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Wednesday, April 1, 2009

How Not To Convince People You Are Capable Of Having An Internal "Devaluation"

The news coming out of Estonia is obviously none too good at the moment. This morning we learnt that both Estonian industrial production and retail sales plunged at the most rapid rate on record in February, giving us very clear evidence that the recession is now deepening. Industrial output (adjusted for working days) fell an annual 30 percent, the biggest drop since 1995, following a 27 percent drop in January, while retail sales, excluding cars and fuel, fell 18 percent, the most since 1994. Month on month, output fell a seasonally adjusted 3.5 percent. And the situation is hardly likely to improve in the short term, since, as Danske Bank point out, all Estonia's main partners are themselves now in deep recessions, so the possibilities of an uptick in activity - even were the economy competitive - are really pretty restricted.

“Industrial production is in freefall, and we expect a continuation of this trend in 2009,” Danske Bank A/S said in a note ahead of the report. “Only an improved outlook for Estonia’s main trading partners, Finland, Sweden, Germany, could change this trend, but this is hardly feasible before the beginning of 2010.”
In fact, while the crisis is a general one, some countries are obviously faring far worse than others, and Estonia’s industrial production dropped the most in the entire 27-nation European Union in December and January. And even if things do start to pick up again elsewhere in 2010, it is hard to see the Estonian economy benefiting that much, since it will still be grappling with price competitiveness issues (see below).

At the present time, as we can see in the index chart below, output is now down around 30% from the 2007 peak, and it continues to fall. Clearly the rate of decline will reduce at some point, and then we may flatten out at quite a low level, but this flattening out will be very different from a rebound, since there is no reason whatsoever to expect a rebound at this point.

Retail sales also fell sharply in February, by 18% when compared with the same month in the previous year. The latest decline dwarfed the 10% fall we saw last month, and may well signal much worse to come. As the statistics office said "In February, the retail sales decreased to their lowest level so far" (see index chart below).

The decline was attributed to the economic slowdown and to deteriorating consumer confidence. According to the Estonian Institute of Economic Research, consumer confidence dropped to a record low of minus 37 in March from minus 35 in February. Compared to the previous month, retail sales declined 7% at constant prices, and after seasonal and calendar adjustments, fell 2%.

New Finance Ministry Forecast

Estonia’s Finance Ministry announced today (Tuesday) that according to their latest estimates the economy will shrink 10 percent this year, if their “worst-case scenario” is realized. This is only in line with what most experts are now saying (although, truth be told, none of us really know) but as recently as last November, the Ministry were forecasting a 3.5 percent contraction for this year and an expansion of 2.6 percent in 2010. Not surprisingly therefore Finance Minister Ivari Padar is having to do his sums again and is now proposing budget cuts of 3 billion krooni ($260 million), as well as a temporary halt to the transfer of pension contributions from workers and employers into the second-pillar pension fund.

But this is now one "chop" on top of the next, since the Estonian Cabinet agreed only last month to cut the fiscal deficit by about 8 billion krooni, or 8 percent of the total budget, in an attempt to ensure the shortfall doesn’t exceed 3 percent of GDP. According to Padar, without further measures the deficit would reach 2.9 percent of GDP this year under the main scenario and but rise to as much 6.1 percent under the worst-case (but possibly more plausible) scenario. Detailed proposals on how to lower the fiscal deficit are to be presented to the government on April 9.

Naturally analysts like myself are rather sceptical about all this. Forecasts have been consistently behind the curve in Estonia, and there is no risen to imagine that this situation won't be repeated across 2009, and 2010, especially looking at the macro data we see coming in. The statistics office announced today that Estonia had a budget deficit of exactly 3 percent of GDP last year, when the economy shrank 3.6 percent. The shortfall was thus precisely equal to the threshold allowed by the EU as one of the conditions for euro entry. Also, when we consider that the country moved from a surplus of more than 2% of GDP in 2007, then it is clear that the rate of deficit creation was very high in the last quarter of 2008.

