Estonia

   

Economic Policies

#10
Key Findings
With a strong focus on fiscal discipline, Estonia scores well overall (rank 10) with regard to economic policies. Its score in this area has improved by 0.1 point since 2014.

Growth rates have been consistently strong in recent years, echoing upturns in the global economy. Employment levels have increased, and long-term unemployment rates have decreased. However, high tax rates on labor and strict immigration have remained major obstacles to attracting needed foreign labor.

Recent labor-market reforms have focused on bringing disabled people into the workforce. A new strategic plans aims to better balance labor supply and demand, increase labor-market flexibility, and transition to more remote work. The changes remain controversial, and will be debated through 2019.

The proportional income tax has been modified with a set of progressive income exemptions. Motor fuel and alcohol excise taxes have increased to well above the EU average. Budgetary discipline is strong, with public debt consequently very low. Anti-money-laundering bodies have played a prominent role in the financial sector in recent years.

Economy

#21

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
7
As an EU member state, Estonia forms its economic policy in accordance with EU strategies and has adopted a reform program, “Estonia 2020,” that describes a set of objectives intended to improve the national economy’s competitiveness. Its two central objectives are the increase of productivity and employment. The implementation of economic and innovation policy is the responsibility of the Ministry of Economic Affairs and Communications. In parallel, the Ministry of Education and Research develops and coordinates implementation of the national R&D strategy. These two strategies are supposed to be complementary but duplication and lack of synergy between ministries have been continuous problems. Similarly, labor policy falls under the purview of the Ministry of Economic Affairs, Ministry of Education and Ministry of Social Affairs. Due to growing labor shortages, the Ministry of Interior, responsible for immigration, has also become an important actor in economic policy.

The global economic climate has been mostly favorable in the period under review. This trend is echoed in improved performance of the national economy. Yet, high tax rates on labor and strict immigration policies prevent Estonia from attracting the foreign labor urgently required due to Estonia’s aging population. The sharp increases in motor fuel and alcohol excise duties since 2015 have met heavy criticism, as the increases boost cross-border trade and make Estonian businesses vulnerable.

Labor Markets

#5

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
9
Recent labor market reforms have focused on the employability of disabled people in order to expand labor supply and increase the sustainability of pension funds. The Unemployment Insurance Fund and EU resources have been used to extend active labor market policy measures and implement the 2016 Work Ability Reform, which aims to bring at least 10% of the country’s disabled population into employment. A new set of proactive measures was introduced in 2017 – 2018 (e.g., the Work and Study Program) to help workers with limited or outdated skills to upgrade their qualifications.

Helped by these reforms and favorable economic developments, employment levels have increased and long-term unemployment has decreased. However, low-skilled employment remains high and low pay is common. The government has responded to in-work poverty and low pay by extending tax credits for low-paid workers. In 2018, the government initiated a strategic plan to adjust the labor law to the changing world of work. To balance labor supply and demand, the government envisages increased flexibility, better regulation of fixed term employment, a transition toward more tele- and platform work, and updated workplace safety regulations for digital jobs. In general, the plans have been warmly welcomed by employers, but more cautiously welcomed by trade unions. Nevertheless, substantial debates and parliamentary proceedings on amending the Employment Contracts Act will likely start in fall 2019.

The national Unemployment Insurance Fund is in good financial shape, having accumulated significant reserves due to the relatively high contribution rate, a strict eligibility criteria and a low level of benefit payouts. The contribution rate have been fixed for the period 2017 – 2020 (0.8% of an employer’s payroll and 1.6% of an employee’s wages), which provides some stability to labor demand.

Taxes

#19

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
7
Estonia is internationally recognized for its straightforward and transparent tax system. In 2018, the principle of perfect proportionality in personal income tax was dropped by making the personal tax-free allowance dependent on a tax-payer’s level of income. The allowance is more generous for low earners and is gradually removed for high earners. Neoliberal opponents have claimed that the reform constitutes a veiled move from a proportional to a progressive income tax.

The Estonian welfare system is financed almost entirely through social insurance contributions. This Bismarckian principle has both advantages and weaknesses. First, high labor costs may weaken the country’s economic position and can lead to labor relations abuses. Second, social insurance contributions alone cannot provide sufficient financing for social services given an aging population and changing work patterns, which destabilize social tax receipts. The public pension funds have persistently accumulated debt, and the health insurance fund is under long-term financial austerity. Major reforms of both health and old age financing are being discussed.

