Estonia's transition to a free-market economy in the early 1990s reflected the difficulties of building an independent economy from the ruins of one that hitherto had been developed for a single market, that of the Soviet Union. The creation of new economic institutions such as a separate monetary system, new regulatory agencies, and new development strategies had to keep pace with the decline of the old economy and its institutions. Real gross domestic product (GDP--see Glossary) dropped continuously in the early 1990s (see table 6, Appendix). Yet, among the former Soviet republics, in roughly four years of far-reaching market reforms Estonia became a model of economic transformation. The right-of-center government of Mart Laar, which took office in 1992, maintained a promarket stance despite criticism from opposition parties and agricultural interests, which were most vulnerable to foreign competition. After the introduction of the kroon in June 1992, inflation fell rapidly to an average of less than 3 percent per month in 1993. Consumer goods were again in abundant supply. Foreign trade grew, although in 1993 the trade balance began to show deficits. Under a program of privatization, 80 percent of the country's state-owned small businesses were sold off, and three rounds of large-scale privatization with foreign participation resulted in the acquisition of thirty major enterprises. By January 1995, after several more rounds of privatization, only twenty large enterprises had yet to be privatized. Official unemployment dropped to 1.4 percent in November 1994, but real unemployment may have been as high as 10 percent. The squeeze on the economy and the state budget intensified as many large, privatized firms were downsized and the transition neared the decisive stage of open competition.
Economic Reform History
Estonia began its reform process in 1987 with the development of a plan for economic autonomy within the Soviet Union. Drawing on examples from both China and Hungary, the radical proposal called for an end to central economic control over Estonia, a separate tax system, and the adoption of a convertible ruble. Until then, it had been said that as much as 90 percent of the Estonian economy was controlled from Moscow; very little was left for the Estonians to decide for themselves. The decline in living standards beginning in the early 1980s and the "years of stagnation" were viewed as direct consequences of this overcentralization. With Gorbachev calling for a "restructuring" (or perestroika
) of the economy, the Estonian proposal was meant to respond to and test this new call for change. The idea was popular among Estonians, not least of all because of the plan's name, Isemajandav Eesti, whose acronym, IME, also means "miracle" in Estonian.
Despite initial resistance from the old-guard Estonian Communist Party leadership, IME became official policy soon after the appointment of native-born Vaino Väljas as first secretary of the party in June 1988. Teams of economists were put to work mapping out the laws and decrees that would enable the plan to begin by January 1, 1990. Much of this work would improve Estonians' knowledge of reform economics by the time more radical measures proved necessary. In May 1989, the Estonian Supreme Soviet approved the plan by an overwhelming majority, sending it on to the Supreme Soviet in Moscow. Kremlin bureaucrats, however, sought to water down the scheme, injecting contradictory clauses that would make the plan unworkable. While the final law passed by the Soviet parliament accorded economic autonomy to Estonia, along with Latvia and Lithuania, it also stipulated that all reform measures be in accord with central Soviet laws.
In the following months, as the popular mood in Estonia shifted toward full independence, it became clear that the IME plan, too, would get nowhere within the increasingly outdated Soviet system. Still, many of the details and general impetus of IME proved very useful for economic reform down the road. In December 1989, the Estonian Supreme Soviet voted to create a central bank, the Bank of Estonia, for the republic as part of the plan for an eventual Estonian currency. Price-reform policies were in full force by October 1990, and an independent law on foreign trade was adopted. Prime Minister Edgar Savisaar sought to broaden Estonia's economic contacts with other Soviet republics, organizing several economic summits in Tallinn with Central Asian and Caucasian leaders. A new tax system was put in place in Estonia, replacing the state budget's dependence on enterprise turnover taxes and phasing in income and sales taxes. In short, economic reform simply was carried out without regard to the Kremlin.
By August 1991, with Estonia's leap to full independence, the economy was beginning to feel the pain of both market reform and collapsing ties to the Soviet Union. Gasoline shortages had been endemic since 1990, and many enterprises were forced to cut production because of a lack of raw materials previously imported from other Soviet republics. Lax Soviet monetary policy also fueled Estonian inflation, undermining reform efforts as long as the new country remained in the Russian ruble zone. An unprecedented fuel and food shortage in January 1992 prompted Prime Minister Savisaar to ask parliament for emergency powers to deal with the crisis. Deputies in parliament, however, had lost confidence in Savisaar, and in the ensuing political crisis he was forced to resign. Savisaar was replaced by his transportation minister, Tiit Vähi.
A temporary fuel loan from Finland helped stabilize the situation, but the need to hasten the introduction of Estonia's own currency became apparent. Other economic reforms such as privatization and foreign trade were also being held up by the country's dependence on the Russian ruble.
On June 20, 1992, against earlier objections from the International Monetary Fund (IMF--see Glossary), Estonia introduced its new currency, the kroon. With only US$120 million in gold reserves and no internationally backed stabilization fund, Bank of Estonia president Siim Kallas said the country could wait no longer. At 800 exchange points across the country, residents were allowed to exchange up to 1,500 rubles at a rate of ten rubles to one kroon. Excess cash was exchanged at a rate of fifty to one. Bank accounts were converted in full at ten to one. By the end of the three-day transition period, the move was declared a success, with only minor glitches reported. For stability, the kroon was pegged by special agreement to the deutsche mark (DM) at EKR8 = DM1. This would make the kroon worth about 7.7 United States cents, or EKR13 = US$1. The kroon would be the only Baltic currency to be officially pegged to any outside value.
Data as of January 1995