Economy of Estonia

In 1992, the country adopted the Estonian kroon as its currency, which was pegged to the Deutsche Mark at a rate of 8 kr = 1 Dm, this stabilised the economy. In 1994, it became the first country in the world to adopt a flat tax, with a rate of 26% regardless of personal income. Estonia received more foreign investment, per person, in the late 1990s than any other country in Central and Eastern Europe. The country has been catching-up with the EU-15 - the richer European countries. Its GDP per capita grew from 35% of the EU-15 average in 1996 to 65% in 2007, similar to Central European countries. GDP per capita (current US$) was $30,133 in 2023 according to the World Bank; this was between the Czech Republic and Bahrain, but below Saudi Arabia.

For Estonia, the 2008 financial crisis was easier to weather, because its budget has consistently been kept balanced, and this meant public debt relative to GDP remained the lowest in Europe. The economy recovered in 2010. In January 2011, Estonia adopted the euro, joining the eurozone. Estonia has demonstrated resilience, with a strong service sector, particularly in IT due to the Tiigrihüpe project, and advanced e-government services. Estonia's commitment to a circular economy, innovation and its success in maintaining a balanced budget, low public debt, and a competitive tax system have positioned it as a model of economic reform and growth in post-Soviet Europe.

History

In the decades prior to World War I and independence, during the Czarist rule a rather large industrial sector developed in Estonia. For example, the Kreenholm Manufacturing Company was then the world's largest cotton mill.

Independence

After declaring independence in 1918, the Estonian War of Independence and the subsequent signing of the Treaty of Tartu in 1920, the new Estonian state inherited a ruined post-war economy and an inflated ruble currency. Despite considerable hardship, dislocation, and unemployment, Estonia spent the first decade of independence entirely transforming its economy. In 1918, The Czarist ruble was replaced by the Estonian mark, which was in circulation until 1927. By 1929, a stable currency, the kroon, had been established. It was issued by the Bank of Estonia, the country's central bank. Compensating the German landowners for their holdings, the government confiscated the estates and divided them into small farms, which subsequently formed the basis of Estonian prosperity. Trade focused on the local market and the West, particularly Germany and the United Kingdom. Only 3% of all commerce was with the USSR.

Historically, Estonia's economy was agricultural, modernising significantly post-independence from Russia in 1918. There was a notable knowledge sector in Tartu and expanding industrial sector, exemplified by the Kreenholm Manufacturing Company. Western European markets were familiar with Estonian dairy, with the main trade partners being Germany and the UK; only 3% of commerce was with the neighbouring USSR. Estonia and Finland had a similar standard of living. USSR's annexation of Estonia in 1940 and destruction during World War II crippled the economy. Post-war Sovietization continued, with the integration of Estonia's economy into the USSR's centrally-planned structure.

Soviet occupation

The USSR's forcible annexation of Estonia in 1940 and the ensuing Nazi and Soviet destruction during World War II crippled the Estonian economy. Post-war Soviet occupation and Sovietisation of life continued with the integration of Estonia's economy and industry into the USSR's centrally planned structure. More than 56% of Estonian farms were collectivised in the month of April 1949 alone after mass deportations to Siberia the previous month. Moscow expanded on those Estonian industries which had locally available raw materials, such as oil shale mining and phosphorites.

Restoration of independence, modernisation and liberalisation

After Estonia restored its independence in 1991 and became a market economy, it emerged as a pioneer in the global economy. Estonia styled itself as a bridge between East and West, adopting significant economic reforms and technological innovations.

In June 1992, Estonia replaced the ruble with its own freely convertible currency, the kroon. A currency board was created and the new currency was pegged to the German Mark at the rate of 8 Estonian kroons per Deutsche Mark. When Germany introduced the euro the peg was changed to 15.6 kroons per euro.

In 1994, it became the first country in the world to adopt a flat tax, with a rate of 26% regardless of personal income. Between 2005 and 2008, this was reduced to 21% over several steps.

In early 1992, both liquidity problems and structural weakness stemming from the communist era precipitated a banking crisis. As a result, effective bankruptcy legislation was enacted and privately owned; well-managed banks emerged as market leaders. The fully electronic Tallinn Stock Exchange opened in early 1996, and was purchased by Finland's Helsinki Stock Exchange in 2001. Estonia joined the World Trade Organization in 1999.

