In Estonia, renewed economic convergence will require stronger productivity growth

Notwithstanding Estonia’s success in the ICT sector, policies are needed that boost digitalisation, innovation, and skills across firms, including through enhancing cooperation between the public and private sector to raise investment in innovation.

The Estonian economy had been hit hard by Russia’s war of aggression against Ukraine and the resulting energy price shock that put the country into recession. Economic activity is now slowly recovering and Estonia faces the challenge to durably return to stronger, more inclusive and more sustainable growth, according to the latest Organisation for Economic Co-operation and Development (OECD) Economic Survey of Estonia.

The OECD is expecting Estonia’s GDP to contract by 0.4 per cent in 2024, after contracting by 3.1 per cent in 2023, before returning to growth (of 2.6 per cent) in 2025.

The modest recovery will be driven by stronger demand for exports, higher public investment, and lower interest rates. Inflation is poised to ease from 9.1 per cent seen in 2023 to 3.9 per cent in 2024 and 2.1 per cent in 2025.

Risks are nevertheless tilted to the downside: weaker than anticipated developments in export markets or worsening geopolitical tensions could undermine the recovery.

The OECD’s survey highlights the need for prudent fiscal policy to balance stabilisation of the economy with narrowing the government budget deficit. It notes that fiscal policy provided important support during the pandemic and the global energy price surge.

While government debt has risen sharply, it remains the lowest in the OECD, at 19.6 per cent of GDP. Estonia’s expenditures have increased due to higher spending on defence, healthcare and family benefits. A fiscal consolidation strategy for 2024-27 will be hampered by the slow recovery and weak growth prospects.

The survey also states that progress needs to be made in boosting productivity, preparing the health system for the fiscal pressures of an ageing population and advancing the climate transition.

Renewed economic convergence with more advanced economies will require stronger productivity growth. Notwithstanding Estonia’s success in the ICT sector (the country is again expected to top Emerging Europe’s IT Competitiveness Index, due to published later this month), policies are needed that boost digitalisation, innovation, and skills across firms, including through enhancing cooperation between the public and private sector to raise investment in innovation, given that spending on research and development, at 1.8 per cent of GDP in 2022, remains moderate.

More funding needed for healthcare

Health and life expectancy in Estonia have improved significantly over the past two decades, but years spent in good health are still among the lowest in the OECD.

Avoidable mortality—notably from heart disease and cancer—remains elevated, outcomes for older men and people on low incomes are particularly weak, and regional disparities are still high.

In a tight budgetary environment, achieving further improvements in health outcomes against the background of an ageing population will likely require additional funding.

While the OECD finds that the health system is well designed and provides good incentives for the use and allocation of resources, there is scope to improve treatment and prevention, and better prioritise resources.

Training more nurses and doctors will help ensure continued access to healthcare for Estonia’s citizens.

A carbon-intensive economy

Due to its continued reliance on domestic oil shale and increasing emissions in several sectors, the Estonian economy remains carbon-intensive. Accelerating the climate transition—by reducing 2005 greenhouse gas emissions by half by 2030—will require ambitious decarbonisation across the economy.

Policy priorities should include upgrading the electricity grid to accommodate increased renewable energy, efforts to reduce vehicle emissions by introducing the planned vehicle tax, and expansion of public transport.

Estonia’s finance minister, Mart Võrklaev, believes that the OECD’s recommendations are, “very much in line with what we ourselves know, that the fiscal situation is difficult”.

“We need to continue with the austerity measures as well as the tax reforms that we have already undertaken to reduce the budget deficit,” he said.

Photo by Jacques Bopp on Unsplash.

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