According to Business Week, as the US was embarking on a US$787bn stimulus package in 2009 Estonian authorities decided to march in the opposite direction and avoided running budget deficits and borrowing money to try and trigger higher growth levels. In order to maintain a balanced budget the government employed a contractionary fiscal policy and did the following:
- they froze state pensions
- lowered salaries by 10%
- raised the tax on goods and services by 2%
As a result of this:
- GDP in Estonia fell by 14% in 2009
- Unemployment in rose to 16%
GDP grew by 7.5% and unemployment down to 10.8% which is still worrying but not as bad as Spain or Greece. However, Estonia has shown that a contractionary monetary and fiscal stance by government does lead to economic hardship but does in the long run generate growth. The IMF praised the country’s export-led recovery and its sought after fiscal position. A lot of Estonia’s success has been its desire to become part of the west since it regained independence in 1991 after the collapse of the USSR and joined the European Union in 2004. The country employed free market policies and with an open, efficient, and wired infrastructure the World Bank ranks it 24th out of 183 countries in “The Ease of Doing Business Index” – see graph.
One area that Estonia is very different than its European counterparts is their ability to follow through on prudent measures. The average salary in Estonia is 10% below the minimum salary in Greece. Furthermore pensions are also much lower and civil servants retire 15 years later. Although the graph below shows the peak of the boom in 2007 Estonian economists believe that this was fueled by cheap household credit and not realistic growth. Whilst the growth from 2010 – 2011 came from mainly exports and therefore seen as genuine. Their belief is “no pain, no gain”.
Another interview with Paul Krugman this time with Paul Solman of PBS. Krugman describes the events in 2008 as the Wile E. Coyote moment – a character in the Road Runner cartoons. That is, according to the law of cartoon physics, it is only when you look down that you realise that there is nothing below. Krugman likens this to the situation where housing bubble had started to burst and banks called in loans to be repaid.
But when everyone everybody tries to pay down debt at the same time what happens is the economy shrinks, prices of assets fall and people lose their jobs, people lose their income, profits crash, and everybody ends up being in a worse financial position than they were before because they’re, they’re… When everyone tries to do it at the same time, the result is mutual destruction.