After experiencing one of the fastest growth rates in the EU in 2021, Coface reports the Estonian economy will slow in 2022 while maintaining a strong pace. Household consumption (49% of GDP in 2020) benefited from the easing of health measures and grew in 2021. It is expected to remain the main driver of growth in 2022, due to savings accumulated during the pandemic and changes to the pension system that allows savings to be withdrawn at any time from September 2021 onwards. Although the labor market is expected to improve in 2022, the high unemployment rate – 6.9% in 2021 – could be a drag on consumption, which is also constrained by high prices for energy and food (12.5% and 29% of the consumption basket, respectively). With an impact on productivity boost strategies too.

One of the biggest problems that the European Union faces is the lack of both strong energy and technology sectors, as the EU is not a serious contender in the technology race. Less than 4 percent of the Stoxx 600 market cap comes from technology compared to 25 percent of the S&P 500. It looks doubtful that a radical change in economic growth and employment will come from the stimulus plan cascaded by governments and focused on environmental themes of climate change and sustainability from a political perspective, not entrepreneurship. Efficient transition to the green economy should be decentralized, driven by both private innovation and transition timed by markets, not merely imposed to meet election slogans. And this before killing the traditional energetic resources.

In Estonia, electricity prices, which were up about 75% year-on-year in September 2021, have pushed inflation to a record 6.6% and are expected to keep it high in 2022. However, the government has reduced the fees payable by energy suppliers and is assisting low-income households until March 2022. In addition, growth will be driven by increased public spending as part of the 2022-2025 budget strategy to combat the impact of the pandemic in the medium term. Public investments, such as those earmarked to upgrade and expand rail infrastructure, will benefit from EUR 969 million in grants (about 3.3% of GDP) under the NextGenerationEU stimulus package and the Recovery and Resilience Facility. To meet demand, companies will need to invest to increase their capacity, mainly in the manufacturing sector (13% of GDP). Growth in fixed investment amounted to 19% of GDP in 2021. Services (transport, logistics, biotechnology, and financial services), which account for about 62.5% of Estonia’s GDP and employ about 68% of the workforce, are also set to attract investment. Strong external demand for telephones, petroleum products, wood, components for construction, and measurement equipment should boost exports (71% of GDP in 2021). Trade in services will be particularly brisk thanks to the ICT sector (nearly 10% of GDP).

The Next Generation EU plan is likely to repeat the Juncker Plan and the Growth and Jobs Plan of 2009. The main problem is that it aims to spend a massive amount of money in areas that are favored by political returns while the European economy suffers from rising input costs, energy, and raw materials. The European economy is losing competitiveness from rising producer prices and weaker margins, and part of it comes from banning shale gas and imposing an uncompetitive, politically directed energy policy.

Unsurprisingly, the Estonian current account deficit is expected to continue to widen. Imports related to business and government investment will fuel the trade deficit. The balance of trade in services was exceptionally negative in 2021, due to imports by Volkswagen as part of its investment. Despite being constrained by a mixed recovery in tourism, the balance is expected to return to surplus in 2022 thanks to continued support from transport and logistics, with increased exports in telecommunications and IT. Dividend repatriation by foreign investors will maintain the primary income account deficit. The current account deficit will be financed by structural funds and EU grants, as well as by substantial foreign direct investment (10% of GDP in 2020), although this is partially offset by portfolio investment abroad by Estonian pension funds and insurance companies. External debt, which amounted to about 89% of GDP in 2020, is mainly owned by the private sector and is more than offset by residents’ assets held abroad.

The public deficit is expected to shrink further in 2022, remaining below the European target of 3%. However, the government plans to increase current- (wages and pensions) and capital spending (80% of the National Recovery and Resilience Facility Plan), thereby increasing the public debt, which will nevertheless remain well below the European average. Fiscal stimulus can work as long as the flow of savings is expanding, since the expanding savings fund government activities while still permitting an increase in the activities of production. However, if the flow of savings declines, then overall economic activity won’t be revived. In this case, the more the government spends, the more it takes from wealth generators and the more it weakens prospects for economic growth. With a larger pool of savings, it is easier to absorb various unemployed resources. Monetary and fiscal policies that undermine the process of wealth generation make things much more difficult. As long as the pool of savings is still expanding, the government and the central bank can pass off the illusion that they can grow the economy. However, once savings begin to stagnate or decline, the illusion is shattered.