EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 505 final COMMISSION STAFF WORKING DOCUMENT Country Report Estonia 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2020) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness reforms and investment 3.5.Environmental sustainability Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and fiscal risks Annex C: Standard Tables Annex D: Investment guidance on Just Transition Fund 2021-2027 for Estonia Annex E: Progress towards the Sustainable Development Goals (SDGs) References LIST OF Tables Table 1.1:Key economic and financial indicators _ Estonia

Table 2.1:Assessment of implementation of 2019 country-specific recommendations Table 3.2.1:Financial soundness of banks Table 3.3.1:Activity rates of subgroups in Estonia and EU‑28, 2018 Table 3.4.1:Completion of TEN-T core network 2016, % in Estonia Table 3.4.2:Main socio-economic indicators by degree of urbanisation, Estonia, 2018 Table C.1:Financial market indicators Table C.2:Headline social scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth Ta²ble E.1:Indicators measuring Estonia’s progress towards the SDGs LIST OF Graphs Graph 1.1: Real GDP growth and contributions Graph 1.2: Export market share, goods and services, nominal Graph 1.3: HICP quarterly growth Graph 1.4: Investment growth and contributions, % Graph 1.5: Breakdown of external position (current and capital accounts) Graph 1.6: Real effective exchange rate based on unit labour cost

Graph 1.7: Components of the Net International Investment Position Graph 1.8: Labour market indicators Graph 1.9: Decomposition of rate of change of unit labour cost in (EA/EU) - Estonia Graph 1.10: At-risk-of-poverty and severe material deprivation rates Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date Graph 3.1.1: Public expenditure by function Graph 3.2.1: Composite cost of borrowing Graph 3.3.1: Demographic change 2009-2019 Graph 3.3.2: At-risk-of-poverty or social exclusion rate, age groups, Estonia Graph 3.3.3: Education and labour market for youth Graph 3.4.1: Gap compared to the euro area in 2018 levels Graph 3.4.2: Growth of labour productivity decomposed as changes in total factor productivity and capital deepening Graph 3.4.3: Direct investment by field of activity as share of GDP Graph 3.4.4: Investment by asset type Graph 3.4.5: Share of environmental costs in Estonia for road and rail transport Graph 3.5.1: Final energy consumption by sector 2008-2017 Graph 3.5.2: Final energy consumption by sector in 2017 LIST OF Boxes Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Estonia

Box 3.3.2: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.3: Investment challenges and reforms in Estonia Box 3.4.4: Regional disparities Executive summary Estonia’s economy is benefitting from the favourable labour market and business environment. Economic growth has been strong across all sectors, boosted by public and private investment. Innovation has increased but has not led to any substantial rise in labour productivity. Skills shortages have emerged due to rapidly changing labour market trends and technological developments, putting pressure on firms’ cost competitiveness. Ageing and the poor health of the population raise concerns about the adequacy of the pension and healthcare systems. Low resource efficiency and high energy and carbon intensity, in particular, due to Estonia’s reliance on oil shale pose challenges in terms of achieving the country’s binding decarbonisation targets under EU climate policy. Future growth and environmental sustainability will depend on how well the country mitigates those challenges while building an innovative economy ( ). In 2020-2021, economic growth is expected to slow to above 2% due to weaker external demand and uncertainties in international trade. Domestic demand is set to remain the key growth driver primarily due to the increase in real disposable incomes supported by moderating inflation. The employment rate and wage increases are forecast to weaken somewhat, but labour market participation is set to remain high. Wages have been growing faster than labour productivity for several years in a row, reducing cost competitiveness. Estonia’s oil shale sector has scaled down production which has reduced GDP growth. Public finances remain in good shape. Public debt was below 9% of GDP in 2018, by far the lowest in the EU. However, in recent years during the cyclical economic peak, the public deficit increased and government spending became pro-cyclical. Estonia has made some progress in addressing the 2019 country-specific recommendations. There has been some progress in the following areas: ·addressing skills shortages and foster innovation by improving the capacity and labour market relevance of the education and training system; ·improving the adequacy of the social safety net; and ·taking measures to reduce the gender pay gap, including by improving wage transparency. There has been limited progress in the following areas: ·ensuring effective supervision and the enforcement of the anti-money laundering framework; ·improving access to integrated social and health services; and ·focusing investment-related economic policy on sustainable transport and energy infrastructure, including interconnections, on fostering research and innovation, and on resource and energy efficiency, taking into account