Estonia - Economic Developments

Foreign Investment and Loans

Foreign investment in Estonia began during 1987-88 with the creation of several dozen joint ventures under the Soviet Union's early reform strategy. The number of joint ventures in Estonia grew steadily after April 1990, when Estonian authorities began registering joint ventures themselves. By January 1991, 232 joint ventures had been registered in Estonia; by October 1991, there were 313. Finland led in the number of joint ventures (159), but Sweden accounted for the most foreign capital in Estonia (35 percent). In mid-1990 foreign investment also started coming into Estonia via joint-stock companies--a more flexible form of ownership for both foreign investors and local capital. Joint-stock companies soon surpassed joint ventures as the prime attraction for foreign capital, totaling 803 by October 1991. In fact, many joint ventures later were converted into joint-stock companies. In September 1991, Estonia passed a new foreign investment law offering tax breaks (new ventures were granted a two-year tax exemption) and import-export incentives to foreign investors. This legislation stimulated further activity. In 1993 foreign investors were also given the right to buy land, but only through the purchase of privatized state enterprises. Non-Estonians could not own more than 50 percent of the equity in joint ventures without government permission.

In the summer of 1993, Estonia merged its two privatization firms, the State Property Board and the EERE, to create the Estonian Privatization Agency (Eesti Erastamisagentuur--EEA). The privatization of small enterprises was coming to a close, and the process needed to be consolidated. During 1991-92 the government sold 676 properties for a total of EKR64.3 million. By October 1993, another 236 small enterprises had been sold for a total of EKR169 million. Roughly 40 percent of these were in Tallinn. A total of EKR117.8 million had been garnered from the sale of the first thirty large-scale enterprises. According to an EEA official, these deals had secured some EKR52 million in investment and provided guarantees for 4,900 jobs.

Following the enactment of reform laws during 1989-90, the state budget in Estonia was broken into three parts: the central government budget, local government budgets, and nine extrabudgetary funds. In 1993 (the first year for which figures are provided entirely in kroons), the central state budget ran a surplus of EKR216 million on total revenues of roughly EKR4.2 billion (US$323 million). This surplus, however, was immediately spent in a secondary budget drawn up in October. The central budget included the financing of government operations (ministries, schools, police, cultural subsidies, and so forth) as well as roughly EKR500 million in aid to cities and towns. About half of the revenue for the central budget came from an 18 percent value-added tax (VAT--see Glossary) on most goods and services. Another 35 percent came from personal income and business taxes. Social welfare taxes on employer payrolls went directly into the state's extrabudgetary social welfare and health insurance funds, which amounted to slightly more than EKR2 billion. In all, general government taxes (including local taxes) in 1991 amounted to about 47.7 percent of GDP. Although successive governments pledged to reduce the overall tax burden, the transition was slow. In 1994 the previous three-tiered progressive tax scale was replaced with an across-the-board income tax rate of 26 percent. Estonia's central budget in 1995 was expected to total EKR8.8 billion, exceeding the 1994 budget and its supplements by EKR2.3 billion, mainly because of additional expenditures on social welfare, the civil service, the police, and the border guard. It was to be a balanced budget, nonetheless, for the second consecutive year. Various forms of taxation, including the income tax, an 18 percent VAT, and a corporate tax were to provide most of the revenue.

In a change of procedure, the government set up the Estonian Privatization Enterprise (Eesti Erastamisettev�te--EERE) to begin dealing with the direct sale of large-scale enterprises to foreign and domestic investors. The EERE was modeled after the successful German agency Treuhandanstalt, with which the EERE signed a cooperation agreement. In November 1992, the EERE offered its first thirty-eight enterprises for sale through widespread advertising in local and Western newspapers. Yet, scarcely ten days later, the newly elected prime minister, Mart Laar, halted the process. He claimed that several restitution claims were outstanding vis-�-vis the advertised properties and charged that the EERE had too much power. Although the controversy took some time to resolve, the EERE's program was back on track by 1993. In May it offered another fifty-four enterprises for sale; in November forty enterprises were put on the block. In each case, sealed bids were accepted by the EERE from foreign and local investors until a certain date. Thereafter, the EERE attempted to negotiate a sale with the highest bidder based on development plans for the new enterprise as well as promises to retain a certain number of employees. The early sale offers by the EERE attracted widespread interest. In April 1993, the Estonian parliament sweetened the incentive to bid by allowing foreign investors to buy the land underneath any privatized property, rather than rent. About half of the enterprises put up in the first two rounds found buyers. Often, however, enterprises were broken up, with only parts being sold off. Many initial sales secured guarantees of employment for up to 60 percent of the acquired enterprise's employees.

