Why Estonia should not be our economic poster-boy

Estonia has much to recommend it, but a look at its recent economic history should give anyone pause

Baltic boosterism is back. Last week Fraser Nelson used his new Telegraph column to sing the praises of Estonia's economic performance, taking his cue from an earlier editorial in the Wall Street Journal which lavished praise on the small Baltic state for cutting spending and keeping taxes "flat and low". Estonia is growing fast -- motoring along at an annualised 8.4 per cent -- and proof positive according to Nelson that expansionary contraction works. It has cut its way back to prosperity.

Last time libertarians cheer-led for the Baltic states like this was when their flat taxes were in vogue, back in 2005. Flat taxes were said to be sweeping across Eastern Europe towards Berlin faster than the Red Army, as Germany's general election approached. George Osborne even briefly flirted with the idea -- until Gerhard Schroder tore chunks out of Angela Merkel's poll lead by demolishing her on the issue. The libertarians retreated wounded, to regroup and find a new line of attack.

Estonia is indeed a fine country. Its people are resilient and dynamic. Its government is open and transparent and it invests heavily in innovation. Like other Northern European countries, it has historically exercised fiscal prudence. It has much to recommend it.

But a brief look at its recent economic history should give anyone pause for thought. During the financial crisis, Estonia's GDP contracted sharply -- by over 5 per cent in 2008 and then a massive 13.9 per cent in 2009. Unemployment rocketed to nearly 17 per cent -- one of the highest levels in the EU. It is still very high at over 13 per cent.

estonia

 

Given such a deep loss of output, high unemployment and lower labour costs, one would expect rapid post-recessionary growth. But even then, much of Estonia's recent bounce back has been driven by increased exports, chiefly to its high performing social democratic neighbours. Meanwhile, inflation is high and consumer spending low, and GDP growth is now returning to a trend that is lower than before the crisis in 2008, in part because of the constraints imposed by euro membership.

That the balance sheet effects of the internal devaluations of the Baltic republics were not more severe was largely the result of negligible public debt before the crisis struck, as Roubini has recently spelled out:

The international experience of "internal devaluations" is mostly one of failure. Argentina tried the deflation route to a real depreciation and, after three years of an ever-deepening recession/depression, it defaulted and exited its currency board peg. The case of Latvia's "successful" internal devaluation is not a model for the EZ periphery: Output fell by 20 per cent and unemployment surged to 20 per cent; the public debt was -- unlike in the EZ periphery -- negligible as a percentage of GDP and thus a small amount of official finance -- a few billion euros -- was enough to backstop the country without the massive balance-sheet effects of deflation; and the willingness of the policy makers to sweat blood and tears to avoid falling into the arms of the "Russian bear" was, for a while, unlimited (as opposed to the EZ periphery's unwillingness to give up altogether its fiscal independence to Germany); and even after devaluation and default was avoided, the current backlash against such draconian adjustment is now very serious and risks undermining such efforts (while, equivalently, the social and political backlash against recessionary austerity is coming to a boil in the EZ periphery).

The Baltic republics are also curious poster-boys for British Eurosceptics, who generally favour the break-up of the eurozone, and positively urge Greece to default and bring back a devalued Drachma. It is doubly odd, therefore, that they should commend a country like Estonia for sacrificing everything on the altar of euro membership, particularly as it now has to contribute to eurozone bailout funds.

Still, when you're arguing for expansionary contraction, why let a little matter of intellectual consistency get in the way?

Nick Pearce is Director of IPPR

 

Nick Pearce is Professor of Public Policy & Director of the Institute for Policy Research, University of Bath.

Photo: Getty
Show Hide image

Forget planning for no deal. The government isn't really planning for Brexit at all

The British government is simply not in a position to handle life after the EU.

No deal is better than a bad deal? That phrase has essentially vanished from Theresa May’s lips since the loss of her parliamentary majority in June, but it lives on in the minds of her boosters in the commentariat and the most committed parts of the Brexit press. In fact, they have a new meme: criticising the civil service and ministers who backed a Remain vote for “not preparing” for a no deal Brexit.

Leaving without a deal would mean, among other things, dropping out of the Open Skies agreement which allows British aeroplanes to fly to the United States and European Union. It would lead very quickly to food shortages and also mean that radioactive isotopes, used among other things for cancer treatment, wouldn’t be able to cross into the UK anymore. “Planning for no deal” actually means “making a deal”.  (Where the Brexit elite may have a point is that the consequences of no deal are sufficiently disruptive on both sides that the British government shouldn’t  worry too much about the two-year time frame set out in Article 50, as both sides have too big an incentive to always agree to extra time. I don’t think this is likely for political reasons but there is a good economic case for it.)

For the most part, you can’t really plan for no deal. There are however some things the government could prepare for. They could, for instance, start hiring additional staff for customs checks and investing in a bigger IT system to be able to handle the increased volume of work that would need to take place at the British border. It would need to begin issuing compulsory purchases to build new customs posts at ports, particularly along the 300-mile stretch of the Irish border – where Northern Ireland, outside the European Union, would immediately have a hard border with the Republic of Ireland, which would remain inside the bloc. But as Newsnight’s Christopher Cook details, the government is doing none of these things.

Now, in a way, you might say that this is a good decision on the government’s part. Frankly, these measures would only be about as useful as doing your seatbelt up before driving off the Grand Canyon. Buying up land and properties along the Irish border has the potential to cause political headaches that neither the British nor Irish governments need. However, as Cook notes, much of the government’s negotiating strategy seems to be based around convincing the EU27 that the United Kingdom might actually walk away without a deal, so not making even these inadequate plans makes a mockery of their own strategy. 

But the frothing about preparing for “no deal” ignores a far bigger problem: the government isn’t really preparing for any deal, and certainly not the one envisaged in May’s Lancaster House speech, where she set out the terms of Britain’s Brexit negotiations, or in her letter to the EU27 triggering Article 50. Just to reiterate: the government’s proposal is that the United Kingdom will leave both the single market and the customs union. Its regulations will no longer be set or enforced by the European Court of Justice or related bodies.

That means that, when Britain leaves the EU, it will need, at a minimum: to beef up the number of staff, the quality of its computer systems and the amount of physical space given over to customs checks and other assorted border work. It will need to hire its own food and standards inspectors to travel the globe checking the quality of products exported to the United Kingdom. It will need to increase the size of its own regulatory bodies.

The Foreign Office is doing some good and important work on preparing Britain’s re-entry into the World Trade Organisation as a nation with its own set of tariffs. But across the government, the level of preparation is simply not where it should be.

And all that’s assuming that May gets exactly what she wants. It’s not that the government isn’t preparing for no deal, or isn’t preparing for a bad deal. It can’t even be said to be preparing for what it believes is a great deal. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.