In contrast to stagnant social taxes, motor fuel and alcohol excises have increased rapidly to levels well above the EU average, raising concerns about the competitiveness of Estonian enterprises. According to some estimates, Estonia lost about €60 million in tax revenues in 2018 due to increased cross-border trade in alcohol and motor fuel. The government put further increases of excises on hold in response to these projections.

Budgets

#9

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
9
Estonia has followed a strict fiscal policy for decades. As a result, the country has Europe’s lowest public debt as a percentage of GDP and is able to meet future financial obligations without placing extra burdens on future generations. Although a small budget deficit has appeared in recent years, it will disappear by 2020 according to current forecasts. The overall tax burden has remained fairly stable, despite the increase in excise duties in recent years.

Government transfers to municipal budgets, which were substantially cut during the economic recession, are being gradually restored. Combined with the radical administrative reform in 2017, which merged small and fiscally vulnerable municipalities into significantly larger entities, this promises to provide broader and better quality public services at the local level. However, the long-term debts of the health insurance and public pension funds pose significant future challenges to the government’s ability to secure citizens’ welfare while adhering to the principles of fiscal sustainability.

Research, Innovation and Infrastructure

#21

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
6
Research, development and innovation (RDI) are national development priorities, reflected in a sophisticated set of strategies and action plans, and bodies and task forces. The outcomes, however, are poor. Public R&D expenditures remained stagnant between 2016 and 2019, while private sector expenditure amounted to about 40% of total expenditure with no evidence that this share will increase. This is partly explained by EU programming periods as well as the need to increase military expenditures, but crucially also by the government’s lack of a clear policy vision. Estonia is one of the few countries worldwide that does not have tax exemptions for enterprise-led R&D activities, nor is there any R&D related risk sharing between public and private sectors. High costs and high risks undermine private sector motivation for investing in R&D.

R&D policy measures have been much more successful in developing scientific research, as indicated by an increased number of highly ranked international publications and the improved international rankings of Estonia’s major universities. Advances in the development of patents, high-tech products and services are noticeable but less prominent. R&D personnel are increasingly concentrated in higher education and cooperation with businesses remains limited. Recent changes in research funding policy strongly motivate universities to establish R&D contracts with the private sector. However, this approach discriminates against the social sciences and humanities, which typically serve public and non-profit sector institutions. Total funding for research from the state budget has consistently attracted criticism from universities. However, all main parties pledged to significantly increase research funding at the end of 2018.

Global Financial System

#3

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
8
Estonia actively participates in developing and securing financial stability and transparency in global financial markets. Estonia is a member of the Council of Europe’s Moneyval monitoring body. In 2014, Estonia passed a Moneyval assessment, which involved an on-the-spot inspection, having registered good progress on the implementation of Financial Action Task Force (FATF) recommendations. Several domestic bodies have been established to combat money laundering, such as the Governmental Committee for the Coordination of Money Laundering Prevention, the Financial Intelligence Unit (FIU) and the Estonian Financial Supervision Authority (FSA). The FIU is an independent unit of the Estonian Police and Border Guard Board, and the FSA is an independent body that supervises all financial sector participants. In the recent years, the FSA has had a prominent role in combating money laundering in the Estonian financial sector. In 2018, in cooperation with the European Central Bank, the FSA revoked the banking license of Versobank (a small Estonian bank) following on-the-spot inspections. After many years of attempting to engage Danish counterparts regarding potential weaknesses within the anti-money laundering (AML) controls of the Estonian branch of Danske Bank, the FSA conducted two very thorough on-the-spot inspections of Dankse Bank’s Estonian branch in 2014. These inspections led to the closure of nearly all services to business and private clients of the Estonian branch in 2018. The FSA’s actions led to the disclosure that the bank branch may have passed up to €200 billion in transactions that are likely to have violated AML controls. Based on the Danske case, in 2018, the Estonian government undertook several measures to prevent similar cases in Estonian financial system. One of the government’s key policy proposals is to make bank clients wholly responsible for proving the legality of their funds. The FIU analyses and verifies information in case where money laundering or terrorist financing are suspected, taking measures where necessary and forwarding materials to the competent authorities upon detection of a criminal offence. The Anti-Money Laundering and Terrorist Financing Prevention Act was amended in 2017 and further changes are being planned.
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