SEB AB’s Ruta Eier makes the point that with the economy quite probably shrinking by as much as 10 percent this year (or more), the risk of breaching the budget deficit goal is significant. “The chances of meeting the deficit criteria this year seem rather small, especially with the economy shrinking at such rates,” she said in her latest report. Indeed she estimates that first-quarter GDP may shrink by over 15 percent, on an annual basis. Violeta Klyviene, senior Baltic analyst with Danske Bank, is more or less in the same line, and suggests that the budget gap may reach 5 percent of GDP this year unless the government cuts spending further.

So spending cuts are looming, but these will add to unemployment and reduce total domestic demand, so, in effect they will lead to a further contraction in economic activity, which will lead to a higher deficit, which will mean more cuts, and yet more contraction, and so on. This is all a very difficult situation really, which is why I think another approach is needed.

In part bank lending will be another important detail, but bank lending will depend on loan defaults, and these will depend on unemployment, and since even the Finance Ministry are forecasting unemployment at 12.2 percent this year and 15.6 percent in 2010, then defaults are surely set to rise, and with them distress in the banking sector. Indeed, while the Estonian economy at the present time is producing few sellable exports, one thing it is producing are loan defaults: indeed we might say at the present time that the present government strategy is turning Estonia's economy into one huge loan-default assembly line, rocketing backwards as it is with neither steering wheel, nor brakes.

Threat to Euro Membership?

In any event, whatever the eventual size of the deficit, it will need financing, and Estonia’s Finance Ministry is at this very moment seeking a loan for these very purposes, on top of funds already approved by the European Investment Bank.

Of course, one of the reasons that these deficit numbers are so important is that they impinge on Estonia's strategy of seeking Euro membership, and we also learnt today that Estonia’s government has set Jan. 1, 2011, as its new official target. This is an effective abandonment of Prime Minister Andrus Ansip's earlier plan to try to join the euro area on July 1, 2010, although the official position is that this option is still being kept open, despite the fact that European Monetary Affairs Commissioner Joaquin Almunia politely made it clear on March 19 that the plan to join in July 2010 was too ambitious, at least under current criteria.

My feeling is still that Estonia's representatives should be actively working with other East European countries to get these criteria changed, since if we don't achieve that position, the spiraling cycle of contraction, deficit, and economic and political instability may well see eventual euro membership put off into a far distant future.

Are We On The Right Road?

Basically, I feel the whole process of addressing the economic issues presented by the boom-bust cycle are being inadequately - almost incompetently - handled. My own view is that the country urgently needs a devaluation of the kroon, but this is evidently a minority, rather than a majority view. So be it. But then if we are going to go down the internal deflation road, then at least lets do it seriously.

For example, I was horrified to read in the Estonian press that Prime Minister Ansip, is saying that the intended benefits of the new Labour Contract Act may be at risk of being postponed because theSupervisory Board of the Unemployment Insurance Fund did not reach agreement with the Government to raise the unemployment insurance payment rates from January 1.

My impression, as an outsider I know, was that the Labour Contract Act was one of the cornerstones of the labour fexibility process which is so vital to the internal deflation strategy, so how can agreement not have been reached on a key clause in the Act?

"The most important provisions of the Labour Contract Act were agreed between employers and employees. The Government accepted them and asked whether all these benefits fit the unemployment insurance tax rate of 1.5% and the unambiguous response was that they will indeed," said Ansip. He added that the social partners promised back then already that if the benefits would not be covered by the existing payment rates, the benefits would have to be cut.

According to Postimees Online, Ansip stated in a radio interview that the crisis surrounding the Labour Contract Act is the fault of both employers and employees. Sorry, but isn't the job of government to see that these kind of logjams don't arise, and especially in delicate moments like these. My point, however, would not be to discover who exactly is responsible for the mess, but to ask a more fundamental question: how can it be that people are still bickering about this kind of thing in the face of a national emergency, when the survival of your economy and banking system is at stake?

Gentlemen, this cannot be taken seriously.

"We certainly cannot allow to fail to fulfil the Maastricht criteria due o the eficit of the Unemployment Insurance Board that would exceed the planned levels," emphasised the Prime Minister.

Well quite, but the fact that this is even being discussed like this suggests that the hope of clawing through to the daylight is much slimmer than might have been hoped.

