HOW AND WHY ESTONIA EMBRACED AUSTERITY

ESTONIA: A CASE STUDY 

RYAN BOURNE 

 Estonia provides a clear case-study of a country which has fully embraced austerity within a fixed exchange rate structure.
 An unsustainable boom between 2004 and 2007 began unravelling as Nordic banks tightened lending conditions due to concerns about private sector debt levels, and this was exacerbated by the 
international crisis in 2008.
 Faced with an economic crisis and shrinking tax revenues, the IMF forecast that Estonia would have a budget deficit of more than 10% of GDP in 2009 on unchanged policies. 
 With many private sector debts denominated in euros and a political commitment to joining the euro currency, Mr. Jürgen Ligi took the helm at the Ministry of Finance. 
 He cut government spending drastically, explaining that the surging revenue growth during the boom (2000-2007) had resulted in pro-cyclical expend 
 Unable to devalue its exchange rate, the only way to eliminate the current account imbalance and improve competitiveness was through internal devaluation. 
 In all two-thirds of the consolidation was done on the expenditure side and onethird on the revenue side. The scale of the Estonian cuts meant a decline in total nominal spending between 2008 and 2010 of 10%. 
 This did, of course, weaken output in the short term. Combined with the global downturn, unemployment peaked at around 20% in early 2010. 
 But since then, on several measures the Estonian programme appears relatively successful: 
 unemployment has fallen back to just over 10% today  the government met its deficit target – 
it never exceeded 3% of GDP – and was back in surplus by 2010  the economy rebounded with 3.3% growth in 2010 and 8.3% growth in 2011. 


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Estonia proves that it’s possible to cut spending 

and continue to grow

RYAN BOURNE

THE on-going Eurozone crisis proves all those who highlighted the design flaws of the single currency were right. They said it would be impossible to maintain common competitiveness between disparate economies like Germany and Greece without fiscal transfers. The result would be significant and damaging imbalances. This was not inevitable, but it was always unlikely the Southern European states would achieve the lasting structural reforms required to make it work. So it proved.

The Spanish austerity measures announced yesterday, for example, highlight how the Southern countries are now belatedly undertaking internal devaluation policies to try to restore competitiveness. But the political failure to liberalise during the good years has meant that these are proving excruciatingly painful. The scale of the adjustment required is economically damaging and politically toxic for national governments and the European project.

In this context, it has proven easy for many Keynesian economists to use the example of the Southern European countries to suggest that austerity in the wake of the downturn is always “self-defeating”. We have a “demand problem”, they say, and the public finances and ballooning debts can only be sorted once growth returns.

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