regional disparities. Estonia performs relatively well on most indicators in the Social Scoreboard supporting the European Pillar of Social Rights, but some concerns remain. Estonia’s labour market is one of the best performing in the EU. However, the proportion of people with unmet medical needs remains one of the highest in the EU. The share of young people not in education, employment or training has increased further. Social transfers are less effective in reducing poverty than on average in the EU and the indicator of people at-risk-of-poverty or social exclusion remains a point to watch. Regarding progress towards its national targets under the Europe 2020 strategy, Estonia already met its employment rate target and its tertiary education target in 2015. It has also achieved a share of renewable energy corresponding to its 2020 target, and has made some progress towards improving energy efficiency and reducing greenhouse gas emissions. However, Estonia is underperforming on reducing early school leaving and on reaching its national targets for reducing poverty and increasing investment in research and development. Estonia lags considerably behind its target for renewable energy in transport. Estonia has performed particularly well with respect to SDG 4 “Quality of education”, showing progress at all levels of education except the most recent trend for early leavers. The important issue to watch concerns SDG 13 “Climate Action”, as Estonia is among the EU countries with the widest gap between its target and the likely greenhouse gas emissions in 2030.()

Key structural issues analysed in this report, which point to particular challenges for Estonia’s economy, are the following: ·Skills shortages and mismatches persist, which limits productivity gains Firms have had difficulties in finding people with adequate skills, including digital skills. While the education and training system performs well and is equitable, its capacity to respond to labour market needs is limited by elevated early school leaving and an insufficient labour market relevance of higher education. Participation in adult learning has increased, but the re- and upskilling of the workforce has not kept pace with labour market trends. One of the reasons is that businesses provide limited on-the-job training. The high share of ageing teachers is a long-term but ever more pressing challenge for the education system. ·Serious challenges remain regarding the social safety net, especially access to social services for some groups. The availability of affordable social services, including long-term care services, remains limited especially for elderly people and low-income earners. The provision of services is particularly difficult in some regions. The underlying reasons are the lack of an overall framework to provide social and health services in an integrated way and the high costs. Poverty and social exclusion have increased, mainly because the incomes of the poorest - the elderly and people with lower educational attainment - have, increased less than average wages. ·Making the second pillar pension system voluntary raises fiscal and economic risks related to the adequacy of pensions. The current first pillar pay-as-you-go system is set to provide relatively low pensions. Winding down the second pillar pension system implies less prefunding for pensions and is set to reduce the diversification of pension income in the long term. In light of population ageing, this aggravates the concerns about the long-term adequacy of the pension system. ·R&D, including digitalisation, have not delivered economy-wide productivity gains. Business investment in R&D remains low compared to other countries, posing a barrier to productivity growth. The transfer of knowledge from universities to companies and the commercialisation of research results are slow. The intermediaries able to support industrial innovation are not yet established or are not functioning at their full potential. While Estonia’s overall innovation performance has improved, the levels of research-based innovation capacity and activity in the business sector remain low. The economy is becoming increasingly digitalised, but the take-up of information and communication technologies in manufacturing has been low. ·Major investment needs persist. Well-targeted investment in infrastructure, research and innovation, and in promoting resource efficiency would strengthen Estonia’s long-term potential. Investments in education and skills, as well as in social inclusion, health and social services could foster sustainable and inclusive growth. Business investment has accelerated but investment in research and innovation and intellectual property assets is relatively low. A high-quality and well-interconnected transport system remains a key for boosting Estonia’s economic activities and deepening its integration to the single market. Public investments, including EU funds, have helped to address Estonia's investment needs. ·Environmental sustainability remains a challenge due to high carbon and energy intensity. Estonia is likely to miss its 2030 greenhouse gas emission targets. The sectors which produce the most emissions are transport and buildings. Both are energy-intensive, and transport in particular relies on carbon intensive sources. A major share of energy in Estonia is produced