Another question revolves around the issue of what kind of adjustment process Estonia is actually committed to. Certainly we are a little short of precise numbers of the kind the IMF spell out in the Latvian case. And the public statements of leading members of the administration do little to reassure us they know what they are about here. Andres Lipstok, the Governor of the Estonian Central Bank, has, for example (see interview extract below) suggested that Estonia's average salary cannot be lowered sharply. Does this man understand what he is talking about at all, I ask myself when I read a statement like this. I fully accept his right to believe that devaluation would contribute nothing to the Estonian economy, but surely, he must understand that substantial internal price deflation is the only half-way viable alternative, that this will be hard, and that this will mean substantial reductions in wages and prices. Basically he doesn't seem to have grasped that Estonia has a competitiveness problem at all, and that all these arguments about not wanting to be a low wage economy (and hence turning the nose up at lower skilled activities) and Estonian wages being lower than the EU average are how we got in the mess in the first place. With an economy imploding at a 10% per annum rate, you can't afford to be that choosy, you know. All I can say is, what's the weather like on his planet?

“One must emphasize that wages in Estonia are still low compared to EU’s verage. Those entrepreneurs and analysts, who think that Estonia should lower alaries remarkably to remain competitive, are wrong. He added that Estonia can’t and won’t be a country with very low wage level. “Estonia’s wage level keeps rising ogether with economy, after necessary correction,” Lipstok said. Inflation is also lowing down. In past 6 months the prices have not grown, after price adaption that ollowed after Estonia joined EU in 2004. The inflation will likely be negative in 009.

For the competitiveness of the economy are no less important to the slowdown in wage rowth. The fast increase in wages in previous years was in part a response to apidly increasing profits. However, at the beginning of last year, the wage level, hich clearly threatened the competitiveness of Estonia. Approximately 15 per cent short of the increase is clearly too much at a time when output per worker is educed. In its first few months, however, wage growth actually stagnated compared o the previous year.

At the same time, it must be stressed that the wages in Estonia, the European Union verage is still low. Analysts and traders are wrong who think that maintaining the ompetitiveness of the Estonian average wages significantly lower. After the ecessary correction will result in the climb to the wage level in Estonia, together ith the overall development of the economy.

At the same time, wage growth has been delayed to stop the inflation of prices.. After the accession to the European Union, followed by adjustment to the price is not for the general price level increased over the last half of the year. 2009 inflation is likely to be negative.

The Price and Wage Correction Is Too Slow

In order to understand why I am being so critical of the Estonian administration in this post, and to see what is wrong with the path on which Estonia is set at the moment we need to keep permanently in mind the objectives that the country has set itself for the coming months and years, which is to carry out a substantial reduction in wages and prices over the next two years (as an alternative to a one off devaluation). Exact estimates are hard to come by here, but we must surely be talking in terms of a very sharp downward adjustment in prices and wages, something of the order of 20% during 2009 and 2010. And my beef is that we see little evidence of that kind of correction taking place. In fact this view is only reinforced on reading the economic policy formulations from the central bank. In its February 2009 statement Eesti Pank had the following to say:

Inflation has fallen rapidly and will not exceed 2% in 2009. The price level is not projected to rise in 2010, either. Many companies have changed their operating strategies and have brought prices and wages into line with the new market situation. This is also proved by rapid changes in the labour market: employment has started to drop, flexible working contracts are becoming more widespread, and nominal wages have started to decline in some sectors.
Let me be blunt: this is thoroughly unsatisfactory as a policy objective, and completely unrealistic (head in the clouds) about the severity of Estonia's adjustment problems.

The pace of deflation at this point is just far too slow to be convincing. According to Statistics Estonia, the percentage change in the consumer price index in February 2009 compared to January was -0.3%, while compared to February of the previous year it was still a positive 3.4%. However, ss reported by the German Federal Statistical Office, the consumer price index for Germany is expected to rise by only 0.5% in March 2009 over March 2008 (down from February's +1.0% - according to initial results available from six Länder). This is the lowest inflation rate registered in Germany since July 1999. Compared with February, prices are expected to drop by 0.1%.

And if we look at the EU harmonised consumer price index for Germany, the downward trend is even clearer, since year on year prices are only expected to increase by 0.4% from March 2008 to March 2009 (February: +1.0%), while compared with February, the index will be down 0.2%.