From the beginning, foreign capital was heavily concentrated in Tallinn. About 75 percent of the first joint ventures were established in the capital; in March 1993, it was reported that 87 percent of all foreign capital invested in Estonia was located in Tallinn and the surrounding area. Although the government hoped that lower property taxes and lower wages might eventually entice more foreign capital to southern Estonia, most investors continued to be drawn to Tallinn for its higher-quality communications, better-trained personnel, and broader transportation opportunities.

Although opposed to restitution, the government of Prime Minister Edgar Savisaar (1990-92) relented, with the stipulation that for any prewar property radically altered during the Soviet era, such as reconstructed factories, only compensation would be offered. In addition, persons currently in houses and apartments subject to restitution claims got assurance that they would not be summarily evicted by the previous owners. With these ground rules, in June 1990 the Supreme Soviet passed the Law on Property, legalizing various forms of property, including individually owned property. The government moved to create the State Property Board (Riigivaraamet) in August to supervise the privatization of at least small businesses and services, which would help to stimulate the economy. These enterprises mostly had been created during the Soviet era and thus were free from potential restitution claims. In early 1991, the board began selling off an estimated 3,000 such enterprises, among them small booths and shops, service outlets, and catering facilities. Initially, preference was given to employee buyouts, but public auctions later became the method of choice in order to speed up the process. By September 1992, out of a total of 855 enterprises approved for sale, 558 had been sold. Service enterprises proved easiest to sell, although retail establishments were not far behind.

Experimentation with large-scale privatization began in mid-1991. Two machine-building factories, as well as the Tallinn taxi depot, were chosen as the first properties to be sold. Preference again was given to employee buyouts, which in the case of large-scale enterprises, however, proved to be unwieldy because several competing groups emerged. The experimental enterprises soon became mired in controversy, and the policy of relying solely on local capital was abandoned. After the adoption of the new currency in mid-1992, privatization was reinvigorated.

Despite some individual warnings as to the cost and rationality of such a move, in December 1990 the Estonian Supreme Soviet adopted a resolution voiding the Soviet government's 1940 nationalization of property and recognizing the continuity of all prewar property rights. In addition, it set a deadline of December 27, 1991, for the submission of claims to local government authorities for the return of property or compensation. The authorities thereafter would decide upon the validity of these claims. In June 1991, the parliament passed a second law laying out the basic principles of property reform. Among this law's three explicit objectives was one calling for the "redress of injustice committed by the violation of property rights" under Soviet rule. More than 200,000 property restitution claims were submitted, and much work in municipal archives to verify the claims lay ahead.

Estonia's transition to a market economy during 1991-93 was eased considerably by the availability of more than US$285 million in foreign aid, loans, and credits. Receipt of this financial assistance was facilitated by the fact that Estonia, unlike many of the other countries of Eastern Europe, had no prior foreign debt. In addition, by claiming legal status as a formerly occupied country, Estonia, along with the other Baltic states, refused to accept liability for the Soviet Union's foreign debt. Instead, it claimed--and received the rights to--more than US$100 million worth of Estonian gold deposited in Western banks by the prewar republic and frozen after 1940.

