HEIDO VITSUR ⟩ The toughest choices lie ahead. Three fundamental problems need to be solved.

Heido Vitsur, economic analyst at LHV and economist. Photo: Tairo Lutter

• It seems that we still haven't understood the most profound thought of President Ilves.
• First, it is necessary to stop depicting the situation as more beautiful than it really is.
• We haven't had any constructive ideas to support economic growth or control costs.

Even if the coalition agreement signed in mid-July enables the budget to be balanced, the planned steps will only allow us a short additional time to solve the even more fundamental financial problems facing the nation, not to mention other problems of socio-economic development, economic analyst Heido Vitsur writes.

After all, the current budget problem began to make itself known many years ago, doing so because in the dynamics it was increasingly impossible to cover growing social needs or the automatic advance growth of expenses secretly written into the laws with the help of the money coming into use by the government.

Such a situation had arisen on the one hand because of our poor ability to use the available money effectively, but also because, instead of considering future trends, we had sought support for our actions or inaction from the past and written obligations incompatible with real development into the laws.

There are three fundamental problems that need to be solved

First, it is necessary to stop depicting the situation as more beautiful than it really is (lying to oneself) and to talk about things as they really are. Above all, we need the truth instead of the fog that has been maintained for years about demography, green energy, integration, social security, our enabling legislation, as well as self-regulation.

It is necessary to acknowledge that the main reason for our troubles is that, although, instead of the previous 12-year average growth of 3.5 percent, higher by two percentage points than the European average, our economy has been in an average decline of 1.5 percent for the third year, we have not had any constructive ideas to support economic growth or control spending.

That, in justifying our difficulties, we have pointed to the rest of Europe, where, at the same time, the economy, in contrast to us, has grown by an average of 1.3 percent per year. We are quick to point to those who are worse off than us at some point to justify our failure, but we can't stand the idea that we could learn anything from those who are better off than us.

When talking about difficulties, it is necessary to realize that the magnitude of our problems is not only expressed by the average GDP decrease of 1.3 percent over more than two years, but even more so by the fact that we do not have the usual average economic growth of 3.5 percent for the third year already, which is why the gap between obligations and opportunities grew so large in our rigid legal space.

Although the most difficult choices lie ahead in the areas of management, social protection and healthcare, major projects such as Rail Baltic (RB) and the plan for the transition to renewable energy need thorough and honest explanations.

This is what the future Rail Baltic passenger terminal in Tallinn should look like. Photo: Rail Baltic Estonia

Let’s face the truth

Since all the economic calculations about RB have not come true as predicted, it is now high time to clearly state that even though RB is very expensive and will not find much use in the near future, we still consider its construction to be justified regardless of the costs and current economic expediency and future operating costs for these kinds of reasons. I cannot imagine what «kinds of» reasons besides political ones there could be.

The same goes for renewable energy. More precisely, about why Estonia, which itself has one of the worst natural conditions in Europe to smooth out the intermittency of wind energy economically (we do not have hydroelectric power plants, but in Europe hydroelectric power plants will cover almost a third of the 42.5 percent renewable energy production obligation also in the middle of the century), has taken upon itself the obligation to speed up the production of intermittent energies three-fold over the rest of Europe, and do so by relying on the most expensive offshore wind farms and by guaranteeing them a market with a solid price floor.

It is impossible to understand whether this is a mistake or something else, because both entrepreneurs and people have started to experience more and more clearly every day that the transition to renewable energy, although its use is becoming more and more necessary, does not bring cheaper energy to the consumer. After all, it is of little use to the end user that when the wind blows, cheaper electricity comes from the wind turbine than from the thermal power plants together with the CO2 market price, if everything that needs to be done in the use of wind energy to smooth out its intermittency, maintain the price floor and subsidies, deliver electricity to the consumer, ensure security of supply, etc. costs all the more as a so-called network fee the more intermittent energy is produced. But with rising energy prices, it is not easy to help the economy back towards growth.

