Did Free Trade Make Estonia Prosper?

Did free trade make Estonia prosper?

Mart Laanemäe Undersecretary (Economic and Development Affairs)

Did it? Was it the only factor in Estonia’s recent relative success?

With the paradigms of world trade appearing to be in constant ﬂ ux, we may never know for sure. Probably it wasn’t the only reason. But Estonia’s experience seems to prove that a compact economy surrounded by some of the largest markets in the world will succeed if it is as open as possible, and economies are open only if they engage in free trade.

Estonian history provides at least a thousand years’ worth of anecdotal evidence on the advantage of having an open economy. Ancient Estonia was evidently attractive enough to catch the attention of Europe’s land-grabbers (would they be called foreign direct investors today?). Tallinn’s architecture provides evidence of rich times and poor times: whereas real estate developers always follow the dominant style of the day, in wartime nobody likes to build anything. The best example is the lack of Renais- sance buildings in Tallinn. In fact, one reason why Tallinn’s mediaeval Old Town exists today is Russian Tsar Ivan the Terrible, who kept Tallinn’s city fathers busy fending off his army at a time when the rest of Europe was rebuilding itself in the Renaissance style.

In the 1920’s the newly founded Republic’s ﬁ rst constitution declared that Estonia would have free trade with the world. But nobody except possibly the Russian revolu- tionaries were interested in free trade back then and when Lenin died in 1923, Soviet Russia ended its early economic experiments too and closed the border. So Estonia had to come to terms with the real world and did a reasonable job of it – in 1940, the hostile takeover of Estonia substantially increased the Soviet Union’s foreign trade.

Then, as regained independence called for a new economic policy, Estonia, with no economy to speak of, could at least look back on centuries of different kinds of experience. Jeffrey Sachs and Milton Friedman may have inspired leading statesmen to take radical steps, but there really wasn’t much choice anyway – Estonia’s economy consisted of a large agricultural sector and run-down industry that nobody wanted anymore – there was nothing to respond to shock therapy.

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Estonia started by creating macroeconomic stability with strict measures like a man- datory balanced budget and an early currency reform. No Estonian government has had any of the toys it might need to distort the economy. The Riigikogu (parliament) passed laws which provided a level playing ﬁ eld for all investors (after all, Estonians didn’t have much capital to invest anyway), successive governments privatised everything they could.

Opening the economy to the world created the conditions for rapid and sustainable growth. A free trade agreement with Switzerland opened the way for further agree- ments with the largest foreign investors, Sweden and Finland, followed by agree- ments with Latvia, Lithuania, other European countries and of course the European Union. The result can again be seen in architecture: the skyscrapers (relatively high like everything in Estonia) next to Tallinn’s mediaeval town centre.

Of course there are all sorts of alternative explanations. One that I thought of myself is that as a consequence of the privatisation policy, virtually all residents of Estonia, even foreigners, are homeowners – very few rent anything. This means that people have more disposable income because they don’t have to pay rent and it also means that nobody, neither the government nor private persons, can get rich off the fruits of other people’s labour simply by charging rent – Karl Marx had a thing or two to say about that and he wasn’t necessarily wrong on all counts.

But let me digress no more. Some economic theorists seem to believe that free trade was the crown jewel of Estonia’s economic policy, when it was really just a tool. For example, it was cheaper not to set up complicated customs procedures. Besides, most of Estonia’s trade since 1991 has been with the European Union and so accession in 2004 changed very little. It does allow us to say that in 2004 Estonia lost around 85% of its foreign trade, which became trade within the EU single market.

Some economists have claimed that joining the EU would be bad for Estonia because the EU is supposed to be the bastion of protectionism. The fact is that Estonia’s trade within the single market is today larger than its total foreign trade was before accession. Trade with EU countries and trade with countries outside the EU have both increased by roughly one-ﬁ fth. So joining the EU was good for Estonia and in retrospect, we can say that maybe the desire to join was a larger beneﬁ t, because it served as an incentive for economic growth.

But now as an EU member, Estonia’s future external economic policy should adapt to the new environment. It is true that trade policy is different in the EU than outside it and we are still formulating it, but here are some general ideas that should not surprise anyone.

44 DID FREE TRADE MAKE ESTONIA PROSPER? 2005

First and foremost, Estonia considers it important to strengthen the European Union. This is a responsibility of the whole Government. Freer trade will make the whole EU richer and Estonia will beneﬁ t from a richer EU. Many other EU countries share this vision. We would like to see more countries understand us better and understand how we have looked for solutions to our problems. Estonia might not provide solutions to every problem but we do have a way of doing things that might be useful for others to know. Estonia’s development cooperation is based on this principle.

Our special interest is to explain how good governance can be achieved by implementing effective laws using modern information technology. Estonia’s transformation to a functioning EU economy was based on policies that were founded on the rule of law – ﬁ rst we argued about what laws to pass and then set about implementing them. There is really no shortcut that makes it possible to have policy with no laws.

Relations with neighbours outside the EU, especially economic relations, deserve special attention because of their great potential and of course the government supports further developing such relations.

Looking beyond the EU’s neighbours, it is to Estonia’s advantage to develop relations with large countries and with emerging economies. Limited resources suggest looking to regions that are closer and countries that are larger. We would also like to see more investment into Estonia and we would like to see more Estonian investments abroad.

And all this of course means that we want everyone else to engage in free trade, so really we should try to prove that free trade is good for everyone. Therefore, perhaps, dear reader, it would be better for you to forget what you have just read and remember just one thing – free trade made Estonia prosper and it will make everyone else prosper too. Really.