Estonia's economic transition entailed the twin challenge of managing the reform from a planned to a market economy while adjusting to major external shocks, especially the increase in energy prices and the disruption of trade with countries of the former Soviet Union (FSU). The extent of these shocks caused an immediate decline in living standards, not least because the terms of trade deterioration resulted in a loss in purchasing power for the whole country. In addition, the disruption in trade led to dislocation in production activities and ensuing job destruction. Even though not enough time has elapsed to evaluate long-run effects of the ongoing transition on income distribution and welfare, the country's emphasis on increasing efficiency and reducing macroeconomic imbalances has achieved remarkable results in a short period of time. The sharp drops in output, employment and real wages are swiftly being reversed, creating an environment conducive to sustainable growth. Broad-based growth that leads to real wage increases offers the best hope for sustained poverty reduction in Estonia.
After a cumulative drop of one-quarter in 1992 and 1993, real output began recovering in 1994. Positive growth rates were recorded in both 1995 and 1996. Successful stabilization efforts slowed inflation from 954 percent in 1992 to 36 percent in 1994, and further to 15 percent in 1996. Unemployment peaked at 8.9 percent in 1993 and began falling thereafter. Real wages, after a 40 percent decline in 1992, recovered to around 80 percent of their 1991 levels by late 1995.
The recovery was led by the strong growth in exports to western markets ad buoyant foreign direct investment. Owing to the country's liberal trade regime and stable and convertible currency, exports to western markets increased five-fold in dollar terms between 1992 and 1995. By the end of 1995, exports to western markets accounted for almost one-third of GDP. Foreign direct investment rose from US$ 58 million in 1992 to US$ 209 million in 1995, averaging 8 percent of GDP during this period.
The outward oriented economic recovery opened room for real wages to increase gradually toward the levels of Estonia's new trading partners. Between June 1992 and December 1995, the average monthly real wage increased by 40 percent -- and in dollar terms from US$ 41 to US$ 260. The open trade policy regime also contributed to the downward trend in inflation. Most of the decline in inflation over the last four years was attributable to the slowdown in price increases in tradable goods. This benefited society as a whole, and the poor in particular, since tradable goods, including food, account for over 60 percent of household expenditures.
Privatization and strict financial discipline imposed on ailing enterprises effectively discouraged labor hoarding, permitting the reallocation of labor to more productive uses. Unproductive jobs were eliminated and many productive ones were simultaneously created. This enabled significant direct job-to-job flows of workers and relatively short spells of unemployment -- almost three-quarters of job seekers found jobs in less than 12 months.
Poverty Profile The 1996 World Bank report "Estonia: Living Standards During the Transition, A Poverty Assessment" considered as poor those households whose consumption expenditure per equivalent adult was less than 482 EEK, the minimum pension in July 1995. The poor constituted 8.9 percent of the Estonian population at the time, or around 130 thousand people. Households with the highest incidence of poverty were primarily households with little or no formal income -- unemployed and underemployed members. This central role of the labor market in defining living standards also left certain households particularly vulnerable: those with few, income earners relative to the size of the household, those with lower levels of education, and those in rural areas producing for self-consumption.
Household Composition — Poverty was more prevalent among households with few income earners relative to the size of the household (e.g., households with extended families and many children and households headed by single parents), leaving the old and the young in a particularly vulnerable situation. Poverty among these households also reflected the impact of changing economic conditions on household composition. During the transition, it became more common for young adults to raise children alone (the number of divorces and birth outside of wedlock more than doubled between 1989 and 1995) and for pensioners to extend help to family members in difficulty.
Education — Household heads with more years of education had better access to jobs and higher wages. Among the formally employed, households whose head had less than a secondary education had above average poverty rates and those in occupations that required higher levels of education had the lowest poverty rate. Workers with more years of education had better access to jobs and higher relative pay increases. Also, the more educated workers were less likely to be laid-off and faced a higher probability of finding a job if they became unemployed. In terms of relative wages, between 1989 and 1993, workers with university degrees gained 27 percent over those who only attended elementary school.
Rural Poverty — Poverty was more widespread and deeper in rural areas. The share of the rural population living below the poverty line was more than two times larger than the urban headcount index. The rural poor tend to be poorer than the urban poor. They have average expenditure levels nearly 45 percent below the minimum pension. This reflected the degree of underemployment in rural areas, where a significant number of farmers were producing mainly for self-consumption. Farmers producing for self-consumption, however, constituted a small part of Estonia's total population and, consequently, accounted for only 10 percent of the poor.
