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.

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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.

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MPs Seema Malhotra and Stephen Kinnock lay out a 6-point plan for Brexit:

Time for Theresa May to lay out her priorities and explain exactly what “Brexit means Brexit” really means.

Angela Merkel has called on Theresa May to “take her time” and “take a moment to identify Britain’s interests” before invoking Article 50. We know that is code for the “clock is ticking” and also that we hardly have any idea what the Prime Minister means by “Brexit means Brexit.”

We have no time to lose to seek to safeguard what is best in from our membership of the European Union. We also need to face some uncomfortable truths.

Yes, as remain campaigners we were incredibly disappointed by the result. However we also recognise the need to move forward with the strongest possible team to negotiate the best deal for Britain and maintain positive relationships with our nearest neighbours and allies. 
 
The first step will be to define what is meant by 'the best possible deal'. This needs to be a settlement that balances the economic imperative of access to the single market and access to skills with the political imperative to respond to the level of public opinion to reduce immigration from the EU. A significant proportion of people who voted Leave on 23 June did so due to concerns about immigration. We must now acknowledge the need to review and reform. 

We know that the single market is founded upon the so-called "four freedoms", namely the free movement of goods, capital, services and people & labour. As things stand, membership of the single market is on an all-or-nothing basis. 

We believe a focus for negotiations should be reforms to how the how the single market works. This should address how the movement of people and labour across the EU can exist alongside options for greater controls on immigration for EU states. 

We believe that there is an appetite for such reforms amongst a number of EU governments, and that it is essential for keeping public confidence in how well the EU is working.

So what should Britain’s priorities be? There are six vital principles that the three Cabinet Brexit Ministers should support now:

1. The UK should remain in the single market, to the greatest possible extent.

This is essential for our future prosperity as a country. A large proportion of the £17 billion of foreign direct investment that comes into the UK every year is linked to our tariff-free access to a market of 500 million consumers. 

Rather than seeking to strike a "package deal" across all four freedoms, we should instead sequence our approach, starting with an EU-wide review of the freedom of movement of people and labour. This review should explore whether the current system provides the right balance between consistency and flexibility for member states. Indeed, for the UK this should also address the issue of better registration of EU nationals in line with other nations and enforcement of existing rules. 

If we can secure a new EU-wide system for the movement of people and labour, we should then seek to retain full access to the free movement of goods, capital and services. This is not just in our interests, but in the interests of the EU. For other nation states to play hardball with Britain after we have grappled first with the complexity of the immigration debate would be to ignore rather than act early to address an issue that could eventually lead to the end of the EU as we know it.

2. In order to retain access to the single market we believe that it will be necessary to make a contribution to the EU budget.

Norway, not an EU member but with a high degree of access to the single market, makes approximately the same per capita contribution to the EU budget as the UK currently does. We must be realistic in our approach to this issue, and we insist that those who campaigned for Leave must now level with the British people. They must accept that if the British government wishes to retain access to the single market then it must make a contribution to the EU budget.

3. The UK should establish an immigration policy which is seen as fair, demonstrates that we remain a country that is open for business, and at the same time preventing unscrupulous firms from undercutting British workers by importing cheap foreign labour.  

We also need urgent confirmation that EU nationals who were settled here before the referendum as a minimum are guaranteed the right to remain, and that the same reassurance is urgently sought for Britons living in mainland Europe. The status of foreign students from the EU at our universities must be also be clarified and a strong message sent that they are welcomed and valued. 

4. The UK should protect its financial services industry, including passporting rights, vital to our national prosperity, while ensuring that the high standards of transparency and accountability agreed at an EU level are adhered to, alongside tough new rules against tax evasion and avoidance. In addition, our relationship with the European Investment Bank should continue. Industry should have the confidence that it is business as usual.

5. The UK should continue to shadow the EU’s employment legislation. People were promised that workers’ rights would be protected in a post-Brexit Britain. We need to make sure that we do not have weaker employment legislation than the rest of Europe.

6. The UK should continue to shadow the EU’s environmental legislation.

As with workers’ rights, we were promised that this too would be protected post-Brexit.  We must make sure we do not have weaker legislation on protecting the environment and combatting climate change. We must not become the weak link in Europe.

Finally, it is vital that the voice of Parliament and is heard, loud and clear. In a letter to the Prime Minister we called for new joint structures – a Special Parliamentary Committee - involving both Houses to be set up by October alongside the establishment of the new Brexit unit. There must be a clear role for opposition parties. It will be equally important to ensure that both Remain and Leave voices are represented and with clearly agreed advisory and scrutiny roles for parliament. Representation should be in the public domain, as with Select Committees.

However, it is also clear there will be a need for confidentiality, particularly when sensitive negotiating positions are being examined by the committee. 

We call for the establishment of a special vehicle – a Conference or National Convention to facilitate broader engagement of Parliament with MEPs, business organisations, the TUC, universities, elected Mayors, local government and devolved administrations. 

The UK’s exit from the EU has dominated the political and economic landscape since 23 June, and it will continue to do so for many years to come. It is essential that we enter into these negotiations with a clear plan. There can be no cutting of corners, and no half-baked proposals masquerading as "good old British pragmatism". 

The stakes are far too high for that.