Addressing Labour Shortages in Estonia?

by Claus Vistesen

Cross posted from Alpha Sources

This is just a small pointer in relation to my note on net migration in the Baltics a few days back as well as my note on Demography.Matters on catch-up growth in Eastern Europe. At the heart of this issue is of course a severe labour shortage in many Eastern Europe fuelled in part by structural labour mismatches as well as a more profound shortage of labour as a result of very low fertility levels throughout the 1990s. In Estonia, as was demonstrated in the post linked above net migration has been virtually positive since 2000 with an ever so small net inward migration flow. Yet, policy makers and employers in Estonia are well aware of the labour shortage which will persist even if net migration is not negative. What is interesting here (see excerpt below) of course is the distinction between whether Estonia should attract low skilled labour or more high skilled labour. At this point you could of course claim that both of these labour groups should be incited to come to Estonia from abroad but it will be interesting to see where the proposed institutional initiatives will predominantly be focused. Here is a relevant excerpt from the article from the Baltic Times linked above ...

The process of bringing foreign workers to Estonia is to be streamlined under a plan to ease the country’s worker shortage. The quota of foreign workers will be doubled to about 1,300 and the bureaucratic paperwork slashed by November under an Economy Ministry proposal. Economy Minister Juhan Parts said the bureaucratic simplifications were an obvious solution to give companies faster access to skilled labor. Employers have welcomed the proposals, but said they did not go far enough in addressing Estonia’s shortage of low skilled workers. Parts told The Baltic Times that the proposal would be before Parliament by November. “Diminishing bureaucracy will make it much easier for entrepreneurs to use labor from third countries,” Parts said.

“The changes have broad consensus from both business and most political parties.” He said it was “unacceptable” that “good qualified brains” were having difficulty entering the Estonian labor market. However, he stopped short of opening the borders to low-skilled workers, saying that employers should look to hire from the 380 million available workers within the European Union to address their staff shortages. “This is not a liberalization of our immigration policy. We don’t want to see millions and millions of third country workers here,” he said. Employers seeking long-term permits for workers will have to commit to paying a salary of at least 1.24 times the average Estonian salary, which currently sits at 9,600 kroons. Those applying for six month permits will have to pay their workers the average salary for their sector, Economy Ministry executive officer Sille Rossi said.

As a final note it is also interesting to note the quibble over whether it is fair (or perhaps prudent?) for Estonian employers to systematically pay a premium for labour just because it is foreign. Of course, this might be necessary in order to actually attract the needed labour. However, with the wage pressure and inflation already at very high levels and even if net migration to Estonia were to pick up, the current inflation/wage expectations are clearly not warranted given the underlying capacity issues which inevitably will materialize in Estonia as well as other Eastern European countries at some point. In short, the longer this goes one the further these economies will fall, I fear, given the relative inability for capacity to respond on the backside of these very high inflation expectations and developments. Having said and as a very final note it does seem (for various reasons which I might go into later) that Estonia is much better suited to handle the inevitable backdrop better than for example its neighbours Lithuania and Latvia.

Estonia Revises Down Economic Growth to 9.8 Percent

From Bloomberg recently:

Estonia Revises Down Economic Growth to 9.8 Percent

Estonia, the European Union's second fastest growing economy, revised down its economic growth rate in the first quarter to an annual 9.8 percent as the property market cooled and export growth slowed.

The pace of growth was revised from the preliminary estimate of 9.9 percent released May 15, the Tallinn-based statistics office, Statistikaamet, said on its Web site today. The annual rate was the slowest in two years. The Baltic country's economy grew a revised 10.9 percent for the previous three months.

``Domestic demand weakened mainly due to slowing investment growth, even as the warm winter benefited construction,'' Maris Lauri, the chief economist with Hansabank Markets, said in e- mailed comment. ``The worst hit came from modest export growth and continued strong import rise.''

The $15.1 billion economy is poised for a ``soft landing,'' according to the central bank, after rising house prices and higher interest rates slowed growth in the property market in the first quarter and banks including the Baltic region's biggest lender AS Hansapank set stricter mortgage lending criteria.

Unemployment at a 15-year low and a 20 percent increase in wages during the first quarter are still boosting spending power and pushing up inflation, which stood at 5.7 percent in May and forced the government last month to postpone its target for meeting euro-adoption criteria to 2011.

May Overheat

Estonia's inflation and widening current account deficit, at 14.8 percent of GDP in 2006, increased worries among foreign investors and credit agencies earlier this year that the Baltic economy may overheat, similarly to that of neighboring Latvia, and trigger a sharp decline in the growth rate.

