences of the energy crisis and high raw material costs, so Dr Tverdostup says labour shortages are no longer the limiting factor on business growth.
Estonia is a small country with a relatively low supply of labour and has long worked to increase its birth rate. However, generous maternity leave policies have incentivised Estonian women to spend more time doing the labour of child rearing which, Dr Tverdostup says, is a large part of why Estonia has the second largest gender pay gap in the EU.
Estonian mothers often work part-time jobs before returning to full-time work, but their formal employment experience upon returning to work is less than those of comparable men who did not take time off for parental leave. This, along with the domination of high-paying Estonian tech jobs by men, contributes to the gap; in 2017, only 29 per cent of Estonian tech employees were women.
The Estonian government has more recently introduced a system of parental leave that allows parents to share paid time off. However, Dr Tverdostup says the pre-existing wage disparity between genders still incentivises fathers—likely to already be making more—to continue working while the mother takes more time off, further perpetuating the inequity.
Gender equality has a strong positive impact on GDP per capita and job creation.
Outlook after March 5 elections
The Reform party of Estonia’s incumbent prime minister, Kaja Kallas, had a strong showing in the March 5 parliamentary elections. Coalition talks are ongoing between Reform and a current coalition partner, the left-leaning Social Democratic party, as well as a new party, Estonia 200.
With the exception of the far-right Conservative People’s party (EKRE), there is broad consensus on national security and the general direction of economic policy between Estonia’s major political parties. However, ahead of the elections, party leaders expressed differences of opinion about the tax system.
Reform and Estonia 200 both want to abolish the tax hump and return to a pure flat tax; the Social Democrats want those making over 3,000 euros a month to pay 25 per cent in income tax. Centre-right Isamaa was previously in a coalition with Reform and could be tapped again if negotiations with the Social Democrats and Estonia 200 fail; Isamaa is the only party that supports keeping the tax hump.
The Vienna Institute forecasts inflation will decrease to a still-high 8.8 per cent in 2023 due to tighter monetary policy and increased borrowing costs. Government support to families and businesses will drive slight economic growth of 0.9 per cent in 2023, and WIIW says growth will pick back up in 2024 and 2025.
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