FISCAL RETRENCHMENT IN ESTONIA DURING THE FINANCIAL CRISIS: THE ROLE OF INSTITUTIONAL FACTORS
| Published date | 01 March 2013 |
| Date | 01 March 2013 |
| DOI | http://doi.org/10.1111/j.1467-9299.2011.01963.x |
| Author | RINGA RAUDLA |
doi: 10.1111/j.1467-9299.2011.01963.x
FISCAL RETRENCHMENT IN ESTONIA DURING THE
FINANCIAL CRISIS: THE ROLE OF INSTITUTIONAL
FACTORS
RINGA RAUDLA
Unlike most other countries in Europe, which engaged in expansionary fiscal policies in 2009,
the government of Estonia followed the opposite path by adopting several austerity packages,
combining expenditure cuts and tax increases. This paper explores whether (and to what extent)
the theoretical propositions from the literature on political economy of fiscal adjustment that focus
on institutional factors are able to explain how it was possible to undertake such extensive fiscal
adjustment in Estonia. The case study shows, first, that a coalition government and a minority
government are able to achieve fiscal adjustments, especially if there is political commitment to
lower the deficit. Second, the study indicates that an externally imposed fiscal rule can act as a
major focal point in guiding deficit-reduction efforts. Third, the Estonian case demonstrates that
centralised budgetary institutions are conducive to fiscal adjustment and mitigate the problems
arising from size fragmentation.
INTRODUCTION
The global financial crisis – as was the case with many other countries in Central and
Eastern Europe – hit Estonia hard and exacerbated the negative effects of the burst of
Estonia’s domestic property bubble at the end of 2007. Thus, the economic boom of
2000–2007, when the real GDP had grown by 8 per cent per year on average, was followed
by a dramatic downturn in Estonia, with its GDP falling by 5.1 per cent in year 2008
and by 13.9 per cent in 2009 (Eurostat). For more detailed reports on Estonia’s economic
development during the crisis in Estonia, see Staehr (2010), IMF (2010), Dabuˇ
sinskas and
Randveer (2010); for a concise summary of the economic development of Estonia after
becoming independent in 1991, see European Commission (2010, pp. 247–8). Based on
such a drop in GDP, one would have expected public sector deficit figures to have gone
up as well, but, in reality, despite having the third largest GDP fall in the European Union,
Estonia’s budget deficit in 2009 was only 1.7 per cent of GDP (Eurostat). With that, Estonia
scored the third lowest deficit, topped only by Luxembourg (0.7 per cent) and Sweden
(0.5 per cent). Indeed, while most other countries in Europe undertook discretionary fiscal
interventions or at least let the automatic stabilizers work in 2009 – reflected in increased
expenditures and high public deficits – the Estonian government followed an opposite
path and went through several rounds of budget cuts and tax increases in order to curtail
the deficit. In 2009, the pro-cyclical fiscal consolidation measures in Estonia amounted
to more than 9 per cent of GDP (European Commission 2010, p. 249). Staehr (2010, p. 22)
notes that among Central and Eastern Europe (CEE) countries, Estonia stands out as a
‘hardliner’, who has retained budgetary discipline, while others (like the Czech Republic,
Poland, Slovakia and Slovenia) either undertook expansionary expenditure policies or
had to turn to the IMF for help (like Latvia, Romania and Hungary) (for a more detailed
overview of fiscal policy measures in the CEE countries during the recent financial crisis
of 2008, see Barbone et al. 2010). As can be seen from table 1, among the CEE countries
Ringa Raudla is in the Department of Public Administration, Tallinn University of Technology, Tallinn, Estonia.
Public Administration Vol. 91, No. 1, 2013 (32–50)
©2011 Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden,
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FISCAL RETRENCHMENT IN ESTONIA 33
TABLE 1 Selected economic and fiscal indicators for EU members from CEE in 2009
GDP growth Budget deficit (according to EDP),
% of GDP
General government debt,
% of GDP
Estonia −13.9−1.77.2
Latvia −18.0−10.236.7
Lithuania −14.7−9.229.5
Hungary −6.7−4.478.4
Poland 1.7−7.250.9
Czech Republic −4.1−5.835.3
Slovakia −4.8−7.935.4
Slovenia −8.1−5.835.4
Romania −7.1−8.623.9
Bulgaria −4.9−4.714.7
Source: Eurostat.
that are members of the European Union, Estonia had the lowest budget deficit and the
lowest general government debt in 2009, despite the third largest GDP drop in the region.
In the light of the high deficits that were incurred by most EU countries during 2009 and
fiscal austerity measures advocated in 2010, Estonia has been celebrated as a ‘poster-child’
of fiscal discipline (see, for example, The Economist 2009, 2010) and was rewarded with
permission to join the eurozone as of 1 January 2011.
Fiscal developments in Estonia raise three important questions: First, why was the
government of Estonia so committed to fiscal discipline in 2009, instead of opting for
counter-cyclical fiscal policy? Second, how was it possible to adopt such extensive austerity
measures? Third, was fiscal consolidation in 2009 a beneficial policy option for Estonia?
The first question has been addressed by Raudla and Kattel (2011), who argue that one
of the major reasons behind Estonia’s fiscal policy in 2009 was the government’s desire
to join the euro-zone. The government hoped that joining the common currency would
restore the credibility of the country in the eyes of foreign investors; the return of foreign
investments was considered necessary to reinvigorate the economy. In addition, they
argue that fiscal austerity measures in 2009 were encouraged by Estonia’s experiences
during the previous crises (in the 1990s), when the government had curbed budget
expenditures during economic downturns (and which had ‘paid off’ in the sense that
Estonia had returned to a growth path after these episodes of fiscal consolidation),
resulting in the view that budget cuts are ‘a natural policy response’ to falling revenues.
While the political commitment to satisfy the Maastricht criteria and the path-dependence
in fiscal policy choices helps to understand why the Estonian government sought to
maintain low budget deficit during a major economic downturn, an answer to the second
question – how was such an adjustment possible – requires further analysis in order to
understand the various factors that have contributed to or hindered the adoption of fiscal
austerity measures. In other words, one can argue that even when a government has
committed itself to a goal of fiscal consolidation, there are a number of factors that prevent
the government from achieving the chosen deficit target.
There is a large (and growing) literature on political economy of fiscal adjustment, which
considers political and institutional factors (like ideology, elections, government type,
fiscal rules, and budget procedures) that influence the likelihood, promptness and con-
tent of fiscal consolidation in a polity (for recent examples, see Alesina et al. 2006;
Public Administration Vol. 91, No. 1, 2013 (32–50)
©2011 Blackwell Publishing Ltd.
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