``Strong consumer demand coupled with a slowdown in export growth means the external balance is likely to have worsened this quarter,'' Neil Shearing, an economist at Capital Economics in London, said in e-mailed comment. ``We want to see signs that consumption is starting to ease before signaling the all clear on overheating.''

The Finance Ministry said it expected the economy to slow further in the second quarter because order books in construction are declining, retail and service industries are forecasting lower revenue growth and consumer optimism has ``slightly'' declined. A ``consumption boom'' will still persist ``in the near term,'' the ministry said in an e-mailed comment.

Increases

Private consumption jumped 18 percent, the biggest increase in 14 years, according to the ministry. Gross fixed capital formation, which includes investment and stock-building, also increased 18 percent, slowing from previous two quarters. Exports of goods and services grew 5 percent from a year earlier, while imports rose 11 percent.

Exports slowed most in fuel shipments and electronics, the Finance Ministry said. Analysts, including Lauri from Hansabank Markets, have said the decline in electronics trade is due to rising wages which are forcing companies such as Elcoteq SE, a Finnish contract manufacturer with a factory in Tallinn and Estonia's biggest exporter, to move its high-volume production to lower-cost countries.

Latvia's economy grew a revised 11.2 percent in the first quarter, the fastest pace in the European Union. Lithuania's economy grew 8.3 percent.

Estonian Current-Account Gap Is Widest in 14 Years

From Bloomberg recently:


Estonian Current-Account Gap Is Widest in 14 Years

Estonia's current-account deficit swelled last quarter to the widest in at least 14 years as soaring wages and consumer borrowing spurred spending on imported cars and clothes.

The deficit, the broadest measure of trade in goods and services, widened to 17.9 percent of gross domestic product from 16.1 percent a year earlier and a revised 17.2 percent in the previous quarter, the Tallinn-based central bank said on its Web site today. The deficit is the highest since at least the first quarter of 1993, when the bank started giving quarterly figures.

Economic growth of 9.8 percent in the first quarter, the second-fastest pace in the European Union, helped trigger a 20 percent surge in wages in the period while credit growth of about 30 percent underpinned household spending. The widening deficit and faster inflation has raised concern the economy may overheat.

``The Estonian economy is living beyond its means,'' said Neil Shearing, an economist at Capital Economics in London, in an e-mailed comment. ``More needs to be done to slow domestic demand. The fiscal position could be further tightened and measures to curb rapid credit growth are needed.''

Estonia's biggest retailer, AS Tallinna Kaubamaja, more than doubled profit in the first quarter at its department stores and supermarkets. New car sales rose 49 percent, according to the association of car sales and service employers, AMTEL. Private consumption jumped 18 percent, the biggest increase in 14 years.

Deficit Outlook

Andres Saarniit, an adviser to the central bank, said the deficit is expected to ``decline in coming years, but still remain sizeable.'' The central bank revised up the 2006 current account deficit to 15.7 percent of GDP from an earlier estimate of 14.8 percent.

The Finance Ministry said it expects the current-account gap to widen further this year, citing fast growth in domestic demand and worsening competitiveness of industries where growing wages make up a bi part of overall costs. It also expects lower demand from abroad due to lower growth in Estonia's export destinations, the ministry added in an e-mailed statement.

Moody's rating service warned today the economy may slow more than expected if confidence slumps among borrowers and banks, which started tightening credit requirements in the first quarter.

Analysts said the risks to the economy were reduced by strong levels of foreign direct investment, which help cover the current account deficit.

``Some comfort is provided by the fact that the financing of the deficit seems to be okay, as 45 percent of the deficit was covered by FDI,'' said Mika Erkkila, a senior analyst with Nordea Bank in Helsinki, in an e-mailed comment.

Estonia's Inflation Rate Rises to Six-Year High

From Bloomberg recently:

Estonia's Inflation Rate Rises to Six-Year High


Estonia's inflation rate increased to a six-year high in July on rising energy costs, adding to concern the Baltic economy is overheating.

Annual inflation accelerated to 6.4 percent, the fastest since June 2001, from 5.8 percent in June, the statistics office based in the capital Tallinn said on its Web site today. Prices rose a monthly 1.1 percent.

Standard & Poor's Ratings Services lowered Estonia's rating outlook to negative from stable last month, citing a higher risk of a ``hard landing'' due to a wide current-account deficit and accelerating inflation. Estonia was forced to delay euro adoption twice last year as economic growth pushed consumer prices beyond targets required for the currency switch.

``While growth rates are slowing, unfortunately inflation remains high,'' Anne Karik-Uustalu, an economist with Sampo Pank in Tallinn, said by phone. ``It's all due to inertia.''