And the point about looking at German inflation (or rather deflation) is that Estonia is not carrying out this correction in a vacuum. What is important here is relative prices, and if all your neighbouring countries are aither devaluing their currencies, or having internal price deflation (due to thelarge contractions they are experiencing, Commerzbank estimate the German economy itself may contract by 7% in 2009) then you have to do more, and go that bit further, not do less. Otherwise when the recovery does, finally, come, you will simply be left behind, since you will still be uncompetitive.

Nor is Germany an isolated case, inflation in Italy, the euro region’s third-biggest economy, also slowed to a record low in March, with inflation dropping to an annual 1 percent from a year earlier, compared with 1.5 percent in February. And, of course, over the last three months prices ahve actually fallen. And Spanish consumer prices declined for the first time ever (on an annual basis)in March, highlighting concerns that deflationary pressure will emerge right across the European economy. Consumer prices fell 0.1 percent from a year ago using the European Union’s calculation method after a 0.7 percent increase in February.

Indeed inflation rates across Europe are now falling near to zero, and fell to the lowest on record in March according to the initial estimates, adding to concerns that deflationary pressures are emerging throughout the whole region. Inflation in the euro area slowed to an annual 0.6 percent in March from 1.2 percent in February, the lowest rate since the data were first compiled in 1996

And most of Europe's economies are facing contractions in the 5 percent per annum region, so Estonia has a tough benchmark to work against, one which is even tougher when those who make policy are totally unrealistic about the magnitude of the task facing them. I would remind Estonian policy makers: it is a fairly easy thing to say that those economists who don't agree with you don't know what they are talking about, and quite another thing to establish that you, yourselves, do.

Now, as I say, basically the problem here is to restore competitiveness and, although not everyone will be prepared to agree with me, I would argue that the only solution for Estonia is to export its way out of trouble. Given the problems the banking system is having and is about to have, it would be sheer fantasy-land (and very foolish) to imagine we are going to see a return at any point in the forseeable future to consumer credit driven growth (we are talking everywhere about more, not less, regulation), so as Estonians work hard (once they finally get a job again) to pay off their debts and try to save for their increasingly uncertain old age, the only really valid way to try to go for growth is by exporting. Saying that this is not possible, well... this is simply defeatism before you start, and I don't imagine the Estonian character that way somehow, not after so many years of fighting to gain a hard won independence.

So if you want to export, you have one benchmark to work againt - Germany. And if we look at the chart below, we will see the extent of the competitveness gap which has opened up since 1999. Now Reel Effective Exchange Rates (REERs) are a nice measure of competitiveness, since REERs attempt to assess a country's price or cost competitiveness relative to its principal competitors in international markets. Since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends the specific REERs used by Eurostat for its Sustainable Development Indicators have been deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness, and as we can see Estonia's index has risen sharply against Germany's in recent years.

Well, just in case anyone thinks that the comparison with Germany is not an appropriate one in Estonia's case, here (see below) is the equivalent chart for Finland, which shows an equally strong loss, and let us remember that the worst year in this sense (2008) is still not included, since Eurostat have not processed the data yet.

And of course, I am only looking at eurozone comparisons here, we won't enter at this point into the embarassing fact that Sweden and the UK have both devalued sharply in rcent months, as have Eastern EU rivals, Romania, Poland, Hungary and the Czech Republic, as well as non EU rivals like Ukraine and Russia. Really hanging on to the peg blindly in these circumstances is not only foolish, it is ridiculous, and I hardly see how following a ridiculous policy (which for sure is not working at this point) is going to enhance your credibility, which is what the decision not to devalue was all about in the first place. Even worse, it won't even shield the Nordic banks from the slew of incoming defaults as people lose their jobs and the biggest slice of their income. Estonia needs a viable strategy, and it needs it now!


Anonymous said...

I try to understand any benefit of an internal/external devaluation.

Taking for example the car industry, salaries are only 10% of the cost of a car. So reducing the salaries has quite minor impact on prices (but it has on consumption...)

Also the productivity issue may not be due to salaries but to low automation which can be improved with importing productivity tools probably priced in strong currency.
It can also be due to poor education of workforce only liekly to improve in strong currency countries.