Public sector

Secondly, regardless of whether it is economic or political projects, the available money must always be used as rationally as possible. The weak point here is not only the organization of our public procurements, but also the basis on which choices are made between different programs and their configurations. For example, the question of how to use European money in such a way that it will be of maximum benefit to us is an always relevant question.

This also includes finding out the extent to which our economy and society can support projects that are largely or entirely driven by artistic or political interest: for example, the desire to build as many spectacular/beautiful public buildings as possible. There is a limit somewhere where one must understand that you cannot put beauty in a pot. That is why the Pärnu city government had to replace the beautiful «Luik» («Swan») with a simple arch bridge. Understandable, but still a shame. Especially when you think that once a rather poor Estonia built a beautiful arch bridge in Pärnu...

Last, but definitely not least, we need a proper overview of what is actually being done in our public sector and what money is being spent on there. Although we have about 5 percent of all employed people working in the public sector, which is not much at all compared to the rest of Europe (on average 6 percent of GDP is spent on general government in the European Union, less than 4 percent in our country), it is precisely the work of the public sector and its rationality that have risen to the center of public interest. Probably not for nothing, because bureaucracy likely also has a part to play in our poor economic condition. Moreover, thanks to the current «activity»-based budget, previous skepticism has been replaced by mistrust.

The problem is not so much the size of the public sector, but the fact that all these years we have paid attention mainly to the financial balance and little to the content of work and the efficiency of spending. In other words, this means that some work has not been done at the national level. However, the result is a superficiality of the analyses necessary for decision-making, a lack of completeness, so-called political decision-making and the often-accompanying inefficient use of resources, poor decisions or decisions not made on time.

Despite the above, cutting back the public sector is not expected to be of much benefit in terms of balancing the budget in the long term: due to the small size of this sector, even the most severe cutbacks will not be able to achieve considerable savings there. However, we need to significantly increase the analytical capacity of the public sector and cross-departmental cooperation, because without it, it is not possible to use the money collected in the budget effectively, nor to keep costs and revenues in the necessary balance.

About Estonia's space for development and the comfort zones of Estonians

It is clear that while the first two problems, which are partly related to human weakness, will permanently accompany us, then with the third one, a lot can be done in a short time with good initiative if we have institutions capable of this and an adequate overview of what is actually happening in our country.

In a normal situation, it is correct to start the trimming of institutions not by assigning saving tasks to agencies (this is only suitable as an emergency solution), but by collecting the necessary data to find places for savings. In fact, the existence and analysis of such data covering the entire public sector should be the rule.

After all, the problem is that looking at any civil servant or other public sector employee at his desk, as well as reading his job manual, it is in no way possible to tell whether his work is worth the salary and the expenses incurred for the job or not. We know from Parkinson's law that any kind of work can take up all the time in use, even to such an extent that there is no time left to do the necessary work.

The first hint about the justification of expenses can be obtained by comparing different expense items or physical indicators across agencies (for example, floor space in square meters, office equipment or number of official cars/cost per employee, etc.).

Evaluating the substantive work is more difficult, but in such a comparison it also becomes clear what percentage in one or another ministry is made up by units performing different functions.

Of course, because of their different work, the agencies cannot be compared one-to-one according to every parameter, but starting from a certain mark, it is worthwhile to start investigating the differences and the reasons for them more.

Although this is the question that has been of most interest to the public for years, the review of the substantive work of the agencies is nevertheless more important than that. It is necessary to understand why our bureaucracy is slow and often not conducive to development at all. Why have we so often chosen the strictest path in the transposition of European directives in some issues, but let it be so lax in other issues that we are again facing several fines. Why many things cost us much more than what was promised, and why investments are made that have no real purpose.

In my opinion, our institutional weakness has also caused the fact that we have not dared to admit that we cannot build a Nordic-type welfare state with a 33 percent tax burden, but by seemingly attempting to do so, we have brought the state's finances out of balance.

Even now, regardless of how the issue of balancing the state budget is resolved in the coming years, it is necessary to give considered answers to three questions that will inevitably require more money in the future:

First, how to prevent a further worsening of pension poverty, including the poor ability of pensioners to pay for care home services.