Estonia's economic growth rate, second only to Latvia in the European Union, slowed to 9.8 percent in the first quarter. Inflation may peak next year as consumer confidence along with purchasing power starts to slow, the economist said.

Tax Increases

From July, the government increased the value-added tax on heating to 18 percent from 5 percent to meet the requirements of the European Commission. Inflation will remain at similar levels in coming months as energy-price increases filter into the economy, Karik-Uustalu said.

S&P said on July 2 that Estonia's ratings may be lowered if inflation accelerates to a level that is ``inconsistent with medium-term euro-zone accession.'' The rating agency also said plans to loosen budget policy would further fuel the $15.1 billion economy.

Unemployment at a 15-year low and wages rising an annual 20 percent in the first quarter boosted Estonians' spending on housing, food and cars, with private consumption rising in the same period at the fastest pace in 14 years.

Euro adoption is limited to countries that meet targets on inflation, budget deficits, debt, interest rates and currency stability. Inflation must be within 1.5 percentage points of the 12-month average rate of the three EU states with the slowest consumer-price growth. The target was 2.8 percent in June while Estonia's rate was 5 percent.

Estonian May Inflation Rate Rises to 5.7 Percent on Fuel Prices

From Bloomberg recently

Estonian May Inflation Rate Rises to 5.7 Percent on Fuel Prices


une 7 (Bloomberg) -- Estonia's inflation rate rose in May, driven by fuel and housing costs, moving the Baltic state further from its goal of adopting the euro.

The annual inflation rate increased to 5.7 percent from 5.5 percent in April, the statistics office based in the capital Tallinn said on its Web site today. Prices rose a monthly 0.7 percent, with transport costs rising 2.5 percent from April.

``The inflation pace was set by increases in fuel prices,'' said Anne Karik-Uustalu, an economist with Sampo Pank in Tallinn, before the report.

Estonia has already been forced to drop plans to adopt the euro because the inflation rate has remained above euro-entry rules. An unemployment rate at a 15-year low and a 20 percent jump in wages in the first quarter boosted spending on housing, food and cars.

To adopt the euro, the nation must keep inflation to within 1.5 percentage points of the average 12-month inflation rate of the three European Union nations with the slowest consumer price growth. That rate in April was 3 percent, while Estonia's rate was 4.7 percent in the same month.

Inflation will continue to accelerate this year amid a labor shortage and fast economic growth, the Finance Ministry and central bank have warned.

Moving Targets

The Cabinet of Prime Minister Andrus Ansip last week cut budget surplus targets in 2008-2011 from 1.5 percent of gross domestic product to 0.5 percent, prompting criticism from Central Bank Governor Andres Lipstok.

International institutions, including the International Monetary Fund, are also concerned that the $15.1 billion economy may overheat.

Reining in government spending is among the few tools available to Estonia to control price increases because the local currency, the kroon, is pegged to the euro in the exchange-rate mechanism.

Estonia Central Bank Says Wages, Prices Threaten GDP

From Bloomberg Recently:


Estonia Central Bank Says Wages, Prices Threaten GDP

By Ott Ummelas

June 19 (Bloomberg) -- The Estonian central bank said soaring real estate prices and ``tension'' about wage increases risk destabilizing the economy and fast inflation may keep the Baltic state from adopting the euro before 2011.

The bank forecast in April the $15.1 billion economy will grow 8.4 percent this year, following last year's 11.4 percent expansion, and slow to 6.5 percent in 2008. The central bank today said there was a risk of an even ``sharper'' slowdown in growth.

``Estonia's economic growth'' will ``slow gradually as projected in the forecast,'' the Tallinn-based central bank said in its quarterly economic policy statement. ``However, the risk of a somewhat more abrupt adjustment in the future has increased.''

Estonia's inflation and a widening current-account deficit, at 14.8 percent of gross domestic product in 2006, has raised concern among foreign investors and credit agencies earlier this year that the $15.1 billion economy may overheat, triggering a sudden decline in growth. Estonia delayed euro adoption twice last year as economic growth caused inflation to accelerate.

Prime Minister Andrus Ansip said last month in an interview that he expects the country to slow inflation enough by 2010 to switch to Europe's common currency in 2011.

Wage Risk

The central bank also said that the inflation rate, at 5.7 percent in May, is still too high and the risk of a slowdown in wage growth has increased after a 20 percent increase in average wages in the first quarter. It expects consumer prices to rise 5.1 percent this year, well above euro entry criteria, after 4.4 percent in 2006.

``The `soft landing' is still a much more probable scenario than a `hard landing,' '' Deputy Governor Andres Sutt said in an interview today.