I mean this current crisis is likely to be a consumption crisis due to lowering wages. How maintaining such a downward spiral can improve anything in the end?

Isn't saying that EEK is overvalued another way of saying we want you to stay poor to keep importing your skilled workers to put pressure on ours and keep a fundamentally deflating system?

Edward Hugh said...


"I try to understand any benefit of an internal/external devaluation."

Well, the big point is, you can't simply stay where you are. Your economy is imploding. There is no stable "bottom point", since all the debts which were accumulated over the last few years have to be paid off. Until they are paid down your situation will not be stable.

ie, Estonia needs to become a net capital exporter over a feasible time horizon.

If it isn't by exporting, I would like to know how it is to be acheived.

I repeat, this is not as if you were in a neutral position, and could simply sit back and watch at your leisure.

"Taking for example the car industry, salaries are only 10% of the cost of a car."

Well then, if it is cars you get into, you need to export one ghell of a lot of cars, is the only thing here, simply saying that the domestic value added component of the things you produce is not high (since you import the capital - FDI - rather than having savings of your own, you can only think about the labour share) doesn't mean you don't need to export, it means you need to export MORE.

"Also the productivity issue may not be due to salaries but to low automation which can be improved with importing productivity tools probably priced in strong currency."

Well, it would have been nice to think about this when your currency was strong, and you could attract the investment.

Now your currency is inherently weak, but you are trying artificially keep it strong, to try to make paying off the debts cheaper.

But this won't work, since at these relative prices you can neither attract FDI to go into productive activities, nor can you export, so you are simply strangling yourselves.

Frankly this is all painful to watch.

"It can also be due to poor education of workforce only liekly to improve in strong currency countries."

This is alas, true. You have not raised the educational levels of your workforce to be commensurate with your living standard desires. Now you are about to be returned to reality.

Of course you need to do something about the educational level of your society, but this will need years of hard work, and earning the money to invest in an improved educational system.

You cannot simply declare yourself a "hard currency" - as Argentina found out the hard way. You have to earn that status, mainly by selling more than you buy. This is not Estonia's present situation, nor is it likely to be in the near future.

"we want you to stay poor to keep importing your skilled workers to put pressure on ours and keep a fundamentally deflating system?"

This sums up the whole Estonian current issue for me. Instead of informed economic argument, what we get, even at the highest level (which is rather depressing) is emotional irrationality, and near paranoia. It is always someone else's problem, or someone who wants to undermine your country. I'm sorry, this sort of stuff stinks of the soviet era.

It is your problem. The facts are there. Now come up with a solution.

In the meantime, each and every Estonian is being sent home from his or her workplace, one by one.

Anonymous said...

First, I'm not estonian but just take a debating position.

A lot of underlying assumptions are made within your comments and I would like to have a more concrete view than pure macro.

Devaluation would not solve any problems by itself, it is just hope to preserve current enterprise tissu: is this really needed?

Or what along the devaluation shall be done? The productivity issue isn't solved by devaluation or in a unsustainable way.

Devaluation is only a sudden death of the debt by defaulting (and deflation an attempt to renegociate the debt with transfering it to the state). You recognize that debt is the problem, but deny the defaulting solution or any debt clearing solution. Why so?

About education level. It is truly above average (compared world wide and given resources) in Estonia but having been an isolated country doesn't help entering larger markets. Only with sending students abroad you make the needed connections. It takes time.

You like to mention Argentina. I'd like to mention France. During early 90s there also have been a real estate bubble. But contrary to 80s, a strong currency policy was chosen because of the will to join euro. It has succeeded.

Edward Hugh said...

Hello again,

"Devaluation would not solve any problems by itself, it is just hope to preserve current enterprise tissu: is this really needed?"

No, this isn't quite the situation. Having an overvalued currency, like in Spain, has simply lead to a lot of structural distortions in the economy. So devaluation will radically alter the enterprise tissue, by destroying a lot of the stuff that shouldn't be there, and forcing a hole where competitive organisations can grow. It is not about presserving what is, since what is doesn't work, I think we should all be able to see that.

"Devaluation is only a sudden death of the debt by defaulting (and deflation an attempt to renegociate the debt with transfering it to the state)."