By 1993 three property reform tasks remained. First, a wide variety of mostly unprofitable state enterprises had yet to be sold off. Second, the issue of how to provide compensation for prewar property claimants remained unresolved. Third, the process of housing privatization, in which the average resident was most interested, had yet to begin. These three tasks were all addressed in a Law on Privatization passed by the Riigikogu in June 1993. Throughout 1993 all adult residents had begun registering themselves and their work histories to qualify for a specific amount of national capital vouchers (rahvakapitali obligatsioonid --RKOs) based on their years of active employment and service to the economy. According to the new Law on Privatization, residents could use their RKOs toward the purchase of their apartments based on apartment values set by the government. If a resident lived in a house or did not wish to buy an apartment, he or she could buy into investment funds, which were to be the main players in the sale of remaining state property. In addition, individuals could invest in pension funds backed by the government. Finally, prewar property claimants who were due compensation for their losses were issued compensation securities, which they could use in any of the new investment modes. According to Liia H�nni, a former government minister, in 1992 the state still held about EKR36 billion worth of property, of which EKR7 billion worth was housing stock. An estimated EKR15 to EKR25 billion worth of RKOs would be issued, along with EKR12 to EKR15 billion in property compensation.

Wages and Prices

After the beginning of economic reform in Estonia, real wages dropped precipitously. From the fourth quarter of 1989, when the first price rises began, to the third quarter of 1991, when Estonia became independent, real wages fell by more than half. Food prices rose an estimated sevenfold as state subsidies were eliminated and the population received only partial government compensation for the higher prices. Fuel prices and apartment rents also increased. Inflation soared even more after independence as trade with Russia broke down even though Estonia remained in the ruble zone. In January 1992 alone, the cost-of-living index rose 88 percent, and in February it rose another 74 percent. The average rate for the year was 1,000 percent according to some estimates. Nominal monthly wages skyrocketed to keep pace, rising from 648 rubles in May 1992 to 3,850 rubles by May 1993.

In 1993 Estonia ran a trade deficit estimated at US$135 million. The trade balance deteriorated partly because of the strength of the kroon and partly because of a growing need for automobiles, agricultural products, and other essential goods. There was a 131 percent increase in imports from 1992 to 1993, compared with a 91.8 percent increase in exports. This imbalance was offset by a strong increase in services, leaving the country's current account in the black at EKR493 million. The trade deficit, however, continued to swell, reaching an estimated US$389 million in 1994.

Property Reform

Privatization, or the selling off of state property, represented the cornerstone of Estonia's efforts at property reform during 1990-93. Although growth in simple private enterprise during this period contributed to the country's shift to capitalism, the allocation to private initiative of state-owned resources ranging from factories to kiosks was considered a more formidable engine for encouraging economic recovery. Much of Estonia's economy had been developed in accordance with central Soviet planning requisites, and it was unclear at first how viable many of Estonia's machine-building and metallurgical factories would be in the context of its small national economy. The fate of these enterprises remained unclear in the mid-1990s. In the meantime, however, Estonia had launched a successful small- and medium-scale privatization program, which showed impressive results after only two years. By August 1993, more than half of all registered Estonian enterprises were privately owned.

As of December 1, 1993, Estonia's official unemployment rate was still very low, 1.7 percent, or 14,682 people. This figure represented the proportion of working-age people officially registered as unemployed with the government's Employment Board and hence receiving unemployment benefits. During the second half of 1993, unemployment had in fact steadily declined from a high of 22,699 in May. In addition, the number of people on unpaid or partially paid leave declined during the first half of the year. By contrast, however, more people were reported working part-time, most often with their full-time workweek having been reduced to three or four days. These people were not included in the official figure. The highest official unemployment rates in December 1993 were in the towns of the southeast (V�ru, 5.3 percent; P�lva, 4.8 percent) and the northeast (Narva, 4.4 percent). Tallinn posted the lowest unemployment rate (0.2 percent), with just 594 registered jobless people. In 1994 official unemployment peaked at 2.3 percent in April, then fell steadily to a rate of 1.4 percent in November, the lowest rate among the Baltic states.

