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Baltic Sea Index In their June 30th Baltic Sea Report, Swedbank takes a look at the shape of the economies around the Baltic Sea and also introduces the new Baltic Sea Index.

Countries covered by the report include, in addition to Estonia and Sweden, Denmark, Finland, Germany, Latvia, Lithuania, Norway, Poland, Russia and Ukraine.

- Baltic Sea economies expand again – but to remain competitive, more reforms are needed, says Swedbank in the report.

Swedbank's new Baltic Sea Index is compiled from several indices, obtained from various sources, and then transferred into a ranking index for these 11 countries. Swedbank selected 10 areas considered most important to monitor business conditions: Entrepreneurship, Labour market, Tax policy, Financial markets, Foreign trade, Education, Governance, Infrastructure, Logistics and Innovation climate.

- The results of this first compilation of the Swedbank Baltic Sea Index indicate that the Nordic countries and Germany rank among the top 20% performers of the world, says Swedbank's Jörgen Kennemar. While these rankings are high, they also indicate that there is still room for improvement. Furthermore, as other countries keep reforming, the Nordic countries also need to pursue continuous adjustments to maintain their positions. Estonia, the only country that has improved its ranking during the period, is above the average for the Baltic Sea region countries, while Lithuania, Latvia, and Poland rank slightly below average. Russia and Ukraine are lagging and fall significantly below the average. In these two countries, the payoff from reforms will be greatest.
Estonia – EMU membership - The Estonian economy is slowly recovering from the recession and we expect GDP to grow by 1.5% this year, and 4.5% next year, says Swedbank's Annika Paabut and Maris Lauri. Exports will support growth, and the main risk for the outlook is thus the global economy, not least the euro zone.

- The most important change in the economy will be the adoption of the euro in 2011, continues Annika Paabut and Maris Lauri. Joining EMU will boost sentiment and help to attract more foreign investments which, in turn, will increase economic activity and create jobs.

- The Estonian institutional setting is relatively strong, and, at the same time, the tax level for enterprises is relatively low (for instance, there is no tax on reinvested profit).

- Consumer spending will remain weak this year and start to recover next. We expect inflows of investments to increase at the end of this year and next, due to improved risk estimates after euro adoption in 2011. Investments will be supported by EU structural funds.

Estonia has elections for the Parliament on March 6th, 2011 and Presidential elections will be held the same year.

- Many different factors favor the current government, says Annika Paabut and Maris Lauri. The government has succeeded in leading the Estonian economy through the current economic crisis but, doing so meant that the government had to make many very unpopular political decisions while trying to control the budget deficit. Nevertheless, the current government can lay claim to having established Estonia as a state with a strong fiscal policy and budget position, something that is extraordinary in the EU in 2010.

- On the other hand, the opposition parties can point to the hardships of the unemployed, as well as the insufficient structural reforms of the current government. Nevertheless, despite these strong campaign issues, the ongoing debates and conflicts inside smaller opposition parties may undermine their chances of success in the coming elections.

- Estonia ranks relatively high in the Baltic Sea Index, and has shown the most improvements over the last couple of years, comments Annika Paabut and Maris Lauri. More importantly, there have been steady gains in most subindices. Estonia is strong in "Education" and "Governance" but is loosing ground in "Infrastructure". The most room for improvement can be found in "Tax policy" and "Labour market".

- The structural problems on the labour market are, however, about to increase; the lack of a qualified workforce, together with high unemployment, is a gradually worsening problem. Because companies are trying to employ qualified workers (as they give notice to less qualified ones), the pool of the former will gradually diminish. Also, some people will probably move to work abroad, and others will lose their qualifications. The number of highly professional workers is not large in many areas, and currently unemployed persons have mostly worked in jobs requiring low or medium qualifications (e.g., in retail, and in construction and other blue-collar jobs). For a while, the economy and investments could expand while supporting a relatively high number of such unemployed, but this cannot last long.

- Although Estonia currently has a high unemployment rate, we forecast that this will start to decline and become low within five to seven years. The reason is aging: there will be more people leaving the labour market than those who will be starting their working life. We are also of the opinion that, at the same time, the share of long-term unemployed will increase. There is, thus, a possibility that Estonia will after some time suffer again from rapid wage increases.

- In sum, in making plans for the long term, the authorities and firms should keep in mind that the period of cheap labour will not last long. Even though the wage level in Estonia may stay lower than in the EU on average, it will nevertheless rise. This suggests that production should become more capital intensive and less labour intensive (this kind of change, however, needs additional investments).

- In addition to the changes in the production process, a reform of the educational system is required to meet the needs of the labour market and to help people to enter and/or re-enter this market. Investments in human capital will become more important, and the government should introduce incentives for firms to invest in their employees, concludes Annika Paabut and Maris Lauri their comments on Swedbank's Baltic Sea Index for Estonia.

Sweden – consumption drives growth - The Swedish elections in September this year are likely to be close, and the campaigns have so far mainly focused on short-term issues, says Swedbank's Magnus Alvesson. It is unlikely that any major structural reform initiatives will be launched during the run-up to the elections.

- The economic recovery is stronger than expected, but mainly on account of restocking by companies and a temporary burst in household consumption. We have raised our growth forecasts to 2½% in 2010 and 2¾% in 2011. The main engine is expected to be household consumption, while investment will continue to lag. The economic policy mix remains supportive, and there is space for further fiscal stimulus should the economy take a turn for the worse.

- Strong consumer demand will benefit companies oriented towards end-product markets. The weak investment climate, both in Sweden and in main export markets, will, however, hold back demand for investment and capital goods.

- The political situation could, on the other hand, create uncertainty that the reform process will continue. An unclear election result in September could delay important initiatives and weaken the resolve to tackle key reform challenges.

- Competitiveness for production in Sweden will remain strong. Unit labour costs are expected to fall as wage demands are restrained; prices remain stable, and productivity growth resumes. A sharp appreciation of the krona vis-à-vis key export markets poses a risk.

- The Swedish economy functions well in a global perspective, as reflected in the Baltic Sea Index, comments Magnus Alvesson. This assessment is reinforced by the recent 2010 evaluation of the Lisbon agenda, where Sweden is ranked 1st among the EU countries and scores particularly well in categories such as "Information society" and "Financial services." In the Baltic Sea Index, the main weaknesses are found in the categories of "Tax Policy" and "Entrepreneurship".

- Thus, many challenges remain. To sustain competitiveness and support growth, the resources of the economy must be used more efficiently. The labour market still suffers from high entry barriers, and in particular, youth and recent immigrants find it difficult to find regular employment.

- The business climate for small and medium-sized enterprises needs to be improved, and this could be accomplished by further deregulating public sector service production and by ensuring competitive public procurement.

- For the medium to long term, it is crucial that the high levels of R&D spending be maintained and that the educational outcome, which is lagging behind peers, be raised significantly. It would be worthwhile for the election campaigns to pay more attention to these issues, concludes Magnus Alvesson.

Swedbank's Baltic Sea Report is available online at www.swedbank.com