Monday, May 27, 2013

The Estonian Miracle, repeatable?

Today I was reading about Estonia's economy and trying to find out what makes it so different from let's say, Greece. We have been taught by the media the past three years that the reason that the Mediterranean nations are failing economically is because they are part of the big bad Euro. However, when one looks at the information on unemployment across the Eurozone one finds that there is a wide range of unemployment ranging from 4.7% in Austria, to 14% in Ireland, and Greece is by far an outlier at 27%, the only country in Europe currently above 15% unemployment. This is really different from what the media have been implying, and compared to all countries in Africa, every European nation, including Greece, is doing extremely well in terms of unemployment. The current status of Greece nullifies the argument that Estonian economic growth is a direct product of austerity because the same claimed means of Estonia's growth are being used in Greece with the opposite effect. There is more to this story.

So, what is so different about Estonia? Well, Bloomberg spilled the beans, they are talking about massive private investment in Estonia going on right now. The equation is quite simple. Businesses move into Estonia and hire Estonians, Estonians work and have money to spend, their spending helps Estonian businesses grow by raising the demand curve, unemployment and productivity improve. The reduction of public investment in Estonia is being offset by private investment. What is happening in Greece in terms of the private sector is quite the opposite in fact. Greece and Estonia have both been practicing austerity. The difference is that while Estonia has seen the private sector come in reaction to a high credit rating and low corporate taxes, people have been fleeing Greece and their banks have run out of money, hurting the chances that they will be able to fund new businesses to put Greeks to work, which reduces one of the four major sectors of the economy (government, financial, consumers, producers/retailers).

I do agree the majority of the economy should be on a free market, I do agree with free trade balanced with human rights protections, and I think some parts of the economy that are naturally oligopolistic need to be regulated or controlled by a democratic government. The Estonian miracle is only repeatable so long as there is enough domestic and foreign investment to offset the collapse of the government's role in the economy.

The only questions remaining has to do with the implementation of a flat 20% income tax in Estonia, the only flat income tax in the world. My question is how is it going to effect their currently relatively equal distribution of wealth and how is that going to effect future growth if my concern of a less equitable economy is realized. What is going to happen to their quality and cost of health care and education in the long term if they are privatized? How much of this economic growth is being seen by the average Estonian? Only time will tell, but my knowledge of American economic history doesn't leave me optimistic.

One lesson however is clear, in the short term it doesn't matter where investment comes from after a recession, there must be investment. However, I am not certain on the effect it will have on distribution of wealth and the quality and cost of public goods. Only time will tell, and I am pessimistic about the long term because of the great potential of a skewed distribution of wealth if economic growth is only felt by a small percent of the population in the long-term which could offset growth if it is not balanced by making sure the doors of opportunity are open for all regardless of income.

The more I study economics the more I realize how balancing different pros and cons is critical, there is no one policy that works all the time, and no one absolute driver to economic growth. It is all about balance. One must counteract an excess of collectivization with privatization and an excess of privatization with some more collectivization. Bubbles must be avoided, economic growth must be positive. Even GDP growth is not isolated because it must be taken in relation to population growth. GDP per capita growth is a more useful metric, because if a country with negative population growth saw a negative GDP growth their GDP per capita growth could in fact be positive. The economist must then look at distribution of income which in the long run is a marker to determine long term stability. Estonia's case is just one more example of how it is critical for economists to look at the whole picture, not just their favorite statistic.

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