As in many other East European countries, property reform in Estonia was intimately linked to issues of property restitution. In Estonia's case, this meant the return of, or compensation for, property nationalized by the Soviet regime in 1940. Estonia's political strategy for independence, with its stress on the illegality of Soviet rule, raised corollary questions and debates during 1989-90 about the legality of the Soviet Union's early nationalization of the economy. The principle of a political restoration of the prewar republic also generated pressures to recognize a kind of economic restoration--recognition of the right of previous property owners to reclaim their property or at least to receive just compensation. This, it was argued, was a simple matter of fairness to society. Thus, the tension between the equally compelling needs for efficient privatization and for judicious restitution was acute. If one accepted the necessity of fostering new economic activity, the imperative to privatize was clear. Yet, in selling off state property, the government was in danger of wrongfully profiting from the sale of property taken from Estonian citizens in 1940. Determining which property could be privatized and which property might have claims on it soon became a legal tangle with long-term consequences.

Foreign Trade

An integral part of Estonia's transition to a market economy during the early 1990s involved reorienting foreign trade to the West and attracting foreign investment to upgrade the country's industry and commerce. In 1990 only 5 percent of Estonia's foreign trade was with the developed West, and of this, only 21 percent represented exports. About 87 percent of Estonia's trade was with the Soviet Union, and of that, 61 percent was with Russia. In 1991 trade with Western and other foreign countries fell further as available hard currency for imports dried up and as many producers of Estonian exports had to cut output because of a lack of raw materials. Although trade with Russia struggled on during the first half of 1991, trade relations broke down after independence was attained in August. New agreements were signed in December 1991, but precise licensing procedures and bilateral trade quotas took several more months to work out. This delayed shipments of fuel and raw materials to Estonia, causing a severe economic crisis.

Among individual countries, Sweden continued to lead all others in both overall value of investments and as a percentage of total foreign investment--37.7 percent in 1993 (see table 10, Appendix). Both the Norwegian company Statoil and the Finnish firm Neste also were heavily involved in the national economy, building gasoline stations across Estonia. Tallinn's premier hotel, Hotel Palace, was owned by the Estonian-Finnish consortium Fin-Est. In 1992 Coca-Cola set up a joint venture with the Estonian bottling plant AS Tallinna Karastus-joogid to produce soft drinks for the Estonian and Russian markets. In 1993 a four-story office building, the Tallinn Business Center, was opened by a United States development group.

Although the initial success of the kroon was gratifying, many fiscal challenges remained that threatened to upset monetary policy in the future. Among these was a high enterprise tax debt to the state. In December 1992, this debt, mostly unpaid revenue taxes from large state firms, amounted to about EKR565 million. A year later, this sum had fallen to roughly EKR400 million, but the possibility that the state might need to use its own funds to bail out these ailing firms remained. Another danger to monetary stability was posed by the possible collapse of several private banks in Estonia. In November 1992, the Bank of Estonia ordered the shutdown of three private banks because of insolvency. One of these was the Tartu Commercial Bank, which in 1988 had become the first private bank to be founded in the Soviet Union. Bad loans, increased competition, and poor management were expected to force other bank closures, with which the state would have to deal.

Employment

The complexion of the Estonian labor market changed rapidly in the early 1990s in the wake of property reform and the growth of private enterprise. In 1990 some 95 percent of the labor force was employed in state-owned enterprises or on collective farms. Only 4.3 percent worked in private cooperatives or on private farms. In 1993 a public opinion survey indicated that less than half of the respondents now received their main income from a state enterprise. As privatization continued and the privately owned share of production increased, the share of state employment was expected to drop even more. Industry (in both the public and the private sectors) employed about 33 percent of workers in 1990; agriculture, 12 percent; education and cultural activities, 10 percent; construction, 10 percent; and trade and catering, 9 percent. The remainder of the labor force engaged in a variety of other activities in the services sector (see table 7, Appendix).

Economic developments

The new Estonian currency became the foundation for rational development of the economy. Money began to have clear value; the currency supply could be controlled from Tallinn, not Moscow; and long-term investment decisions could be made with greater confidence by both the state and private enterprise. The president of the central bank, Siim Kallas, made "hard money" the benchmark of his policy. In return, the bank saw its reserves grow rapidly, to US$184 million by the end of 1992 and US$365 million by December 1993. The central bank was independent of the government but subordinate to the parliament. In addition to its president, the bank was managed by a board of directors, whose chairman was also appointed by parliament.

