Ardo Hansson, Eesti Pank 5 April 2014 A financial forum organised by The European House – Ambrosetti in Italy http://www.ambrosetti.eu/en/news/2014/financial-markets-workshop

1. AGENDA FOR EUROPE:
WHICH OF ESTONIA’S SUCCESS FACTORS CAN BE USEFUL FOR
OTHER EUROPEAN COUNTRIES AND THE EUROPEAN UNION
Ardo Hansson
Eesti Pank
5 April 2014

2. What are the features that have led to
success in Estonia’s economic development?
a) Strong economic growth over the last 20 years
b) Resilience to adverse shocks, especially during the global economic and
financial crisis in 2008-09
c) Speedy adjustment and recovery in the aftermath of the financial crisis
At the same time, important insights for other countries may be gleaned
from the less successful moments in Estonia’s economic
development, especially from the unsustainable boom prior to the global
crisis

3. (A) During the last 20 years Estonia has
experienced strong economic growth
Average annual economic growth 1996-13 (%) GDP per capita in PPS 1996-2013 (EU-28=100)
Source: Eurostat
0
1
2
3
4
5
6
European Union (28
countries)
Euro area (18
countries)
Central/Eastern
European (11
countries)
Estonia
0
20
40
60
80
100
120
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
European Union (28 countries)
Euro area (18 countries)
Estonia

4. Determinants of Estonia’s economic growth
Source: World Economic Forum Global Competitiveness Report 2013-14
Rank Rank
out of all 148 countries out of EU-28
Global Competitiveness Index (total) 32 12
Basic requirements (21.7%) 26 11
Institutions 27 11
Infrastructure 40 19
Macroeconomic environment 22 3
Health and primary education 29 15
Efficiency enhancers (50.9%) 30 13
Higher education and training 23 10
Goods market efficiency 30 12
Labour market efficiency 12 2
Financial market development 35 9
Technological readiness 29 15
Market size 99 26
Innovation and sophistication (28.3%) 35 14
Business sophistication 51 18
Innovation 31 13

5. However, Estonia experienced an
unsustainable boom prior to the global
financial crisis, followed by a severe recession
The boom in 2004-2007 was accompanied by:
1) large current account deficits/capital inflows;
2) strong credit growth;
3) rapid increases in asset prices;
4) deterioration in cost/price competitiveness.
Economic growth, current account balance
and unit labour costs
Loan growth and change in real estate
prices (%)
Source: Eurostat, ECB
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Economic growth (%)
Current account balance (% of GDP)
ULC-REER (%)
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Loan growth Change in real estate prices

6. (B) During the severe recession the
Estonian economy showed a high
degree of resilience
Cumulative decline (peak to trough) in GDP in selected euro area
countries in 2007-2013 (%)
Despite a very severe recession in 2008-09 Estonia did not experience a systemic
financial crisis and did not need to apply for international financial assistance
-30%
-25%
-20%
-15%
-10%
-5%
0%
Estonia Latvia Greece Ireland Portugal Cyprus Spain
Source: Eurostat

7. Factors of resilience (I):
Lower levels of private and public sector
indebtedness
0
20
40
60
80
100
120
140
2007 2013
Euro area
Estonia
0
10
20
30
40
50
60
70
80
90
100
2007 2012
Euro area
Estonia
Bank credit to households and firms (% of GDP) Public sector debt (% of GDP)
Source: Eurostat, ECB

8. Factors of resilience (II):
well-capitalised banks;
limited size of the financial sector
Ratio of capital and reserves to total assets (%) Ratio of MFI total assets to GDP (%)
Source: Eurostat, ECB
-
50
100
150
200
250
300
350
2007 2013
Euro area
Estonia
0
2
4
6
8
10
12
14
16
18
2007 2013
Euro area
Estonia

9. (C) Speedy adjustment and recovery:
GDP and unemployment
75
80
85
90
95
100
105
t0 t2 t4 t6 t8 t10 t12 t14 t16 t18 t20
Estonia
EA-4
0
5
10
15
20
25
t0 t2 t4 t6 t8 t10 t12 t14 t16 t18 t20
Estonia
EA-4
GDP after the cyclical peak in 2007-08 (GDP at
cyclical peak=100; quarterly data)
Unemployment (%, t0 = cyclical peak in GDP
during 2007-08; quarterly data)
Note: EA4 consists of Ireland, Greece, Spain and Portugal
Source: Eurostat

