EKIP– Expert Club for Economics and Politics A Different Opinion
The years of transition can be characterized with many epithets, including “controversial”, “uncertain”, “disappointing”, and perhaps someone with a more optimistic view of the period would use words like “successful”, “dynamic” or “inevitable”. However, one thing stood out as an irrefutable trend during these years, and these are precisely the long lists of promises that politicians made to potential voters, but rarely managed to fulfill for one reason or another. And while in Bulgaria every reform was planned and implemented painfully and slowly, a small country from the former socialist camp showed that in fact the path to Western economies can be far shorter and painless.
Situated on the Baltic Sea, Estonia has a number of strategic advantages. The country is located in a highly competitive region that includes countries such as Finland and Sweden, known for their egalitarian social systems and high ratings for the business environment and competitiveness of the economy. Estonia's key location makes it a key link with Russia, and the possibility of year-round use of its ports makes it a desirable trade destination compared to its server neighbors. However, geographical advantages are far from the only, nor are they the main prerequisites for Estonia becoming the second fastest growing country (after Poland) in Central and Eastern Europe over the past 20 years.
After a period of political upheaval and uncertainty, Estonia managed to gain its independence in 1991. Suddenly, the horizons went beyond the borders of the union, and the newly formed republic felt a pressing need to create a constitution, democratic institutions and a judicial system [1]. Infrastructure was lacking, and the banking system was far from Western standards. The main trading partner (Russia) was largely lost, and this contributed significantly to the severe recession, accompanied by high inflation and unemployment in the early 1990s.
Despite the negative prospects for the new Baltic Republic, political leaders managed to find a solution to the problems and put the economy back on track. A number of reforms were carried out in the 1990s (Figure 1). A currency board was introduced, with the local krona pegged to the German mark. Targeted actions were taken to build a transparent government, and a priority in the first years of the transition was to open the economy to international trade and foreign investment. Tax reform was also not late, with the key elements being the transition to VAT (18%) and flat income (26%) and corporate (26%) taxes. Trade agreements were signed with the EU and the countries of Central and Eastern Europe, and negotiations began for accession to the EU, NATO, and the World Trade Organization (WTO).
Chart 1: Main reforms carried out in Bulgaria and Estonia during the transition (1991-2008)
Building a modern economy from the perspective of the former socialist countries includes a mandatory privatization process. It is here that Estonia manages to achieve an enviable result. The process is carried out through auctions using the best price method, with a large part of state-owned enterprises being bought out by foreign investors. In addition to the direct benefits for the business environment from the “know-how” imported directly from Western economies, successful privatization becomes a source of funds with which the government is able to start building a modern infrastructure. Significant investments are made in a number of areas, including education, science and the IT sector. Despite increased government spending, the country manages to maintain its fiscal discipline, and to this day maintains its external debt at levels below 10% of GDP, and deficits after 2000 are rather an exception [1].
The results were not long in coming. The economy began to develop at an exceptional pace, with the average annual growth for the period 1996-2012. being close to 5% (Graph 2). Moreover, the rapid recovery after the recessions in 1999. and 2008-2009. shows that Estonia has managed to build an economy that is flexible to the business cycle. The key lies in the favorable business environment. After the first ten years of the transition, Estonia occupies the 4th position in the world in terms of freedom to do business and the 1st position in terms of freedom to invest [2]. Combined with the entrepreneurial spirit of the population and their reputation as hardworking employees, this inevitably leads to an improvement in the country's competitiveness. In the first edition of the "Global Competitiveness Report" (2006-2007), Estonia ranked 26th (behind Belgium and Luxembourg), while Bulgaria remained far behind - in 74th position (behind countries such as Namibia and Egypt).
Chart 2. Change in real GDP of Bulgaria and Estonia (1996-2014), %
Source: Eurostat
With a closer look at the reforms carried out by the political elite in Estonia, we will come to the conclusion that most of them were also observed in Bulgaria during the transition in one form or another. So how did Estonia become an example for developing economies, while Bulgaria is increasingly mired in its structural problems? There are several reasons:
Timeliness and speed. The Estonian government managed to launch reforms immediately after gaining independence. Moreover, the speed and efficiency with which they acted helped them to implement the most important changes within the first 2 years of the transition (currency board, tax reform, launching the privatization process and opening the economy to trade and investment) and lay the necessary foundations for economic development.
Goal setting and consistency. The political elite has set itself a clear long-term goal – joining NATO and the EU. Despite growing doubts and dissatisfaction among the population about these goals, the ruling elite is consistent in their pursuit.
Coordination. Effective coordination between the public and private sectors is essential for building a competitive economy. Unlike the difficult implementation of this coordination in Bulgaria, where it is largely focused on issues related to limiting competition in a given industry, the rulers in Estonia manage to “understand” the needs of the private sector. An excellent example of this is the efforts to improve the telecommunications and IT sectors. Among the measures taken, it is difficult to find the well-known subsidies and long-term protectionism. On the contrary. Estonians practically “invented” e-government, introduced electronic ID cards and electronic voting, built a new IT university in response to the shortage of qualified labor in the sector and created joint public-private initiatives to promote Internet services. Interestingly, all this happened between 2000-2002.
Estonia is an excellent example of how taking timely and targeted actions, combined with successful coordination between the state and the private sector in the context of building a competitive business environment, leads to enviable results in the foreseeable future. Moreover, the new leaders in the country managed to eradicate corruption in its infancy on the eve of independence, forming a government that is not overshadowed by the shadow of former political leaders. At the other extreme is the unfortunate Bulgaria, where corruption found its footing in the 1990s, a desire for effective reforms is difficult to detect, changes occur too slowly, there are no specific long-term goals, and populist promises continue to dominate among the ruling elite. Estonia is proof that the statement “we are small and dependent on others” is more of an excuse than a sustainable argument. The small Baltic country in northeastern Europe has shown that the key to improving living standards is not more aggressive social policy, but building a competitive economy, a process that is entirely achievable under conditions of fiscal discipline.