He said that a ``soft landing'' would require wage growth to fall into line with productivity increases and credit market growth to become more sustainable.

``We will know by the autumn whether the adjustment of the economy has become permanent,'' he said.

The central bank said labor costs grew ``considerably faster'' than the economy in the first quarter of 2007, which ``refers to decreasing competitiveness and possible stronger inflationary pressures.''

Real Estate Risk

The real estate market was most at risk because of high indebtedness, while developers may have overestimated the strength of demand during the period of rapid growth, it added.

House prices in Estonia's capital, Tallinn, jumped 24.5 percent in the first quarter from a year earlier, the second- fastest growth globally after neighboring Latvia, according to data published last month by Knight Frank residential research in London.

The central bank also said that the government's budget strategy is too ``lax.''

Last month, the cabinet approved a four-year spending plan last week, cutting budget surplus targets in 2008-2011 from 1.5 percent of GDP, announced during a visit by the International Monetary Fund's mission, to 0.5 percent of GDP.

Russian Minority in the Baltics

From Bloomberg recently:

Baltics' Russian Integration Engulfs EU in Disputes

By Leon Mangasarian and Ott Ummelas

July 31 (Bloomberg) -- Aleksei, a Russian in the Estonian capital Tallinn, longs to become a citizen of the Baltic state, where he was born. There's one snag: The 31-year-old taxi driver, who asked that he not be identified by his last name, failed the language exam when he applied for citizenship.

Difficulties integrating ethnic Russians in Estonia and Latvia -- former Soviet republics whose populations are one-third Russian -- are contributing to tension with Moscow. Russians rioted in Tallinn over the relocation of a Soviet World War II memorial in April, leaving one dead and 153 injured. Pro-Kremlin protesters in the Russian capital replied by attacking the Estonian embassy.

Since Estonia and Latvia joined the European Union and North Atlantic Treaty Organization in 2004, any spat with the Kremlin risks becoming an international crisis, adding to disagreements over issues such as U.S. plans for a missile-defense system in eastern Europe.

``The EU is now engulfed in the historic disputes that these countries have with Russia,'' Oksana Antonenko, senior fellow and program director for Russia at the London-based International Institute for Strategic Studies, said in an interview on July 27.

Perceived threats from Russia -- and 20th-century history -- fuel demands in the Baltic states for stronger security guarantees from NATO, the EU and the U.S.

Retaking Control

The Soviet Union occupied Estonia, Latvia and Lithuania in 1940 under a secret agreement with Nazi Germany. From 1941 to 1944 they were occupied by Germany, with the Soviets retaking control in 1944 until the countries regained their independence in 1991.

Hundreds of thousands of Russians settled in the region during the Soviet era. Estonia and Latvia didn't grant these Russians automatic citizenship after independence. Instead, the two countries require applicants to pass language and other citizenship tests.

About 29 percent of Estonia's 1.3 million people belong to the Russian-speaking minority. Half don't have Estonian citizenship; and according to official figures, 126,000 of these people are stateless and have no passport.

In Latvia, 36 percent of the 2.3 million people are Russians, Belorussians or Ukrainians; and 424,000 are stateless or have ``non-citizen Latvian passports.''

Free of Contention

Things are different in Lithuania -- the third Baltic state and also a NATO and EU member -- where 6 percent of the country's 3.4 million people are Russian. Lithuania gave citizenship to all residents, and the country is largely free of Russian minority contention.

Alexander Rahr, at the German Council on Foreign Relations in Berlin, says the EU is partly to blame for Estonia's and Latvia's ethnic strains, because it didn't demand better integration policies before letting both countries join.

``If the EU had helped win over Estonia's Russians for its values, the chance for Russia to use these people for dirty games would be marginal,'' he said. ``Of course Russia will try to use a radical minority in this group to raise tensions.''

Some analysts, though, say granting citizenship to Estonia's Russians might have delayed EU and NATO entry.

``The homogeneity of the Estonian community allowed for very painful reforms to be carried out fast,'' said Andres Kasekamp, the head of the Estonian Foreign Policy Institute. ``The Russo- phone community would have undoubtedly voted for left-wing political parties, which would not have favored rapid economic reform.''

`Discord and Distrust'

Antonenko said Estonia and Latvia must accept some responsibility for the tension because they dragged their feet on integrating the ethnic Russians and ``are not prepared to overcome old rivalries and share the EU spirit,'' she said.

When Estonia relocated the war memorial from the center of Tallinn to a cemetery on the edge of the capital, Putin criticized the move as sowing ``the seeds of discord and distrust.''

