Challenges to Estonia's Economic Policymaking at the Eve of EU Enlargement1

By Freytag, Andreas | Demokratizatsiya, Fall 2003 | Go to article overview
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Challenges to Estonia's Economic Policymaking at the Eve of EU Enlargement1

Freytag, Andreas, Demokratizatsiya

In the past decade, Estonia has undertaken remarkable and effective efforts to restructure its economy and prepare the factors of production for the challenges of the world market. Estonia proved itself as the reform country of Central and Eastern Europe with the most far-reaching and comprehensive reform package, leading to the fastest structural change in the region. It is fair to state that Estonia has matured enough to become a full member of the European Union.

As one-if not the decisive-part of the reform package, Estonia opted for rulebound policies, of which there are numerous examples. In monetary policy, it chose the most restrictive regime, with its own currency under the currency board system. In its ten years of existence, the board has provided the stability and liquidity necessary to finance the economic growth necessary to bring its economic welfare to Western European standards. The labor market is organized flexibly with very low minimum wages and almost negligible unionization. The board has fostered structural change, in particular the retreat of huge parts of the work force from agriculture and their inclusion in the service industries. In this respect, Estonia is far ahead of its Baltic neighbors, albeit with a very high rate of unemployment. Fiscal policy is characterized by the requirement to balance the public budget, at least over a cycle of a few years. Again this rule has proved binding and successful. Finally, the trade regime is unique in Europe-Estonia opted for unilateral free trade in the 1990s. In 1997, all barriers to trade were removed. Estonia has followed the post-World War II German economic policy model.

Nevertheless, Estonia will face even more challenges because of accession to the EU. The acquis communautaire requires a number of policy changes from accession candidates. Often, these changes are beneficial for the country. In the case of Estonia, this cannot be said of every element of the acquis. In particular, the transfer of CAP and the introduction of an admittedly moderate, but still in parts selective and distortive, trade policy will harm the country. Still, further integration will increase the division of labor and deepen the commitment to stability. The accession to the European Union will equip the country with additional funds, which can enhance structural change and trigger economic growth and convergence, if they are used properly. One option is to use EU funds to invest in the Estonian education system. This article will develop this argument by first introducing the intellectual framework used to analyze economic policymaking. Second, the remarkable success of the Estonian reform project to date will be briefly analyzed. Third, the requirements of the acquis will be introduced before we suggest a reform of Estonian education policy. Conclusions round off the paper.

Economic Policymaking under Constraints: The Intellectual Framework

The basic model applied in the context of Estonian economic policy can be characterized as a supply side model. It clearly follows the neoclassical assignment where each policy objective is assigned one mean and one agent.2 Put in a simplistic form, monetary policy is dedicated to price stability, fiscal policy to growth, and wage policy to employment. This policy program requires open markets, flexible factors of production, and governmental discipline. However, to safeguard economic policy objectives and to maintain discipline, stability, and flexibility, it is not sufficient to argue purely on economic aspects and to neglect political ones. The logic of politics demands for economic policy commitment, which is necessary to stabilize expectations and reduce the danger of time inconsistency in economic policymaking.

Commitment decreases the government's discretionary leeway for surprises, be it fiscal or monetary policy measures. The commitment mechanism is the choice of a set of rules or policy regime.

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