Why did Estonia move from a planned economy to a market economy Essay Example

Why did Estonia move from a planned economy to a market economy Essay When Estonia first gained independence after the First World War, it enjoyed great economic success and development during the twenty-year inter-war period. However, the economic gains were negated by fifty years of Soviet occupation following World War II, leading to economic stagnation. The central government of the Soviet Union had destroyed the Soviet Republics economy as a whole, as the decision of what to produce, how much to produce and for whom to produce was placed solely on the government. Thus inefficient monopolistic state-owned industries employing the entire population regardless of skill level churned out poor quality goods that nobody wanted, while the rationing of basic foodstuffs was part of daily life. With the loss of the profit motive and no hierarchy system where the better were rewarded, both people and companies had little motivation to be efficient or innovative. The Estonian economy was in reality just the sum of the enterprises physically located on one territory. Due to the closed Soviet Unions huge shortage economy and immense quantities of natural resources, the Estonian economy could seemingly ignore world competition. As raw materials were bought at heavily subsidized prices from Russia (which led to the unaccountably low prices of energy and raw materials etc. ) the majority of enterprises created were material, energy and transport intensive, producing mainly low quality goods. But when the Soviet Union began to collapse in 1991, Estonia declared independence and started shifting towards a market economy. It sought an end to the incessant shortages, poor quality goods and inefficient state-owned industries suffering from diseconomies of scale which had plagued it as a planned economy and the diversity and dynamism of a market economy, which would hopefully bring much needed foreign investment, a well-oiled private business sector and stable economic growth to raise living standards. We will write a custom essay sample on Why did Estonia move from a planned economy to a market economy specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Why did Estonia move from a planned economy to a market economy specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Why did Estonia move from a planned economy to a market economy specifically for you FOR ONLY $16.38 $13.9/page Hire Writer The Estonian economy faced deep structural problems immediately following independence. After the collapse of the Soviet Union, the Russian ruble continued to function as a currency in the former Soviet empire. Russia had the sole authority to print ruble notes and so in some sense controlled monetary policy throughout the currency area. Estonia remained part of the ruble zone the remnants of the Soviet monetary system even after independence in 1991. But political and economic instability in the CIS, coupled with the complete lack of monetary discipline within the ruble zone, offered little international credibility for the nations using the ruble. With the removal of subsidies on a multitude of goods, prices rose to real levels. In 1992 inflation exceeded 1,000 percent. Without the Soviet Union juggernaught providing cheap raw materials and a market for exports, the Estonian economy was left completely exposed. Inefficient state companies were forced to close, aggravating unemployment and dragging down GDP: the cumulative decline of the GDP during the period 1990-1994 was 36%. Foreign investment was desperately needed; enterprise was almost non-existent and capital had to be imported. What are the benefits of its transition? (5) Today, Estonia has a booming economy that is rapidly reaching western standards. Its economic success is based on a liberal economic policy, a currency board system with a stable currency pegged to the Deutschmark/Euro and a balanced budget (The Estonian government solved the problem of rocketing inflation by introducing a new currency, the Kroon, in 1992. It was pegged to the stable Deutsch mark and helped to calm prices, allowing the economy to start anew). Thanks to an extremely favorable business climate, excellent communication links, a low-cost base, plus a highly skilled and productive workforce, Estonia has become an attractive location for inward direct investment and an active and rapidly growing exporter: in 1998, Estonian exports were four times the level they were five years before. Exports increased faster than imports in 1998, cementing the export sector as a key factor contributing to the countrys economic growth. In 1995, Estonian signed an association agreement with the EU and was among the first six associated countries invited to accession negotiations in December 1997. In 1995, Estonia formally submitted its application to the WTO and negotiations for membership are now entering the final stages. Estonia has succeeded in reorienting its foreign trade away from the former Soviet Union and the shrinking eastern market to western markets. Today, the EU is Estonias biggest trading partner, accounting for over 60% of Estonias exports in 1998. Russia continues to be an important export partner, although total exports to the Russian Federation declined from 19% in 1997 to 13. 4% in 1998. The Russian financial crisis had an effect on industries whose main target for export was Russia (namely the food industry). The GDP declined in 1999 by 0. 7%, but started growing again in 2000. Due to important changes in the direction of foreign trade and the economic relationship in general from east to west during the 1990s, the effect of financial crises in Russia had a more moderate influence on the Estonian economy than would have occurred if Estonia had been more closely linked to the Russian market. The structure of the Estonian GDP has become rather close to that of the GDP of developed countries. These structural changes are a result of the deep economic decline experienced during the difficult years of transition and foreign trade shock (a rapid change of terms of trade, and a deep decline of trade with Russia). These shocks enabled Estonia to develop an export-orientated and well-oiled free market economy, which in turn brought economic growth and an increase of general wages well ahead of inflation. Estonia is now investing heavily in the technology sector, and 40% of its citizens now use the internet. With living standards rising steadily, more and more economists are beginning to call the difficult transition Estonia has endured the Estonian Economic Miracle.