From the early 2000s to the latter part of that decade, the economy experienced considerable growth. In 2000, Estonian GDP grew by 6.4%. After accession to the European Union in 2004, double-digit growth was soon observed. GDP grew by 8% in 2007 alone. Increases in labor costs, the imposition of tax on tobacco, alcohol, electricity, fuel, gas, and other external pressures (growing prices of oil and food on the global market) inflated prices in 2009.

2008 financial crisis, response and recovery

The 2008 financial crisis had a deep effect on the economy, primarily as a result of an investment and consumption slump, that followed the burst of the real estate market bubble that had been building up. In December 2008, Estonia became a donor country to the IMF-led rescue package for Latvia. In response to the crisis, the Ansip government opted for fiscal consolidation and retrenchment by maintaining fiscal discipline and a balanced budget in combination with austerity packages: The government increased taxes, and reduced public spending by slashing expenditures and public salaries across the board.

After a long period of very high growth of GDP, the GDP of Estonia decreased. In the first quarter 2008, GDP grew only 0.1%, and then decreased: negative growth was −1.4% in the 2nd quarter, a little over −3% (on a year-to-year basis) in the 3rd quarter, and −9.4% in the 4th quarter of that year.

The government made a supplementary negative budget, which was passed by the Riigikogu. The revenue of the budget was decreased for 2008 by EEK 6.1 billion and the expenditure by EEK 3.2 billion. A current account-deficit was extant, but began to shrink in late 2008. In 2009, the economy further contracted by 15% in the first quarter. Low domestic and foreign demand depressed the economy's overall output. The economy's 34% industrial production drop was the sharpest decrease in industrial production in the European Union. Estonia was one of the five worst-performing economies in the world in terms of annual growth, and had one of the highest rates of unemployment in the EU, which rose from 4% in May 2008 to 16% in May 2009.

In July 2009, the value-added tax was increased from 18% to 20%. The recorded budget deficit for 2009 was just 1.7% of GDP. The result was, that Estonia was one of only five EU countries in 2009 that met the Maastricht criteria for debt and deficit, and had the third-lowest deficit after Luxembourg and Sweden; Estonia did not ask for support from the IMF. Despite the third-largest drop in GDP, the country had the lowest budget deficit and lowest public debt among Central and Eastern European countries. In 2009, the Estonian economy began to rebound, and economic growth resumed in the second half of 2010. The country's unemployment rate dropped significantly to pre-recession levels. To top it off, Estonia was granted permission in 2010 to join the eurozone in 2011.

Joining the euro

Before joining the eurozone, the Estonian kroon had been pegged to the euro at a rate of 15.64664 EEK to one euro; before then, the kroon was pegged to the German mark at approximately 8 EEK to 1 DEM.

The design of Estonian euro coins was finalized in late 2004. Estonia's journey towards the euro took longer than originally projected, owing to the inflation rate continually being above the required 3% before 2010, which prevented the country from fulfilling the entry criteria. The country originally planned to adopt the euro on 1 January 2007 and officially changed its target date twice: first to 1 January 2008, and later to 1 January 2011.

On 12 May 2010, the European Commission announced that Estonia had met all criteria to join the eurozone. On 8 June 2010, EU finance ministers. In July 2010, Estonia received the final approval from ECOFIN to adopt the euro onwards from 1 January 2011; on that date Estonia became the 17th eurozone member state and circulated alongside the kroon until 14 January 2011. With that, Estonia became one of the first post-Soviet states to join the eurozone.

In August 2011, Standard & Poor's raised Estonia's credit rating from A to AA-. Among various factors, S&P cited as contributing to its decision was confidence in Estonia's ability to "sustain strong economic growth." Estonia's GDP growth rate in 2011 was above 8%, despite having negative population growth.

The Estonian economy was hit by the COVID-19 recession before bouncing back with an 8.6% rise in GDP in 2021, this was followed by the economic effect of the Russian invasion of Ukraine in February 2022 resulting in a fall in GDP of 1.3% in 2022 and high inflation which hit 24% before falling to single digits in 2023.