Academic journal article Demokratizatsiya

Free Trade in the 1990s: Understanding Estonian Exceptionalism

Academic journal article Demokratizatsiya

Free Trade in the 1990s: Understanding Estonian Exceptionalism

Article excerpt

Every economist is familiar with the theory of international trade and learns to appreciate the merits of economic openness. As noted by the leading trade economist Paul Krugman, "if there were an Economist's Creed it would surely contain the affirmations 'I understand the Principle of Comparative Advantage' and 'l believe in Free Trade.'" (1) In reality, trade is almost never free. Countries levy tariffs, quotas, and countervailing duties; negotiate voluntary export restraints; launch anti-dumping proceedings; and impose various kinds of regulatory barriers to trade. Although there has been substantial liberalization of trade in recent decades throughout a number of countries (most notably in some emerging markets), genuine free trade has been achieved only in some exceptional cases, such as Hong Kong. In other words, there is generally a stark discrepancy between economic theory and political reality.

Estonia in the 1990s defies this generalization. The early adoption of a free trade regime, which was sustained throughout the 1990s, made Estonia somewhat akin to a European Hong Kong. This raises what I have elsewhere called the "Estonian puzzle." (2) At the end of the 1980s, Estonia was part of the Soviet Union and the economy was managed by central planning. Economic interaction with the West was minimal. As part of a package of radical market-oriented reforms, Estonia adopted unilateral free trade--abolishing tariffs on all imports, including agricultural goods--and reoriented its economic relations completely within a few years. Reforms in other areas of international economic relations were equally far-reaching and included liberalization of the foreign direct investment regime, current and capital account convertibility, and the introduction of a currency board, which has been sustained at the original parity for more than a decade.

The purpose of this article is to understand the emergence and sustainability of this remarkably open economic order and, more specifically, the free trade regime. After an overview of Estonian economic reforms with a focus on foreign economic policy in the 1990s, I turn to a political economic analysis of the factors leading to the adoption of free trade. In this context the free trade regime is also interpreted as part of a classical liberal policy package. (3) The next section discusses the likely effects of European Union (EU) accession on Estonian trade policy, and is followed with a final section of conclusions.

Estonia in the 1990s: Unilateral Liberalization on All Tracks of Foreign Economic Policy

The Estonian economy underwent profound and rapid changes in the 1990s. At the start of the decade Estonia was a constituent republic of the USSR and fully integrated into Soviet central planning. Production and investment decisions were determined largely by union-wide central planning, and economic relations with foreign countries were managed by foreign trade associations. Estonian exports outside the Soviet Union constituted about 2 to 3 percent of its GDP in the second half of the 1980s, with two-thirds of that going to other COMECON countries. (4)

Political independence was restored in 1991 amidst an escalating economic crisis. The breakup of the Soviet economic system left the small Baltic markets in a very vulnerable position. Their most important export market, the rest of the former Soviet Union, collapsed. Independence also imposed adverse terms of trade shock on a large scale as a result of massive and sudden price increases on energy imports. In the Baltic region as a whole, GDP declined by 40 percent and industrial production by 60 percent between 1990 and 1994, accompanied by hyperinflation in 1991-92. (5) Moreover, given the presence of Soviet troops and sizeable Russian-speaking minorities (especially in Latvia and Estonia), there was significant political uncertainty. The conditions at the outset of economic transition were therefore worse for the Baltic states than for the East Central European states that were part of the Soviet sphere of influence without actually being part of the Soviet Union. …

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