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So, Quo Vadis, Estonia?

A few weeks ago I had the honour to moderate a discussion session between President Tomas Hendrik Ilves and an international group of wealthy and successful people who have become, for various reasons "Estophiles". I too count myself a full paid up "Estophile", since I have been interested and indeed involved in the idea of a free Estonia almost all my adult life.

The President asked a question: "After we have achieved so many things: freedom, independence, a democratic society, growing prosperity, membership of NATO, membership of the European Union, membership of the OECD, joining the Euro in January 2011, what are the things that we should aim for now?"

It is a difficult question, because the fact is that Estonia has been an exceptional success. Estonia stands as a standing rebuke to the violent society and essentially criminal government of Vladimir Putin's Russia. It seems astonishing that the two were still under the same state as recently as twenty years ago. Estonia has become a model and a mentor for Latvia and Lithuania in their own struggles, as Finland was for Estonia over the course of the last two decades. Indeed the clarity of the single tax regime has marked Estonia as an important experiment in economic Liberalism, which has been emulated from Tbilisi to Tirana.

Yet, as the Estonians themselves know, much remains to be done.

To my mind, the success of the country has been founded on clarity of regulation and transparency of implementation. From the very beginning, the Estonians understood that in order to create a prosperous society, both the cost of the state must be kept to a minimum and that what it dies it should do fairly and openly. In this they have been remarkably successful: simple and clear rules are cheaper to enforce than large numbers of complicated ones. The judicious use of secure technology has allowed the emergence of an extremely efficient e-administration. Entrepreneurship has been fostered by simplicity of regulation: companies can be established on-line, in the course of a few minutes, for example, and they do not pay tax on retained earnings. The result has been a vibrant and rapidly growing economy.

Nevertheless, it is not true to say that Estonia is a particularly low tax country. The nominal rate of income tax is relatively low, at 21%, but on top of this is "social taxation" of employees of another 30%. Even allowing for the untaxed allowance, the fact is that the effective percentage rate of income taken in tax is still in the mid forties for most people. While this may be lower than the Scandinavian economies, it is higher than the UK, for example. By the time one factors-in VAT and local taxes- based around a land tax- the total tax take is not especially low at all, even if the cost of administration is a fractional level of the European average. Even if administration is generally cost-effective, this is not the same as a liberal economy.

Although figures such as Mart Laar, the former Prime Minister, enthusiastically agree with this analysis, the President himself- quite rightly- points out that Estonia needs to invest in infrastructure, especially highways and perhaps in the long run, high speed rail as well. However such projects are not usually funded entirely from current expenditure, but from long term debt. Yet Estonia does not have any debt- and this has been a cause of great satisfaction over the last two years. The nominal debt of 9.2% of GDP is off-set by 11% reserves, and the government has been taking more tax than the money it pays out: a fiscal surplus that would be the envy of most of the rest of Europe were it but more widely known. To my mind, despite the stress in the financial markets, infrastructure expenditure could be funded by tolls on heavy trucks entering the country and a modest increase in debt. This could then allow a reduction in taxation which could promote further growth- as the Laffer curve predicts.

Then there is issue of social cohesion. After some disturbances three years ago, that were seen -rightly- as being incited by the Russian government, there was much soul searching in Estonia as to why relations between the majority Estonian population and the minority Russian speaking population were still so poor. The malign influence of the Putin government was not sufficient explanation, although the cyber-attacks which the Estonians successfully fended off at that time were proof- if any were needed- of Kremlin involvement in deliberate attempts to destabilise this highly Internet-dependent country. Nevertheless, people on both sides of the linguistic divide have now begun to reach out and the process of national healing- still tentative- is under way. In this, the country can benefit from some core Estonian values.

President Ilves pointed out the backbone of Estonia as its "peasant democracy". It is indeed a generally egalitarian and open society, and this is particularly refreshing even to one raised in the USA and even more so the UK, where social barriers are particularly obvious and long lasting. These values allow Estonians to feel that no one is their master and has given the country something of a can-do spirit, which has stood Estonia in good stead over the nearly 93 years since independence was first obtained. However, as the President himself points out, this self reliance can also express itself as stubbornness and even a kind of arrogance. One only has to read the comments pages in Estonian newspapers to see a carping and unpleasant tone that is far from the trust and respect that one sees in the political discourse of, for example, Denmark. There is still a certain national rancour, rooted in the primeval Estonian peasant fear that someone, somewhere, is out to cheat him. This, of course, has not been helped by the horrors and lies of the years of the Soviet occupation, where snitching and betrayal were the social norms most encouraged by that vile tyranny. The reborn "peasant democracy" for all its determination and resilience could do with at least a thin veneer of courtesy. Even if the Estonians might regard such courtesy as occasionally hypocritical, it would certainly help the national discourse a lot.

So, where is Estonia going?

In many ways, when the country is so clearly going the right direction, and when even the national football team is scoring successes against major international opposition, then these observations from me might be considered a little presumptuous. Yet I clearly do see challenges on the horizon. Estonia, despite spectacular progress, is not in the same league as -say- Singapore. Small changes in regulation could promote Estonia as big a centre of finance as it already is of trade today. Investment in physical infrastructure is clearly needed, and Tallinn-Narva, Tallinn-Tartu, Tallinn-Ilka and Kohtla-Jarve, Tartu-Valga highways should become firm commitments for the near future. Yet in my view this should go hand in hand with a renovation of the overall business infrastructure, including a renewed commitment to lowering the overall tax burden in order to promote growth. Education, excellent at high-school level, declines rapidly at the tertiary level, and this is the result of the Universities failing to promote the needs of international scholarship alongside their role as upholders of Estonian cultural values. Away from the Humanities, more effort needs to be made to make Tartu, Tallinn, Viljandi and Narva more accessible and open to international scholars.

Estonia needs to improve the interaction and dialogue with its international partners, especially investors. I recently made some sharp comments on this blog concerning problems that have emerged with several international investments in Estonia. These comments have been widely reported- and indeed quoted with some glee by Estonia's enemies. I can only say that a true friend of Estonia should not be a sycophant and should be honest where problems exist. In any event I believe that these problems could be largely alleviated simply through better communication. Nevertheless it is also true that a greater commitment to the idea of "my word is my bond" that forms such a part of Danish society would also help. It is an increasingly widely held view that individual happiness rests on an ability to trust your society. After the breakdown of social values under the Soviet era, the independent Estonian Republic has been at least partially successful in restoring a measure of respect and trust for itself- indeed it still shocks foreigners that the Estonian tax authorities have an 86% approval rating. In order to continue towards a more prosperous and more socially content country, it is important that all stake holders- international as well as the citizens of the state- know that Estonia will do what it says and says what it does. Estonia's critics should gain no comfort from her occasional lapses and a renewed commitment to honesty and transparency would leave these critics no platform.

Perhaps this restoration of national trust is the greatest challenge for the Estonian Republic and its people. The ground rules of clarity which were laid in the rebirth of the country have created a strong ethos, and given the country real discipline in facing the challenges of the past few years. Even these extraordinary achievements may yet be succeeded by the emergence of Estonia at the top of the rankings of national prosperity and national happiness over the next two decades if such discipline can be maintained.

I look forward to seeing it, and to playing my part in supporting the Estonian cause of freedom as much as I can.


Blackacre said…
Can I just mention that the Laffer Curve does not do what you say it does. It predicts that there is an optimum tax return at somewhere between 0% and 100% of income. But no one actually knows where this is. It does not predict anything else and is sadly misused.

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