As Estonia recovers from the crisis, it remains optimistic

TALLINN - The experts’ view on the current state of Estonia’s economy is overall positive. While not yet reaching pre-crisis levels, recovery from the economic downturn of 2008 is progressing at a pace that is consistent with optimistic predictions. There are several reasons why. Olavi Grunvald, Deals Manager at PricewaterhouseCoopers, and Jaanus Tamm, CEO of Defendec, a firm specializing in high-tech surveillance equipment, credit the favorable conditions to exporting goods abroad. “Estonia did have luck in having strong foreign trade partners in Sweden and Germany, as well as Finland and Russia,” Grunvald stated.

The introduction of the euro is expected to contribute to the economy, and is already doing so by inspiring confidence and slightly lowering transaction costs. “Euro adoption will be setting Estonia apart from other Baltic countries and will result in strong foreign direct investment inflow, especially from the Scandinavian countries. Additionally, I think [the recovery is largely due to the] austerity measures the government carried out in 2009,” stated Kristel Kivinurm-Priisalm, managing partner of Avaron Asset Management. 

Unfortunately, unemployment remains extremely high, and continues to be problematic. It peaked at 19.8 percent in the first quarter of 2010, according to a Bloomberg report, and has been slowly but steadily declining, with the current rate hovering around 17 percent and a predicted 2012 rate of 13.6 percent.

The decline is not as fast as most would like, though. Tamm believes that the unemployment problem is more structural and fundamental than it appears. “Reports I have seen show that most unemployed people do not have a [good] education and do not have useful skills. [There are] too many construction workers. I believe that our future is [in] educated people and highly valued skilled employees, [because in my sector, advanced defense technology] we lack experienced candidates.”
Yet even highly trained entry-level candidates are finding the employment market challenging. This of course is a global problem. Peter Carter, Her Majesty’s Ambassador to Estonia, points to statistics of youth unemployment in the United Kingdom, where 20 percent of university graduates of Spring 2010 remain unemployed. In this respect, Estonia is not unique.

However, Estonia is slightly more vulnerable to unemployment of young professionals in a recession because of its size. In the legal industry, for example, the unemployment rate is high, and the turnover rate is extremely high – an annual 25 percent. Risto Vahimets, a partner at Tark Grunte Sutkiene, a leading Tallinn law firm, attributes this phenomenon to the loss of large transactions which accompany a booming economy. With fewer large legal transactions there is less need for attorneys. Specifically, these are young and inexperienced lawyers who typically work in groups under a senior lawyer to handle a large case. Without sufficient practical experience to handle smaller transactions on their own, these young professionals are often left without work. 

As the economy recovers the unemployment rate should normalize, and there are indicators that this is already happening. Kivinurm-Priisalm states that “EU funds could make up to 5-6 percent [of Estonian] GDP for [fiscal year] 2012-2013, compared to the average estimated 3.4 percent.  Around 1.5 billion euros will be [allocated by the government] to the real estate and construction industries in the next 2 to 3 years, thus enabling a recovery of those sectors.” People are confident in the government’s fiscal policy, which helps domestic investment and consumer confidence.

In the future, however, success for Estonia lies in niche markets. HMA Carter explains that “Estonia has a small population, therefore, a small work force. That work force is well educated, but [Estonia] is never going to be the location of large manufacturing. Estonia is no longer a low-cost country. It is not high, either, but it is no longer low-cost. So, my observation is that Estonia should focus on niche areas where Estonia either has, or can, develop expertise. Biotechnology certainly, certain medical devices, particularly those that contain an IT component, some areas of manufacturing, like chemicals, adding value to the timber that grows here through furniture-making. If you look at some of the other niche factors that Estonia has developed, you will see ship building or ship repair. Particularly small, specialized shipyards. Other things which Estonia is already doing is making use of its expertise in oil shale extraction to other markets elsewhere in the world.” 

Risto Vahimets seconds forestry and IT, and adds transit to and from Russia as growth possibilities. However, he warns against global ambition. “IT is frequently mentioned, and it is not a bad choice for growth, but I think that politicians’ talk of Estonia assuming a global role is unrealistic.” So is attempting to enter every market and field in order to achieve visibility within the European Union. Michael Haagensen, managing director at Refiner Translation Bureau, pointed out the inconsistency of focus. “The government has stated that it wants to generate a knowledge-based economy, but so far it has focused its efforts on measurable input in order to prove to Europe that it is investing in the right things. I feel it should be focusing more on measurable output. It seems logical for Estonia to focus on a selection of its most promising industries, rather than spreading support funding too thinly, and tie active support for these industries to measurable outcomes, such as unique developments, international patents, scalable added value, and export volume, to name a few. Once a few eggs in the basket have hatched, and the economic benefit starts to flow in, the government can move on to supporting a broader selection of industries.”