from oil shale, which plays an important economic and social role. It is however also a significant contributor to the country’s high greenhouse gas emissions, and harms the environment. The government has implemented some measures to tackle these issues, but the results have been modest. Furthermore, there are no tax or other incentives for reducing CO2 emissions. Reducing carbon intensity in transport and buildings, restructuring the oil shale sector and implementing circular economy business models could improve environmental sustainability. The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for the period 2021-2027 includes a Just Transition Fund, a dedicated just transition scheme under InvestEU and a new public sector loan facility with the European Investment Bank. It is designed to ensure that the transition towards climate neutrality is fair by helping the most affected regions in Estonia to address the social and economic consequences. Key priorities for support by the Just Transition Fund, set up as part of the Just Transition Mechanism are identified in Annex D, building on the analysis of the transition challenges outlined in this report. ·The Estonian banking sector is sound overall but money laundering risks remain. Estonian banks are profitable thanks to high efficiency, good quality assets and low cost funding. Banks operating in Estonia have become less dependent on their parent banks and now largely fund themselves from domestic deposits and the wholesale funding market. While the share of non-resident deposits has declined and action has been taken against non-compliant banks, money laundering risks remain. Proposals to increase the level of sanctions are still to be adopted. The capacity of the financial supervisor has not yet been strengthened and the risk-based approach has not yet been fully implemented. Failing to address these issues could expose the economy to risks that may undermine competitiveness. ·Measures to help the north-east and south-east regions catch up with the rest of the country have stalled. Regional disparities are linked to past industrial restructuring, but differences in skills and labour supply have increased over time. The way local authorities are financed has not yet been reformed. In the absence of sustainable funding solutions, municipalities’ room for manoeuvre to promote entrepreneurship and to attract people is limited. Despite investments in infrastructure, concerns about depopulation, low labour activity and access to health and social services have emerged, suggesting the need for a holistic regional development strategy. ·The health system is facing major challenges. Although life expectancy is increasing rapidly in Estonia, the number of healthy life years remains among the lowest in the EU and is decreasing, with large disparities by gender, region, education and income. Poor health outcomes can be linked to insufficient healthcare funding, shortages in healthcare staff and lifestyle-related risk factors. Self-reported unmet needs for medical care have further increased and remain one of the highest in the EU due to long waiting times for both primary and specialist care.

·The gender pay gap remains among the highest in the EU. Recent reforms of the parental leave and benefit system are helping women move back into work, but care responsibilities remain high for parents, especially for women. Estonia is developing information technology tools to help employers to increase pay transparency and is running a research project to address the unexplained part of the gender pay. 1. Economic situation and outlook Macroeconomic developments and outlook Estonia’s real economic growth in 2019 was relatively strong reaching an estimated 3.8% (see Graph 1.1). Domestic demand was the main growth driver, with key contributions coming from a recovery in investment and from private consumption, supported by high employment and increased real incomes. Economic activity was rather strong in most economic sectors, with the notable exception of mining and energy production, where activity decreased following the partial closure of Eesti Energia’s generating capacity in north-east Estonia. Graph 1.1:Real GDP growth and contributions Source: European Commission GDP growth is forecast to moderate further to just 2.2% in 2020 and 2.4% in 2021. In line with cyclical developments affecting Estonia’s main trading partners, export growth is expected to slow. Private consumption is forecast to ease somewhat, as the labour market is set to cool down, wages adjust and unemployment increase slightly. At the same time, investment is set to moderate more substantially given its high growth rate in 2019. The current account is projected to remain in surplus over the coming years. Over the period 2012-2018, the Estonian economy became increasingly specialised in the export of services, notably of information technology services, where Estonian companies have developed a competitive advantage and have increased value added (European Commission 2019a; European Commission, 2018b). The current account surplus stood at about 2% of GDP in 2019. Exports were a major source of growth for traditional sectors such as paper, wood, plastics, pharmaceuticals, metal products, and machinery and equipment. Export growth is forecast to moderate in 2020 due to weaker external demand.