Secondly, how to ensure the availability of medical care in an aging society.

And finally – how to get to the rational spending of money not only in education, which has become an object of special interest, but also in making other public expenditures.

On average, 76.2 percent of general government money is spent on these problems in the European Union (2022 data) and 73.6 percent in Estonia, while the increase in spending here is predetermined for decades due to the demographic development that has already taken place on the one hand, and on the other hand, with advances in medicine and increasingly complicated work (requiring special and life-long training).

No matter how unpleasant it is from the point of view of domestic politics, we have to say firmly and in a way that we can be trusted, whether we will continue down the path of solidarity, relying on the state budget and increasing taxes, or increasing the share of paid services and compulsory insurance for people in these areas.

At that, when making a choice, we cannot limit ourselves to the observation that we belong to the cultural space of the Nordic countries. This is only partly correct, because in terms of our socio-economic beliefs, we are actually closer to the Anglo-Saxon cultural space and in a couple of points even to its most right-wing edge.

For example, no thoughts were prompted here when Janet Yellen said to journalists (after the G20 meeting in July): «We think that all countries should make sure that their taxation systems are fair and progressive. Washington is strongly supportive of progressive taxation, and making sure that very wealthy high income individuals pay their fair share.» We, on the other hand, consider our regressive tax system to be fair and progressive and see nothing wrong with deepening this regressivity, and we have created a situation where most of the population and politicians have the wrong idea of a graduated income tax.

An attitude that is just as peculiar and dismissive of real needs as there is in taxation can also be seen in the field of social protection. Thus, thirty years of cynical attitude towards the elderly has led us, unlike the rest of the developed world, to the understanding that a more than two-fold decline in the standard of living or poverty in old age is the natural and inevitable condition of the last fifth of human life, and we do not consider it necessary to do anything here.

So, we chose to dismantle our pension system rather than improve it, believing that coping in old age is up to each individual, even though it is known that three-quarters of people do not become interested in their retirement until it is hopelessly late. We have no right to speculate on the idea that it might be possible to significantly increase the pensions paid from the first pillar in the future, if it is clear that the demographic development that has already taken place does not provide the possibility to maintain the current pension replacement rate, one of the lowest in the OECD world, without increasing the social tax rate, and that the social tax must be lowered rather than raised in order to restore the competitiveness of the Estonian economy. It is time to recognize that making the second pillar voluntary did the greatest disservice to those whose retirement is decades away and set about correcting the mistakes as soon as possible.

But today even the dullest person should understand that Ilves was right and we have simply wasted the ten or so years that could have been used to set the plow.

There are things that cannot be voluntary in the cultural space of the West. One of them is universal basic education and the second is social security covering the entire population.

It is even somewhat strange that, in education, we consider it important to maintain the relatively most expensive and student-friendly physical school network in Europe, but when it comes to the social protection of the population, we still live partly in an agrarian society and partly in socialism.

If our institutions were up to par, we would have started calculating things like the cost of mass sprawl versus more compact settlement a long time ago. We would have started thinking about what is different in our legal and economic space, that we have chosen a way of life that requires such expensive infrastructure and high operating costs.

One reason is probably that we have not taken into account the alternative cost of this type of settlement, and that this cost has been paid in solidarity, not by those who enjoy a dispersed lifestyle.

We have the same contradictory situation in trade

The competition between retail chains has made the margins so thin that the workers in the stores are paid one of the lowest wages in Estonia and that the stores suffer from high turnover and shortage of labor even in times of high unemployment.

At the same time, however, our competitive conditions force entrepreneurs to further expand their retail space and keep stores open longer than necessary and hire more labor than European ones allow. Unfortunately, the competitive situation in trade is not only a trade problem, because the downside of abundant retail space and generous opening hours are higher operating costs and such low margins that every additional percentage of VAT is added to the prices of goods and pushes our already high price level even higher.

It seems that we still haven't understood the most profound thought of President Ilves: what brought us here will no longer take us forward. But today even the dullest person should understand that Ilves was right and we have simply wasted the ten or so years that could have been used to set the plow.