The official unemployment figures, however, did not tell the whole story. The unemployment rate was based on the working-age population (about 880,000 people), not the smaller number of active persons in the population (about 795,000). In addition, the figure did not include unregistered jobless people. In general, the low level of unemployment benefits also discouraged many people from even registering as unemployed. In October 1992, unemployment benefits in Estonia were reduced from 80 percent to 60 percent of the minimum monthly wage. Benefits were paid for 180 days with the possibility of a ninety-day renewal. In 1993 the government allocated EKR90 million for an expected 40,000 unemployed but ended up disbursing only EKR30 million because of the low number of registered jobless people. Still, in the final quarter of 1993, the Economist Intelligence Unit estimated that the real level of unemployment was as high as 10 to 12 percent.

During 1992-93 Estonia received a total of about US$125 million in humanitarian aid, including emergency shipments of fuel, grain, and medical supplies. In August 1992, Estonia signed its first memorandum with the IMF to secure a US$32 million loan from the IMF and US$30 million from the World Bank (see Glossary). The memorandum obligated the Estonian government to balance its budget, to limit wage increases, to privatize state enterprises, and to maintain a strict monetary policy. Fourteen months later, the IMF released the first US$16 million of its loan to Estonia, after it was satisfied that the government has maintained its economic reforms. In early 1992, Estonia also had become a member of the European Bank for Reconstruction and Development, from which it would later receive a total of US$46 million in loans for improving its energy industry. Other foreign loans were received from Japan, the United States, Sweden, and the European Union (see Glossary), among others (see table 11, Appendix). In addition, in December 1993 the European Investment Bank gave Estonia a credit worth 5 million European currency units (ECUs--see Glossary) for loans to small businesses. The credit was the first from an ECU200 million fund allocated to Baltic states through the European Union's Poland/Hungary Aid for Restructuring of Economies (PHARE) program.

The introduction of the Estonian kroon in June 1992 proved decisive in stabilizing foreign trade. By the third quarter of 1992, Estonia experienced strong growth in foreign trade, finishing the year with an EKR136 million surplus. The total volume of trade amounted to nearly EKR11 billion, two-thirds of that coming during the second half of 1992. Moreover, by the end of the year, the very structure of Estonia's foreign trade had begun to change. European countries accounted for 56 percent of Estonia's trade in 1992. While 28.4 percent of Estonia's imports continued to be from Russia, 22.6 percent now came from Finland. In 1993 Finland surpassed Russia as a source of Estonia's imports, 27.9 percent to 17.2 percent. The two countries were roughly equal as a destination for Estonian goods, both accounting for just above 20 percent in 1992 and 1993 (see table 8, Appendix). Textiles constituted Estonia's leading trade article in 1992, accounting for 14 percent of exports. Among imports, Estonia primarily continued to receive mineral products (27.2 percent) and machinery and equipment (18.3 percent) (see table 9, Appendix).

The introduction of the kroon in June 1992 did much to stabilize wages and inflation. In 1993 increases in the consumer price index averaged about 3.0 percent per month; in 1994 they averaged 3.5 percent per month. The average monthly wage settled around EKR500 in August 1992. Thereafter, it began a steady climb, reaching roughly EKR1,200 by the end of 1993. Yet, according to Arvo Kuddo, an official of the Bank of Estonia, real wages in mid-1993 still amounted to only 95 percent of their June 1992 levels and barely 50 percent of their levels from early 1991. In the meantime, wage differentials between the highest- and lowest-paying jobs grew markedly, from 3.4 times to ten times. According to the Estonian State Statistics Board, in mid-1993 the top 10 percent of wage earners received 32.9 percent of all income, while the bottom 10 percent received only 2.1 percent. Residents of Tallinn had the highest average monthly wage, some 20 percent above the national average. Personal savings also declined during this period. In December 1992, 41 percent of survey respondents said they had no significant savings at all. In 1993 some 17 percent said they were behind in paying their utility bills for lack of money.

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