I don't see this difference. the debt needs to be renegotiated in both cases, devaluation simply means you have to face up to the problem sooner, and then put all this behind you quicker.

The defualts will come either way, and arguably there will be more of them without devaluation.

"You recognize that debt is the problem, but deny the defaulting solution or any debt clearing solution. Why so?"

Look, I don't think we want default (sovereign default that is) either in the case of Estonia, or Latvia, or Hungary. All of this is about how to avoid that eventuality. Sovereign default would be a disaster, which is why we need a negotiated solution - spreading the load between individual citizens, companies, the government, and the nordic banks. I would really like this to take place under an EU umbrella, which is why the ECB and the EU Commission are going to have to take a more proactive position, they just haven't realised it yet.

The writedowns are going to be substantial, and no one is going to find this easy.

But we come back to the same point, to pay the debts off, Estonia needs growth not contraction. Since everyone - individuals, companies, and now the state - will all be in colossal debt (even after restructuring) there is no growth to be had from domestic consumption - just how exactly would you finance that - so it has to come from exporting, but to export you need something to sell.

Anonymous said...

"Look, I don't think we want default (sovereign default that is)"
To me what matters is WHO really don't want default and see how much he then can absorb the insolvency. Historically, I think this level of crisis has probably often lead to sovereign default.
Because I don't see any reason why export can take the lead while international trading is just vanishing like a souvenir.
So a solution is maybe a global debt clearing to kill running interests.

Edward Hugh said...

Hi again,

"Because I don't see any reason why export can take the lead while international trading is just vanishing like a souvenir."

Obviously, if you are right, and this continues like this, then countries like Estonia are simply bankrupt, and there isn't much to do about it. Both strategies (devaluation and deflation) fail if global trade doesn't pick by the end of 2010, start of 2011. If global trade does pick up however, then Estonia can avoid total bankruptcy by devaluing now and getting ready for the opportunities. On the present strategy, Estonia will (at best) be where it is now, and the possibilities of outright bankruptcy are much higher.

So I agree with you, and the answer you give depends on how pessimistic you are. At this point I think I am not as pessimistic as you, and think it is worth giving devaluation a go. I think it is always better to do something than sit back and wait for the worst to happen.

"Historically, I think this level of crisis has probably often lead to sovereign default."

Historically I don't thinkwe've had this level of crisis before. The "great" depression was always a much more US focused thing.

This time Japan and Ukraine etc are already surpassing things we saw in the 1930s. Globalisation has simply made the transmission mechanisms much more dramatic and much more rapid.

Anonymous said...

What will happen to Latvian economy if it will not receive the payment of the bail out programm in June?

Anonymous said...

In Estonia almost all dept inc. mortgages are in foreign currency (Euro).
After devaluation, which you recommend, debt burden will increase and because the wage level stays the same as before devaluation there will be more defaults.

Most equipment is imported and after devaluation fixed investment costs for domestic entrepreneurs and public sector will rise. There will be even less real investment.

How devaluation helps in such circumstances?

Justin said...

Often people bring this up: If there was a devaluation, then lots of people will default on their EUR-based loans.

However, those are linked to Euribor, which has dropped drastically (more than 60%) in the last year. So, wouldn't their EEK monthly payment after devaluation end up similar to what it was a year ago?

Anyway, back to the main topic. Yes, I also agree that the government is ignoring the problem and not realizing the gravity of this crisis. It's a shame actually, as a lot of people are going to suffer as a result of the government's inaction.

On the deflation side, just look at public sector salaries. No 20% cuts there... many actually went UP over the last year.

So, I'll be at an event later this month where PM Ansip will be presenting. Edward, if you could ask him one question, what would it be? I was planning to ask what information he has that others don't, that indicates devaluation is not the right path even though many economists think it is.

Anonymous said...

Justine said "So, wouldn't their EEK monthly payment after devaluation end up similar to what it was a year ago?"
No, if loan terms will not be renegotiated. Loan principal will rise and monthly payments are denominated in EUR. Very low EURIBOR is not here for ever. Also living expenses rise.
That is why even Sweden banks do not want devaluation of Estonian currency.
One can not have solution taking one variable at the time, variables are interconnected and there are nonlinear connections. There is no neoclassical textbook solution.