Graph 1.2:Export market share, goods and services, nominal Source: European Commission Inflation Inflation was set to decelerate to 2.3% in 2019 and to remain slightly above 2% over 2020 and 2021. This trend is largely due to lower global energy prices (see Graph 1.3). The changes to consumption taxes will have a smaller inflationary impact than in the past, while the strong wage growth will exert inflationary effect on prices of services. Overall, inflation in Estonia is forecast to stay above the euro area average. Graph 1.3:HICP quarterly growth Source: European Commission Financial sector and private debt The Estonian banking sector remains sound overall. Banks are profitable and well-capitalised, and this limits risks to financial stability. Banking sector assets stand at around 110% of GDP. Concentration in the banking sector is relatively high, as the three largest banks hold 85% of banking sector assets and interest rates have been slightly higher than in the euro area on average. Some money laundering risks remain (see Section 3.2). Private sector deleveraging continued and private debt level appeared sustainable. Private sector debt dropped to 102% of GDP in 2018, below its prudential threshold and fundamental benchmark ( ). This is also true for the debt subcomponents, household debt and debt of non-financial corporations. Overall, vulnerabilities associated with private debt are assessed to be limited. Investment Following a year of subdued growth, investment picked up robustly in 2019, and its share is projected to stabilise at around 25% of GDP. The investment recovery was mainly driven by private investment, which is expected to have increased by over 15% in nominal terms. Investment increased in most sectors, with particularly high investment rates in machinery and equipment and in industrial manufacturing (see Graph 1.4) supported by favourable borrowing conditions and corporate profits. Investment's contribution to growth is set to moderate in 2020-2021, and the overall investment intensity is likely to level off at slightly above the EU average (see Section 3.4). Graph 1.4:Investment growth and contributions, % Source: European Commission Construction sector and housing market Estonia’s construction sector has recovered given the buoyant demand for housing. Construction increased by more than 70% since 2010, peaking in 2018-2019, while profitability of this activity also picked up considerably. Demand for housing increased mainly in urban areas, and so far Estonia does not seem to face particular housing supply shortages (European Commission, 2019f), which helps to contain the upward pressure on house prices. House price increases have trended downwards to below 6% in the first half of 2019, with moderate growth in household debt (see Section 3.2). Graph 1.5:Breakdown of external position (current and capital accounts) Source: European Commission Cost competitiveness Cost competitiveness compared to the EU has declined since 2008 as incomes have continued to rise. Income convergence continued throughout 2019 as wages increased significantly in both the private and public sectors. Income convergence is partly reflected by Estonia’s improved labour productivity and has contributed to positive net migration in recent years. At the same time, structural labour and skills shortages have contributed to an erosion of cost competitiveness. Wages have increased faster than labour productivity. Nominal unit labour cost growth accelerated to 6.5% in 2018 and its three-year average continues to breach the macroeconomic imbalances procedure threshold. The real effective exchange rate appreciation accelerated to 4.6% in 2018 but is projected to moderate substantially from 2019 onwards. Export market share is projected to decline, suggesting that cost competitiveness issues may increasingly weigh on export of Estonian firms ( ). Still, the current account has been in a stable surplus and well above the level required to stabilise the external debt position (see Graphs 1.5 and 1.6), while the cyclically adjusted current account is even more positive, estimated at 4% of GDP in 2019. Graph 1.6:Real effective exchange rate based on unit labour cost Source: European Commission Vulnerabilities associated with Estonia’s net international investment position are limited and continue to diminish (see Graph 1.7). The net international investment position is moderately negative, at -28% of GDP in 2018, and is forecast to improve going forward. It compares favourably to the prudential threshold but remains above the benchmark that fundamental drivers would suggest is sustainable. When excluding non-defaultable debt instruments, such as foreign direct investment and equity, Estonia’s external position is even positive, suggesting that associated vulnerabilities are limited. Public finance The general government budget is expected to show a small nominal deficit over 2020-2021. While the 2020 budget plans some expenditure restraint, slower economic growth will affect tax revenues. Given that the economy is forecast to grow below its potential rate in 2020 and 2021, the structural fiscal position is projected to improve from a deficit of around 1½% of GDP in 2019 to a deficit of ½% of GDP by 2021. Public debt is set to remain low at about 8% of GDP by 2021, by far the lowest level in the EU.