Kivinurm-Priisalm agrees. “What will be the main drivers of the economy? In which sectors can Estonia be competitive in Europe and in the world? Unless the government decides [to heavily endorse and promote] 5-7 sectors, I do not think we will become among the five richest nations in Europe, as our prime minister likes to predict. Estonia needs to think of itself like a company, and small companies cannot compete in all fields.”

There was for some time a perception that Estonia has moved beyond subcontract work and should enter more value-added fields of business. Now, there is some reconsidering of this view. “That attitude was arrogant,” admits Vahimets. “The manual work involved in some subcontracts is complicated and technical, and we should not look down on that. As in sports, we should build on our strengths rather than spend all our time attempting to compensate for our weaknesses. The strength of Estonia is undoubtedly in niche markets that require specialized knowledge,” he says.
For future growth, the fundamentals are there. HMA Carter points out that Estonia is among the top 30 countries, according to

Transparency International’s world transparency index, which measures the lack of, or presence of, corruption. “That is a very significant achievement, to achieve this level of openness in society,” Vahimets notes, indicating the great respect for the rule of law. “Sometimes Estonians are more German than the Germans, in this respect,” he adds. This too is a great advantage for a young and small economy. It reassures foreign investors and keeps the local investors from venturing abroad for safety and security of assets.

Euro adoption is a very positive indicator and sets Estonia apart from the other Baltic countries. It is predicted to cause a strong foreign direct investment inflow as well as indirect cash flow from related industries, such as tourism. Education is encouraged and is accessible to the population. Additionally, Estonia has a linguistic advantage. English is widely spoken and a large percentage of the population speaks Russian, which is a clear advantage in doing business regionally. So, what does Estonia need to recover from the recession and become a successful economy that can serve as an example within the EU? HMA Carter sees the primary resource to exploit to be public relations. “The problem, I would say, is that not enough people and not enough businesses know about Estonia. And that’s something which I think needs correcting. It’s a matter of messaging, of making sure that those who represent Estonia are constantly beating the drum for Estonia, talking it up when they are overseas. The example I give is that if you look at London, it still is arguably the world’s financial center. Yet it still puts a huge effort into promoting itself. The truth is that London faces competition from New York, Frankfurt, Hong Kong. And it can’t afford not to continue to promote itself for all its worth. Otherwise, business would go elsewhere. And if London needs to do that, Estonia certainly needs to do that.” 

Vahimets jokes that what Estonia needs is to become much larger, with a very long history of independence and stability. “Realistically, that’s not possible and Estonia is doing what it can. A somewhat negative aspect of joining the eurozone and emulating the Nordics is that Estonia is beginning to be somewhat overregulated in certain areas, such as registration and notarization. A lot of new laws are being implemented. I personally do not like the tendency of legislature and the Ministry of Justice changing the economy by making rules. Some laws of economics are as strong as the laws of physics, and I wish court judgments would be more understanding of economic reality. [When we joined the eurozone] we had a very idealistic view of Old Europe and of what it meant to be Europeans, so we implemented every EU law and accepted all EU guidance. But when you look at countries like Spain and Greece, and compare their compliance with EU laws, such as the smoking bans and the issuance of purchase receipts in shops, it is clear that Old Europe is not as orderly as we had imagined.” 
Kivinurm-Priisalm is optimistic and believes that investors are underestimating Estonia’s ability to bounce back. She thinks that Estonia can surprise investors with an annual growth rate of above 5 percent, much higher than conservative analysts estimate, if the government formulates a clear strategy for the future. She sees Estonia as a small but industrious enterprise that needs clear guidance. 

But the possibility for such success is there.  There is broad consensus that the future will be brighter, and that business will recover and grow. Avaron, an asset management company with a focus on Central and Eastern European listed equity investments, hopes to quadruple its current 100 million euros of investor assets in the next 10 years. Grunvald expects PwC to grow with the growth of the Estonian economy. He says that “The structural unemployment will certainly have its impact on the growth potential in the coming years – there is a lack of employees with required qualifications. But, hopefully, the training measures applied by the state will ease it.”

With the issue of skilled professionals and unemployment, Estonian youth is naturally looking abroad for education and employment opportunities. Asked whether this seemingly benign phenomenon can lead to problems known as a “brain drain” later on, the respondents did not deem it likely. “Estonians have looked for work since independence in 1991, but they come back,” HMA Carter stated, adding that “Estonians did return from abroad during the boom years. The labor market was at that time full, and employers were chasing employees for a time. When you talk to young Estonians, they are interested in going abroad for experience as well as to earn money, but most of them have no intention of leaving Estonia permanently. They want to come back here, sooner or later. I have met many Estonians who had gone abroad for work and have then taken a conscious decision to come back. And if you look at senior management, in both public and private areas, you will see that this is true as the CVs of senior management attest to work and education outside of the country.” 

Estonia has reason to be very optimistic for its future. It has reason to be cautious and focused as well, but if it focuses on niche markets, utilizes the advantages brought by the adoption of the euro, and actively promotes itself - something that culturally is contrary to the Estonian mindset - an economic recovery will not be far behind.