Estonia

Highlights

• Economic expansion is accelerating. Following a slow-down in 2015, GDP growth has been gaining momentum since 2016. Investment growth, which turned positive only in 2017, and robust private consumption will likely boost GDP growth further.
• Digital Europe and the free movement of data are key priorities in Estonia’s EU presidency. Estonia is chairing the work of the European Council during the second half of 2017 and the focus on an open and innovative European economy builds on the country’s reputation as one of the world’s most digitally advanced countries.
• Several changes to the pension system have been introduced. Among others, the retirement age will be tied to average expected life expectancy from 2027 onwards, a solidarity-based first pillar will be introduced from 2037, and special pensions for some professions will be abolished from 2020.

Key priorities for 2018

• The government should continue with its efforts to address the labour shortage issue. After several good labour market policies have been introduced, such as the work ability reform, further efforts to mobilise labour supply for the private sector remain necessary. For example, some labour resources could be freed up from the public sector or more immigration from outside the European Union (EU) could be allowed.
• A successful implementation of administrative reform will likely deliver substantial efficiency gains. The already-undertaken local government reform is aimed at a more efficient tasks distribution between municipalities and local government as well as at implementing the local government’s financing scheme.
• Cooperation between business and academia should be further enhanced. While Estonia substantially outperforms its regional peers in innovation, the still-low level of business investment in technological development and weak research and development commercialisation remain challenges for productivity growth and for increasing the value-added of exports.

Main macroeconomic indicators %

Macroeconomic performance

GDP growth is gaining momentum. Following a sharp slow-down in 2015, GDP growth accelerated somewhat to 2.1 per cent in 2016 and further to 5.2 per cent in the first half of 2017. This year, investment growth has turned positive for the first time since 2013 (see below). Private consumption, which was the key growth engine over the last four years, has been gradually superseded by strongly recovering investment and exports.

Investment growth has picked up. Investment started to recover at a rate of 17.6 per cent during the first half of 2017, after registering a cumulated contraction of above 12 per cent during 2013-16. A gradual rise in EU funds utilisation from the current EU budget is expected to boost public investment, further supported by fiscal loosening in 2017 and 2018. Amid strong private credit growth and improving external demand, private investment is also likely to rebound in the near term.

Employment rates are booming. An increase in the effective pension age, rising real wages and the recent government’s active labour market policies (see below) have resulted in historically high employment rates. In the first half of 2017, the employment rate reached 75.5 per cent (20-64 age group), placing Estonia among the highest countries on this measure in the European Union.

The fiscal balance is expected to turn slightly negative in the short term. In 2016, public finances saw a marginal budget deficit of 0.3 per cent of GDP. However, starting from 2017, the new State Budget Act, adopted by the parliament in June 2017, allows the government to run temporary structural budget deficits of up to 0.5 per cent of GDP in a single year in the account of previously accumulated structural surpluses, but still targeting structural balance in the medium term. Higher fiscal spending is expected to finance government investment programmes as well as some new programmes in healthcare, education, social funding and in local governments. At the same time, public debt is expected to remain below 10 per cent of GDP.

Strengthening investment is expected to boost GDP growth. Amid substantial recovery in both public and private investment, GDP growth will likely accelerate to 3.7 per cent this year and 3.4 per cent in 2018. The impact of recovering external demand on GDP will be somewhat neutralised by strong investment-driven imports. The main downside risks are associated with a possibly weaker-than-expected recovery in Finland and Russia as well as low shale oil prices.

Major structural reform developments

Changes to the pension system are ongoing. In January 2017, the ruling coalition agreed to make substantial changes to the pension system. First, the retirement age will be tied to the expected average life expectancy from 2027 onwards. Second, a solidarity-based first pillar will be introduced from 2037, in which the insurance component would be replaced by a length of service component, exclusively dependent on the number of years worked. And third, special pensions for some professions, such as military, prosecutors and police would be abolished from 2020. The draft bill is expected to be ready at the beginning of 2018.

The government has agreed to sell stakes in four state-owned enterprises. In April 2017, the government approved a decision to list 30 per cent of the Port of Tallinn in the first half of 2018. Also, the railway company EVR Cargo, the road construction company Eesti Teed and Eesti Energia’s sustainable energy division are scheduled to be sold through initial public offerings. More details will be announced by the end of 2017. The government believes these operations would revive local financial markets by providing new opportunities for residents and local institutional investors to invest in Estonia.

Estonia’s EU presidency is to give a strong push towards Digital Europe and the free movement of data. During its presidency, which started in July 2017 and will last until the end of the year, Estonia’s priorities include the promotion of an open and innovative European economy, EU security, ensuring free movement of data and fostering an inclusive and sustainable Europe, mainly by modernising the rules to promote labour mobility. As Estonia is one of the world’s most digitally advanced countries, especially in terms of e-governance and e-residency, the digital transformation and cross-border movement of data, in particular in the context of e-health, are expected to top its presidency’s agenda.

The first offshore wind farm project is moving forward. In August 2017, the council of the Hiiu municipality signed a cooperation agreement with Nelja Energia, the Estonian wind energy developer, to build an offshore wind farm near Hiiumaa island in the Baltic Sea. According to the plans, the offshore wind farm would comprise 100 to 160 wind turbines with an aggregate capacity of 700 to 1,100 MW. Construction is expected to start in the second half of 2018. With a renewable energy share of 27.9 per cent in 2015, Estonia has already exceeded its 25.0 per cent target for 2020. Nevertheless, the national energy development plan, which was adopted by the government in October 2016, targets renewable energy to account for 50.0 per cent of total electricity consumption by 2030, with renewables to cover 80.0 per cent of the entire heat production by that time.

Perception of corruption remains the lowest in the region. In the 2016 Corruption Perception Index prepared by Transparency International, Estonia moved up one position to 22nd, which is ahead of all EU new member states. By and large, the corruption-related risks have been effectively reduced through the well-developed e-services sector. Today, all voting can be done online and about 95 per cent of tax returns are being completed in this way.

The government has introduced further active labour market policies. Following the successful introduction of a reforms package in January 2016 aimed at bringing more workers with disabilities into the workforce, a new employment programme was approved by the government in November 2016, which aims to provide fresh measures to help people stay active in the labour market. In particular, it concentrates on excluded groups such as people lacking specialised education or having outdated education, those lacking a good command of the Estonian language, and people older than 50 years of age. The shrinking working-age population and labour skill-mismatch remain the key challenges for further productivity growth of the Estonian economy.

Estonia Country Assessment