Graph 1.7:Components of the Net International Investment Position Source: European Commission Labour market The labour market has continued to perform well. Employment increased in 2018 and reached 79.5%, as demand for labour has been high in all sectors. Activity rates have increased since 2012, mostly on the account of positive return migration and higher activity of those who study and of the elderly. The unemployment rate decreased to just over 5% in 2018. 1.3% of the labour force were long-term unemployed and youth unemployment declined to 11.9% in 2018. Graph 1.8:Labour market indicators Source: European Commission Demand for labour resulted in strong wage increases in 2018. According to Statistics Estonia, the average monthly gross wage increased by 7.3% in 2018, to €1,310. While wage growth was broad- based, the rise was notably driven by the public sector, given the wage adjustment for teachers and medical personnel. Compensation per employee, which is somewhat broader measure than wages, increased by 10.2% and the nominal unit labour cost by 6.5% in 2018. Wage growth was relatively rapid in 2019 but still grow above what is expected based on the historical relationship with inflation, productivity and unemployment ( ). Graph 1.9:Decomposition of rate of change of unit labour cost in (EA/EU) - Estonia Source: European Commission The purchasing power of employees increased in recent years, but unevenly across different income groups of the population. In 2018, real wages increased by 5.4%. Estonia’s statutory national minimum wage is agreed by the social partners, the Estonian Employers’ Confederation and the Confederation of Estonian Trade Unions,. At 37% of the average wage and 43% of the median wage in 2018, the minimum wage level was among the lowest in the EU. Overall, the share of full-time employees earning the minimum wage is around 7%. According to the labour market analysis, Estonia’s minimum wage earners are likely to be employed in service, retail and unskilled jobs (Eesti Pank, 2018). The risk of poverty is increasing, but inequality is slightly below the EU average. The at risk of poverty or social exclusion further increased above the EU average at 24.4% in 2018 due to the income of the poorest not keeping up with the average wage growth. The monetary poverty rate was the highest among people with lower educational attainment and older people. Since 2011, the share of people at risk -of -poverty has increased, while the share of people with severe material deprivation and people living in low- work intensity households has declined (see Section 3.3). Overall, income inequality decreased, as the relative income of the top 20% of households was five times that of the poorest 20%, which is just below the average income inequality ratio in the EU. Graph 1.10:At-risk-of-poverty and severe material deprivation rates Source: European Commission Regional development The socioeconomic urban-rural divide has reflected growing inequality in terms of social situation, employment and policy outreach. In 2017 ( ), GDP per head in the capital region was 113%, while in the remaining four regions the income levels ranged between 45% and 57% of the EU average. Better skilled and educated workers ( ) have moved to cities, leaving behind lower-income and older residents. The lack of qualified workforce and of good job opportunities has constrained the competitiveness and has had negative social effects. The gap in the at-risk-of-poverty-rate between rural areas and cities is high and growing (29.5% compared to 22.1% in 2018). In 2000-2018, the population decreased in all Estonian regions except Harjumaa, and almost one out of four people left Ida-Virumaa (see Box 3.4.2). Sustainable development goals Estonia performs relatively well overall in achieving the sustainable development goals (SDGs). Over the past 5 years, Estonia has made progress in almost all areas, with the notable exception of environmental goals, in particular SDG 12 responsible consumption and production and SDG 13 climate action, where a number of indicators show deteriorating trends. While in social areas Estonia has performed relatively well, its performance has been persistently weak on SDG 3 ‘good health and wellbeing’, namely in the areas of access to healthcare and the share of people with good health. The situation has remained challenging with respect to SDG 5 ‘gender equality’ and SDG 8 ‘Decent work and economic growth’ due to the wide gender gaps in pay and inactivity due to caring responsibilities. Estonia has performed well on SDG 16 ‘peace, justice and strong institutions’ and SDG 17 ‘partnerships for the goals’. Table 1.1:Key economic and financial indicators _ Estonia Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, Autumn forecast 2019 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 93% of all country-specific recommendations addressed to Estonia have recorded at least ‘some progress’. 20% of these country-specific recommendations (CSRs) recorded ‘substantial progress’ and 7% ‘limited progress’ (see Graph 2.1). Graph 2.1:Overall multiannual implementation of 2011-2019 CSRs to date Source: European Commission