Anonymous said...

Justin:“…though many economists think it is.”
What many economist thought got the world into this mess. Economist are not trusted anymore so much.
But you are right about government salaries. PM-s wanted to freeze their salary, but Estonian president did not let it happen and got highest court decision in this matter.
He got nice pay rise for himself too.

Justin said...

Anonymous said: "What many economist thought got the world into this mess. Economist are not trusted anymore so much."

Ok, who should we trust then? Ansip?

Anonymous said: "PM-s wanted to freeze their salary, but Estonian president did not let it happen and got highest court decision in this matter."

I believe it was unconstitutional to freeze the salaries of the current members of parliament. However, why did they need to go to all this trouble and time-wasting? Couldn't each MP just give back their raise to the government (or some charity) after they receive their salary each month? No one is forcing them to keep the raise and spend it on themselves.

Anonymous said...

I suggest to read the interview with Siim Kallas in today's Postimees. http://www.postimees.ee/?id=103364 where he says bluntly that the economists are wrong, and that the main thing to do is to avoid devaluation. He says many of the analysts do not know anything about Estonian economy and that it is more convenient to predict doom and gloom. He also says that the textbook truth that devaluation helps exports is no longer applicable, because times have changed.

Anonymous said...

Estonian govermet has little control over their economy.
Government policy was based on neoliberal idea that markets take care of everything.
Banks belong to Sweden and Denmark parents banks. Most important enterprises also belong to foreign company’s inc. those with low value added to export goods.
You are right of course; low value added is main problem. But it is also the result of
foreign direct investments made so far. Estonian entrepreneurs do not have considerable capital. Foreign owners outside Estonia take their own decisions based on their own interests.

Now they do not want devaluate and at the same time they want avoid budget deficit and inflation to join Euro. All this during economic contraction at exports markets. Seems very difficult task to do indeed, if at all possible.

Probably there will be high unemployment rate about 15-20% for couple of years and political problems. But they also have experience of deep crisis after the collapse of Soviet Union when GDP contracted about 30-40%. This crisis they survived are now somehow forgotten in West.

Edward Hugh said...


"I suggest to read the interview with Siim Kallas in today's Postimees."

Well look, everyone is entitled to an opinion, so Siim Kallas is entitled to his, and I am entitled to mine. Which is that Estonia should devalue, in a coordinated way with the other peggars, but as soon as possible, and as part of a process of euro entry.

"He also says that the textbook truth that devaluation helps exports is no longer applicable, because times have changed."

Well times certainly have changed, since previously financial markets were willing to tolerate large current account deficits, and high levels of personal and corporate indebtedness, and now they are not.

So basically you have to pay off the debts, and I'd like to know how Estonia will be able to do this without exports, since the debts are largely external. Even Euro membership doesn't help here (look at Spain) since members of the Eurozone lose the right to print money, and so if you don't export the goods to cover the debt repayments your economy steadily runs short of money (as I say, look at Spain now).

So imagine you bring the CA deficit gradually down to zero, but you still have to pay down debt (ie now you are no longer increasing it, but it still remains). Can't you see that the only way to get some cash to pay some debts is to sell more than you are buying? This point is so simple I don't know how to make it better. You can either see, or you can't, I suppose. And if you can't I don't know what else I can say that will help you to see. But you not being able to see doesn't stop it being the case, that's the catch, so the Estonian economy can simply contract and contract while the politicians struggle to understand a simple point.

And it doesn't matter a silly fig what the raw material and labour components of the exports are: this argument is a complete irrelevance to the issue in hand. What matters is how much domestically value added there is in what you export. And if re-exports constitute a high proportion of what you export, and you have a high volume of debts to pay down, then you need an even higher volume of exports to accumulate the needed value added to make the payments, that is all.

But the payments still need to be made. Of course, you could always send your creditors your household furniture as a declaration of good intent or something while you convince yourselves that you DO need to export.

"After devaluation, which you recommend, debt burden will increase and because the wage level stays the same as before devaluation there will be more defaults."

