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Estonia: What Is Behind Economic Success?

September 6, 2007 (RFE/RL) -- The Economic Freedom Network, a global association of research and educational institutes, has just issued its annual report, which rates only one former communist country among the world's top nations with policies that support economic freedom. That country is Estonia.

The report has high praise for Estonia, whose economy grew by over 11 percent in 2006.

It notes that Estonia performed better not only in comparison with its Baltic neighbors, Latvia and Lithuania, but also placed ahead of countries like France and Germany -- not to mention Belgium, Ukraine, or Russia, which are near the bottom of the list.

Estonia was ranked as a top performer, alongside Hong Kong, Singapore, Switzerland, Britain, Canada, and the United States.

So what has Estonia done to attract such praise?

Dumping Soviet Legacy

Andres Kasekamp, the director of the Estonian Foreign Policy Institute in Tallinn, says Estonia deserves the accolades it receives because it has managed to create a modern market-based economy with strong ties to the West -- in a record amount of time.

After regaining independence in 1991 following 50 years of Soviet domination, Kasekamp says Estonia started radical market reforms earlier than its neighbors.

"The most important thing would be that in Estonia, in the beginning of the 90s, there was a strong societal consensus to distance the country as quickly as possible from the Soviet legacy and from Russia and to do everything in the exact opposite fashion -- what was bad under the Soviets would now be good," Kasekamp says.

In Estonia's case, the young new leaders who came to power in the 1990s played a huge role in pushing reforms.

"In our first free, independent elections in 1992, the government that was elected was headed by Mart Laar, who knew nothing about economics except that he read one book and that was by Milton Friedman," Kasekamp says. "And he was very inspired by that, and he was also inspired by [former British Prime Minister Margaret] Thatcher and, basically, he was a young guy who's main idea was to clean away the old Soviet mess."

Radical Reforms

Laar inherited an economy with 1,000 percent inflation, loss-making government enterprises, and growing unemployment.

His answer was to remove price controls, cut welfare programs, and slash business regulations. State firms were sold off and a new currency introduced. And most importantly, the government instituted a simple, flat income tax that attracted foreign investment and is now being copied in many other countries.

The government also concentrated on turning Estonia into a high-tech leader, upgrading communications networks and offering incentives to Internet startups that earned the country the nickname "E-stonia."

Almost two decades later, inflation in Estonia has dropped below 3 percent, unemployment has plunged below 6 percent, and foreign investment has poured in. Estonia has enjoyed the greatest growth in real per capita income of any of the former Soviet states. Today the country is a member of NATO, the European Union, and the World Trade Organization.

Favorable Climate

Kasekamp says geographical proximity to Finland is also a big help as many Estonians go to work in the neighboring country and bring back their earnings.

Vytautas Radzvilas, an analyst at the Lithuanian Institute of International relations, says that there are no radical differences between the Estonian and Lithuanian economies, but without any doubt Estonia has a more favorable climate for business than Lithuania.

"All investigations and research clearly shows that there is less corruption in Estonia [than in Lithuania] and fewer obstacles for business," Radzvilas says. "There are no structural or fundamental differences [between the economies of Lithuania and Estonia] but one fact is clear -- there is less influence of the former Soviet nomenclature in the Estonian economy."

Estonian reformers did not allow former Soviet officials to take over the economy as happened in Lithuania, Radzvilas says.

However, some questions about the Estonian development model remain.

Although the Economic Freedom Network ranked Slovenia below Estonia, it is Slovenia which has been invited to join the euro zone, not Estonia. Kasekamp explains this paradox by the fact that Estonia's economy has become overheated and inflation has gone up.

On the other hand, he says many economists in Estonia wonder if the quick adoption of the euro would be good for Estonia's liberal economy.