Putin followed his words with action. Transit of goods from Russia, mostly oil and oil products, fell 22 percent in May and 15 percent in June, Estonian officials said. Several Estonian companies, including AS Kalev, a 201-year-old confectionery maker, have said exports to Russia had to be halted since the start of May because of a boycott by Russian retailers.

Estonia was also hit by attacks that disabled Web sites, which Estonian President Toomas Ilves said were traced to the Kremlin. The Estonian government called on NATO to defend it against Russian ``cyber attack.''

Rally Voters

Masha Lipman, a political analyst at the Carnegie Moscow Center, said Putin is using the spat with Estonia to rally voters before Russia's March 2008 presidential election.

It's ``easy'' to create ``this sense that the Baltics are our enemy and we should not allow them to disrespect us like this,'' Lipman said.

Last month the U.S. warned Russia it had to handle its ``deep and difficult'' relations with the Baltic states ``in an honest and civilized way.''

``The past is not forgotten, but it need not determine the future,'' U.S. Assistant Secretary of State Daniel Fried said June 14 in a speech on the Baltic states in Washington. ``Threats, attacks, sanctions should have no place'' in the countries' relations with Russia.

For Tallinn taxi driver Aleksei, there may still be a happy ending.

``I am learning Estonian again, and at some point I want to try applying for Estonian citizenship again because this is my home,'' he said. ``This is where my roots are.''

Migration in the Baltics

I am back from Barcelona with and ready to slowly pick up the pace again. I am going to start easy and leave the heavy stuff for some later posts in the beginning of next week. One of these posts will be on my view of the recent flurry on rising bond yields and global interest rates. Will the trend linger? How far will rates go? and is Greenspan's famous bond market conundrum finally unravelling? All these vexing questions will be answered here at Alpha.Sources (ahem, attempted I think :)) next week so stay tuned.

For this one I really only want to present one bar-graph for you in the spirit of the proverb that a picture says more than a thousand words. Consequently, the graph below plots net migration in the Baltic states (Latvia, Lithuania, and Estonia) from 1995 to 2005.

Now, to put all of this into context you might want to head over briefly to Demography.Matters where I posted recently on the economic convergence/catch-up process in Eastern Europe. In many ways, the general analysis quickly converged on the nature and availability of human capital which is becoming an increasing scarcer ressource. This is mainly due to two factors and in some countries three. The two factors which are common across the region seems to a structural mismatch on the labour market with a lot unemployed people in lower value added sectors and a very tight labour market in high value added sectors. Secondly and more profound is the very rapid and essentially unprecedented speed by which these countries have ventured throught the demographic transition. The third factor represented by migration does not present the region's countries with equal effects and as such this is the point of this entry. This is a case in point in terms of the Baltic countries where there are considerable differences between the reality in the respective countries. Of course, the relative large negative net migration in terms of Lithuania should be seen in the light of the fact that it has a comparatively larger population than Estonia and Latvia. Since the Y-axis shows real numbers it obviously biases the result. However, there is still a clear trend to be inferred I think. Whereas Estonia and Latvia have managed to decrease the negative migration flow in the last five years it has actually accelerated in Lithuania. In Estonia, the last five years even show a small positive net migration rate even if it is ever so tiny.

The bottomline here seems to be clear. The Eastern European countries face, on a whole, a tremendous challenge in terms of human capital. This relates to a general mismatch between the desired economic activities (high value added) and the educational composition of the labour force. Yet, more worryingly labour is set to become a regionwide scarce ressource and in the high value added sectors it already epitomized by very tight labour markets in the service sector on a region wide scale. Also, there is the perceived drainage of well educated young people to Western Europe. I say perceived here since the dynamics are very different across countries and also subject to change very quickly as labour markets tighten and wages increase in the domestic markets.

As a litmus test to discern which countries are better at creating employment and opportunities for people net migration seems to be a very important indicator. In this light there is a clear difference between the Baltic countries where especially Estonia seems to be fairing much better than Lithuania and also Latvia. This does not mean that complacancy is warranted though. My guess is that the inevitable flipside to the capacity constraints, which are obviously materialising themselves with the whopping increase in labour costs as a proxy, will soon emerge as a real ceiling for economic growth and thus convergence. Quite simply the labour supply will be perfectly inelastic in the long run which again means that in stead of worrying about soaring labour costs now we should really worry on what comes next after that. And now I guess I have already opened up pandora's box on this whole global interest rate and bond yield discussion. As such, it is all well and good to note that global rates are going up to reflect inflationary pressures mounting but what happens in those countries (read, the rapid agers!) where capacity will largely be inelastic to any stimulant which may come as the central banks decide to call it a day and perhaps loosen the string again? Well, as I said above, this is for another day.