Gender differences in poverty rates did not appear to be significant, although there were more poor women than men, reflecting the high proportion of females in Estonia's population. The risk of poverty varied across the life span: children and elderly individuals are more likely to be poor than those of working age. Estonians aged 71 and over compose over 12 percent of the poor. Poverty indicators also varied considerably across regions and between the capital city of Tallinn and the rest of the country -- which is almost a corollary of the differences between urban and rural poverty.
Safety Net Estonia's safety, net incorporates cash benefits as well as in-kind assistance. Cash benefits currently provided under the Estonian system include: (i) pensions; (ii) child benefits (primarily family allowances); (iii) sickness, maternity, and other leave-related benefits; (iv) unemployment compensation; and (v) means-tested income support. Housing support for lower income families constitutes an additional cash benefit, although the household itself does not receive cash; payment is made directly to the property owner to cover rent and heating expenses over and above a certain share of household income for a specified maximal floor space. In-kind components of Estonia's safety net include: (i) job training for the unemployed and other employment services and (ii) counseling, institutional care, and material assistance administered through the social welfare offices. The vast majority of benefits are paid on the basis of categorical criteria. Only social assistance, which includes both housing support and income support, is explicitly targeted by income.
Estonia's social safety net policy has achieved several of its intended goals: (i) programs have provided minimum support to some vulnerable groups in the population; (ii) overall spending has remained fairly stable, both as a share of GDP and in real terms, in an environment of tight budget constraints; and (iii) the levels of benefits and the eligibility requirements have kept appropriate incentives for beneficiaries, thereby avoiding a problem of "welfare dependence." However, several refinements to these programs are needed to better allocate resources, improve targeting, and increase the poverty reduction impact of social safety net programs.
Poverty Strategy Broad-based economic growth is the key to poverty reduction in Estonia. Such growth is crucial not just to raising the incomes of the poor but also to providing a fiscally sustainable safety net for temporarily or chronically vulnerable households. Economic growth helps generate the revenues needed to fund the social safety nets that redistribute the benefits of growth. In other words, expanding the social safety net beyond the available fiscal resources risks the endangerment of long-term prospects for poverty reduction and welfare improvements. Modest social cash benefits today will assure budgetary savings to support investments. Investments will, in turn, generate growth and employment, thus reducing the need for social assistance programs and permitting the real value of benefits to increase for those requiring help from the social safety net.
The proposed poverty reduction strategy involves strengthening the safety net by: (i) improving the monitoring of living standards and its link to policy formulation; (ii) increasing means-tested social assistance by allowing county-level social assistance offices to allocate funds between social assistance programs according to local needs; (iii) decentralizing responsibility for social assistance programs to permit the development of new programs on a pilot basis, possibly involving Non-Governmental Organizations (NGOS), and minimizing budget commitments and demands on the administrative capacity of social assistance offices; (iv) means-testing child benefits and using budget savings to increase the real value of social safety net benefits. Proposals to increase benefits per child, therefore, need to be financed by shifting resources currently directed toward less needy families; (v) increasing the real value of unemployment compensation. At end of -1995, a 50 percent increase in the value of unemployment benefits, at the current level of officially registered unemployment, would cost an additional EEK 13.6 million to the State's budget, less than one percent of the budgeted expenditure for 1996, and could be covered with budget savings obtained from means-testing child benefits; (vi) examining options for reducing old-age poverty; and (vii) exploring options for pension reform.
Statistical System Currently the Estonian Statistical Office collects data from the household budget survey. The data, however, does not play a large role in spending decisions on social cash benefits. These decisions are driven almost exclusively by budgetary considerations. While this ensures fiscal discipline, it provides little guidance to benefit targeting. More detailed analysis of the household survey data could help provide the information needed by policymakers. This is especially important if the Estonian social safety net will continue relying on categorical benefits. Another important step the Estonian authorities may consider is improving the household survey itself. Rather than relying on a large sample (2,000 households per month) with a relatively short number of questions per interview they could rely on a smaller sample of households that receive more attention from the interviewers. This should help increase the response rate and widen the range of questions included in the questionnaires. |
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