Look, I'm getting tired of answering this one. I'm sorry, if you haven't understood yet that this is simply NOT the case, but please read through my articles that the number of defualts is GREATER with internal devaluation than it is with devaluation. I would say again that this isn't a simple matter of opinion but a case of fact.

"How devaluation helps in such circumstances?"

Please see the above.

"What many economist thought got the world into this mess."

This is very demagogic you know, and simply not true. You could say that what many bank analysts were saying got the world into a mess. But then why the hell did so many gullible people believe what those (hardly disinterested) bank analysts were saying?,

In any event, in the Baltic case, this is definitely not true when it comes to what economists in the ratings agencies said, nor those at the IMF, and the consensus at the IMF, the ECB, and people like Krugman and me was very definitely that all the unhedged foreign currency borrowing was flirting with disaster. So many economists were raising the key issues the whole time.

But basically people weren't listening, just like now they aren't. So later people will blame probably blam nameless "economists" because Estonia gets into an even deeper mess as it is forced into disorderly devaluation, conveniently forgetting that most quality economists are currently arguing that you should devalue before this happens.

What most got you into this mess was the ability of a lot of ordinary people to fool themselves into thinking that they could assume large quantities of debt (more than they could pay for) and that house prices would never drop permamently (ie ongoing deflation).

And now people are trying to "kid" themselves into believing that it is possible to avoid loan defaults, even when it isn't. Basically, the key problem is that far too many people aren't willing to assume responsibilites for their own actions, and "economists" make convenient whipping boys.

Some of these arguments sound more like "the last time I had a water leak I called in a bad plumber, and he made the problem worse, so this time T simply won't call in a plumber".

I simply hope most people in Estonia don't get too wet!

Edward Hugh said...


"Probably there will be high unemployment rate about 15-20% for couple of years and political problems. But they also have experience of deep crisis after the collapse of Soviet Union when GDP contracted about 30-40%. This crisis they survived are now somehow forgotten in West."

You know I have heard this argument so often, it is so sad, tragic even. You in the East are the "hard men" who like and know how to live through crises. But wouldn't it be nice, just for once, for you to get some of the joys of this life? What is so wrong with a problem-free, "nice" life. Why do we have to enjoy crises?

You are poorer, and live shorter lives than your western counterparts, why is that something to be happy about? Why not strive to try to change the pattern of one tragedy following another?

Anonymous said...

"You are poorer, and live shorter lives than your western counterparts..."
When someone from Estonia travels in Spain and UK, what is surprising is exactly low living strandards are in. many parts of towns inc. Barcelona suburbs. One thought that western countries are richer. In UK, there often is not even decent heating available, detached houses are often very humble, but cost a lot. Also a lot of old cars.
There is great inequality everybody can see.
Of course Northern countries as Finland and Sweden are much more better.

Edward Hugh said...


"One thought that western countries are richer."

Yep. I think this is right. I think that this is a mistake, for example, that many migrants who come to developed economies make, that everyone is rich. It isn't like this unfortunately.

"There is great inequality everybody can see."

This unfortunately is true everywhere.

"UK, what is surprising is exactly low living strandards are in. many parts of towns inc. Barcelona suburbs."

Again, a lot of these districts are where migrants go, and migrants mainly have to work hard in low skilled jobs for poor salaries. That is why they are there, to do the jobs locals don't want. Naturally such districts accumulate poverty in the first generation. What surprises me, looking at Barcelona, is how well the third generation (of the poor migrants who came from Andalucia in the 1960s etc) now live. So migration isn't an easy get rich solution, but it may well help your grandchildren, if you are prepared to work hard and sacrifice.

"Of course Northern countries as Finland and Sweden are much more better."

Not sure about this. I've never been to Finland, but when I was in the outskirts of Stockholm I was surprised by how old style "working class" the whole thing felt. It reminded me in ways of Scotland. Similar population, of course. And again such impressions are purely subjective. And of course one should not exaggerate. In general terms, and in comparison with most of the rest of the planet almost everyone in the "old Europe 15" lives comparatively well.

Anonymous said...

Hi Edward,

I enjoy reading your analysis and it is also very usefull me since I have some Estonian contacts through my work. I think one reason why the Estonian policicians are so much against devaluation is the fact that Swedish banks very much lobby against it. I think the politicians still rely on these banks.