10. Speedy adjustment and recovery:
External and fiscal adjustment
Current account balance (% of GDP) Fiscal balance (% of GDP)
Source: IMF, World Economic Outlook
Database, October 2013
-20
-15
-10
-5
0
5
2007 2008 2009 2010 2011 2012 2013
Estonia
EA-4
-16
-12
-8
-4
0
4
2007 2008 2009 2010 2011 2012 2013
Estonia
EA-4

11. Speedy adjustment and recovery:
Deleveraging
Net international investment position (% of GDP) Loan to deposit ratio (%)
Source: Eurostat, ECB, Eesti Pank
0
50
100
150
200
250
2007 2012
Estonia
EA-4
-120
-100
-80
-60
-40
-20
0
2008 2013
Estonia
EA-4

12. Speedy adjustment and recovery:
the role of wage flexibility and
productivity growth
90
95
100
105
110
115
120
2008 2009 2010 2011 2012 2013
Real unit labour costs Nominal output per person empoyed
Nominal wage costs per employee
Real unit labour costs, whole economy (2008=100)
Source: Statistics Estonia
Cost competitiveness was mostly restored via strong productivity growth
and to a lesser extent via downward (nominal) wage adjustment.

13. Fiscal consolidation in Estonia in
2008-2010
Fiscal consolidation in Estonia was front-loaded (consolidation measures amounted to about 10%
of GDP: 2/3 on the expenditure side and 1/3 on the revenue side).
The fiscal consolidation strategy had the following components:
1) Protection of the most vulnerable groups;
2) Broad-based reductions in current expenditures;
3) Reduction of wages in the public sector;
4) The phasing in of structural reforms.
0%
5%
10%
15%
20%
25%
30%
35%
40%
2008 2009 2010
Social protection (% of total government expenditure)
Social protection
(% of total government expenditure)
Headline and structural budget balance
(% of GDP)
Source: Eurostat, Eesti Pank
-8%
-6%
-4%
-2%
0%
2%
4%
2007 2008 2009 2010 2011 2012
nominal budget balance structural budget balance

14. 14
The advantages and disadvantages of a
sharp adjustment rather than a gradual one
Disadvantages of a sharp adjustment:
- an overreaction might force ‘viable’ firms out of business, leading to
losses in physical and human capital;
- it is politically difficult if the electorate is not informed or is reluctant;
- the high speed of adjustment might lead to mistakes in economic policy.
Advantages of a sharp adjustment:
- a shorter period of high uncertainty weighing on economic
activity, especially on investment decisions;
- faster closure of ‘non-viable’ firms and elimination of unsustainable
businesses and activities
- avoidance of reform fatigue;
- avoidance of excessive accumulation of public and private debt.

15. What can be learned from the unsustainable
boom in Estonia before the global financial
crisis?
1. A strong external anchor in the form of a credible fixed exchange rate
arrangement might lead to policy complacency
2. The build up of imbalances and vulnerabilities created by the
amplification channels of the economy needs to be addressed early and
decisively (e.g. through more active use of fiscal and macro-prudential
measures). Under a fixed exchange rate regime/monetary union some of
these channels might be especially strong (e.g. the real interest rate
channel associated with the asset price/credit channel)
3. Overall, the experience of the euro area has demonstrated that in a
monetary union there is indeed a stronger need for policy discipline in
other economic policy areas

16. Which of Estonia’s success factors can
be useful for other EU countries
Estonia has been successful thus far in ensuring relatively high growth and
strong resilience in the economy.
Both of these achievements have been strengthened by:
- Strong fiscal policy discipline;
- Flexible labour markets;
- Relatively low levels of indebtedness (especially public sector
indebtedness);
- Well capitalised banks and the limited size of the financial sector;
- Extensive sustained structural reforms;
- Strong and prompt policy responses to adverse shocks.