Estonia and the Euro

(from the Economist print edition)

The Baltic states 

Euro not bust
May 13th 2010
From The Economist print edition


Estonia gets a green light to join the euro. Other Baltic states will benefit too

SURPRISES are Estonia’s stock in trade. Its return to the world map in 1991 after a 51-year absence startled outsiders. So did what came next: a fast-growing economy, based on flat taxes, free trade and a currency board. In 2004 it confounded pessimists’ expectations by joining the European Union and NATO. Now it is set to pull off another coup, gaining green lights from the European Commission and the European Central Bank in its bid to adopt the euro on January 1st 2011.

Many thought that highly unlikely. Only two years ago a property bubble in the country popped, rocking the banking system and sending GDP plunging by 14.1% in 2009. Doom-mongers said devaluation was inevitable. But they were wrong. Flexible wages and prices have helped the economy stabilise: unit labour costs fell by 7.5% in the final quarter of 2009. Exports were up by a sixth in the first quarter of 2010 and the central bank forecasts growth this year of 1% (although that depends on the pace of recovery in Sweden and other export markets).

Thanks to a fiscal tightening of a stonking 7.5% of GDP, Estonia easily meets the euro zone’s public-finance rules. Its gross debt in 2009 was only 7.2% of GDP (compared with 115% in Italy), and the government deficit is 1.7% (Greece’s is 13.6%). The concern is sustainability: will future governments be so thrifty? Inflation is low: in the past 12 months the average figure was negative, at -0.7% well below the euro zone’s 1% target. But the ECB report calls for “continued vigilance”, as well as efforts to raise productivity and competitiveness.

The real problem for Estonia is political, not economic. Some euro-zone members (France is often mentioned) think that allowing an obscure and volatile ex-communist economy to join a currency union that already has too many dodgy members should not be a priority. If Estonia is really so solid, why not wait a year to be sure?

Yet that would send a perverse message. Estonia is almost the only country in the whole EU that actually meets the common currency’s rules. All those that use the euro have gaily breached the deficit and debt limits. The grit shown by Estonian politicians and the public in shrinking spending, raising taxes and cutting wages has been exemplary. Punishing Estonia, which obeyed the rules, while bailing out Greece, which has breached them flagrantly, would do little for the euro’s credibility with governments and investors alike.

Estonia has two more hurdles to jump before it can scotch the scoffers: an EU committee meeting at the end of May, followed by a finance ministers’ summit in early June. Few think that France and other doubters will actually block Estonia’s bid; persuasion and horse-trading will probably bring agreement. Then the decision will be irrevocable. That will give heart to Latvia and Lithuania, which hope to join the euro later in the decade. Like Estonia, their currencies are pegged to the euro, so they bear the pain of a rigid monetary regime, but also miss out on the lower borrowing costs and higher investment that membership of the currency can bring.

The next task is to stoke growth and cut unemployment (now over 15%). After that, the aim should be to reach Nordic-quality public services and an economy based on brainpower by 2018, when Estonia celebrates its 100th birthday and also holds the presidency of the EU.