Estonia

   

Economic Policies

#7
Key Findings
With a strong focus on fiscal discipline, Estonia scores well overall (rank 7) with regard to economic policies. Its score in this area has improved by 0.2 points 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 fallen. Employers are increasingly concerned about labor shortages. However, high tax rates on labor and strict immigration rules have prevented the country from attracting foreign workers.

Recent labor-market reforms have focused on bringing disabled people into the workforce. A broad new plan aimed at increasing labor-market flexibility was put on hold by the change in government. A separate plan is seeking to boost employment rates in borderland regions.

The flat income tax has been modified by a set of progressive income exemptions. Motor fuel and alcohol excise taxes have been increased to well above the EU average, although alcohol taxes were subsequently reduced. Budgetary discipline is strong, with public debt consequently very low. A money-laundering case involving foreign-owned banks has prompted stricter oversight.

Economy

#14

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 by the 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.

Labor Markets

#13

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
8
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 training measures was introduced 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 unemployment has decreased; employers are increasingly concerned about labor shortages. In 2018, the government initiated a strategic plan to adjust the labor law to the changing world of work. The plan envisaged increased flexibility, better regulation of fixed-term employment, expansion of tele- and platform work, and updated workplace safety regulations for digital jobs. Yet, the change of government in spring 2019 put these large-scale plans on hold. Instead, some local problems were addressed. To combat higher unemployment in borderland regions, a governmental program (2019 – 2021) was launched. It provides wage and training subsidies for employers who create new jobs in the northeast and southeast of Estonia. The regulation of migrant workers has been discussed several times, although no major changes have so far been introduced as a result of these discussions.

A 2019 report by the Praxis Centre for Policy Studies suggests that welfare support for unemployment people suffers from low rates of benefits and limited coverage. The lack of cover and short benefits period can encourage early retirement.

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 payout. The contribution rate has 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.

Citations:
Praxis Centre for Policy Studies (2019). Unemployment insurance benefits and unemployment allowance system analysis. Availiable at: http://www.praxis.ee/en/works/unemployment-insurance-system/

Taxes

#3

How effective is a country’s tax policy in realizing goals of revenue generation, equity, growth promotion and ecological sustainability?

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
8
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. Old-age pension benefits are subject to an additional tax exemption.

The Estonian welfare system is financed almost entirely (80%) 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 in 2017 – 2018 to levels well above the EU average, raising concerns about the competitiveness of Estonian enterprises. Estonia lost about €60 million in tax revenues in 2018 due to increased cross-border trade in alcohol and motor fuel. As a result of these developments, the excise on alcohol was lowered by 25% from July 2019.
Ecological taxes have not been a policy priority in 2018 and 2019.

Budgets

#12

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
8
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.

The current state of and forecasts regarding the future of social security funds in Estonia pose the largest risk to fiscal sustainability. At present, the national public pension fund runs a deficit equivalent to nearly 2% of GDP each year. The recent government decision to make second-pillar pension schemes voluntary and allow insured persons to withdraw savings prior to retirement poses a significant challenge to the government’s ability to secure citizens’ welfare while adhering to the principles of fiscal sustainability. The country’s Health Insurance Fund and Unemployment Insurance Fund lost autonomy over their significant reserves when the funds’ reserves were merged with the government liquidity reserves in 2011 – 2012. As a result, the government now draws on social insurance reserves to cover the government’s daily operating costs – a situation that has drawn criticism from the auditor general.

Research, Innovation and Infrastructure

#18

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
7
Research, development and innovation (RDI) are national development priorities, which are reflected in a sophisticated set of strategies and action plans, and bodies and taskforces. The outcomes, however, have been poor. The Estonian Research Council (ETAG) has stated that national strategies “have not triggered any significant changes in the R&D structures and strategies of universities or companies.” Public and private R&D expenditures have remained stagnant or even decreased; the shortage of funds remains one of the main obstacles to promoting RDI. At the end of 2018, all major political parties and higher education institutions signed an agreement that promised to increase public RDI expenditure to 1% of GDP over the next three years. However, half a year later, the government broke the promise and froze RDI expenditures at 0.71% of GDP for 2019 – 2021. In response, researchers, professors and several advocacy groups protested the decision, and warned that the freeze would negatively affect teaching and research.

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. The government policy toward this problem has been to encourage innovation and the transfer of scientific knowledge to enterprises via special grant schemes (NUTIKAS) by supporting collaboration between R&D institutions and companies.

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.

Citations:
ETAG (2019). Estonian Research 2019. https://www.etag.ee/wp-content/uploads/2019/04/Estonian_Research_2019_veeb.pdf (accessed 10.10.2019)

Global Financial System

#1

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. 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 recent years, the FSA has had a prominent role in combating money laundering in the Estonian financial sector. After evidence of money-laundering involving the Estonian branch of Danske Bank emerged, the FSA ordered Danske Bank to close its Estonian branch in fall 2019. Because of the Danske case, which has also implicated Estonia’s largest bank, Swedbank, the Estonian government introduced several measures to prevent similar cases in the future. One of the government’s key policy proposals is to make bank clients fully responsible for proving the legality of their funds. In cases of suspected money laundering or terrorist financing, the FIU analyzes and verifies information, taking measures where necessary and forwarding materials to the competent authorities upon detection of a criminal offense. The Anti-Money Laundering and Terrorist Financing Prevention Act was amended in 2017 and further changes are being planned.
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