Over the past years, Estonia has made substantial progress in addressing the challenge of the shrinking labour force. It has improved the labour market integration of people with disabilities through the Work Ability reform, which has been in force since July 2016. Specific measures have been deployed for bringing young people and the long-term unemployed to the labour market, helping to lower the unemployment rates. Estonia improved work incentives by reducing the tax burden on low-income earners, lowering the unemployment insurance contribution rate and abolishing the fringe-benefit tax on work-related studies. Steps have been taken to reduce the very high gender pay gap. The implementation of the 2016-2023 Welfare Plan addresses gender segregation in the labour market. The parental leave and benefit system has been reorganised. Some changes already in force include greater flexibility and incentives for parents to take up jobs. Estonia has made progress in improving the labour market relevance of the education and training systems. The funding model of the higher education was changed in 2017. The skills forecasting tool OSKA was introduced in 2016, and it is continuously assessed and improved. Regarding R&I, Estonia has made progress in strengthening its R&D system, but not in the business sector. The country’s difficulties in retaining researchers in business organisations have turned into a permanent weakness. However, there are signs that the governance of the R&D system is improving in terms of merging research and business strategies and making strategic choices. Estonia has made some progress ( ) in addressing the 2019 country-specific recommendations (CSRs). With respect to the CSR 1, Estonia has made limited progress as regards ensuring effective supervision and the enforcement of the anti-money laundering framework. While steps have been taken against non-compliant credit institutions, limited resources and tools hamper effective action by supervisors and the full implementation of risk-based supervision. The delay in introducing new sanctioning thresholds limits the deterrent effect of supervisory fines. While more resources are being allocated to the Financial Intelligence Unit and to the Prosecutor’s Office, proactive cooperation has still not been achieved. The number of prosecutions and convictions of money laundering cases remains limited. Table 2.1:Assessment of implementation of 2019 country-specific recommendations Source: European Commission With respect to CSR 2, Estonia made some progress in improving the adequacy of the social safety net with regard to pensions and benefits. Disability benefits for children have increased two- to threefold as of 2020. Annual pension increases come in particular from indexation of pensions, subsistence benefits, and work ability allowances. From April 2020, the basic pension will marginally increase. The changes to the second pillar are expected to reduce the future sustainability and adequacy of pensions. Estonia made limited progress in providing good quality and affordable social services and this remains an outstanding challenge. Some measures have been taken, e.g. care homes have been made more energy efficient, homes made more accessible, social transport improved and a dementia competence centre developed. There is an agreement on the concept regarding the financing and management model for the long-term care. However, a new framework for integrated provision of social and healthcare services has yet to be designed and implemented. Estonia made some progress in reducing the gender pay gap. From July 2020, paternal leave will increase from 10 days to 30 days and the use of the parental leave period will become flexible or the first 3 years of the child’s life. Estonia is developing information technology tools to help employers to increase pay transparency and is running a research project to address the unexplained part of the gender pay. Estonia made some progress in improving the labour market relevance of higher and vocational education. The forecasting system OSKA was evaluated to know how to make the skills supply match the labour market demand at each level of the education and training system. With respect to CSR 3 (investment), Estonia made limited progress. R&D investments in the private sector have remained low and have decreased further over the last years to 0.59% of GDP in 2018. Regarding investment in energy infrastructure, Estonia has made substantial progress, as the implementation of the Baltic interconnection project is proceeding as expected. Estonia has made some progress with regards to investment in energy efficiency, but improving access of low and medium income households to finance could facilitate further improvements. Estonia has made limited progress in focusing its investment on resource efficiency of companies and no progress with focusing its investment related economic policies on sustainable transport. The assessment of CSR 3 (investment) does not take into account the contribution of the EU 2021-2027 cohesion policy funds ( ). Upon request from a Member State, the Commission can provide tailor-made expertise via the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2017, such support has been provided to Estonia for 16 projects. In 2019, several projects have been delivered on the ground. The Commission, for example, supported the authorities in the full digitisation of the construction sector.. The Commission is also supporting Estonia’s efforts to provide social and health services in a more integrated and data-supported way. In addition, by supporting the Estonian government in its fight against cyber-crimes, the Commission laid the groundwork for more effective prevention, investigation and prosecution of those crimes. In 2019, work started on an input study to inform the new transport and mobility masterplan, on building a stronger link between the use of spending reviews and the performance based budget processes, and on improving labour market services. Support also started on data management as a pre-condition for e-Government and digital public administration, with the aim of fully benefitting from the main emergent technologies in the future. Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Estonia Estonia is one of the countries benefiting most from EU support. The financial allocation from the EU Cohesion policy funds ( I ) for Estonia amounts to €4.7 billion in the current Multiannual Financial Framework, equivalent to around 2.8% of the GDP annually or around 52.9% of all public investment per year on average. As of the end of 2019, some €3.9 billion (around 86% of the total amount planned) was allocated to specific projects, while €2.2 billion was reported as spent by the selected projects ( II ) showing a level of project implementation well above the EU average. While bringing about a more harmonious development through reducing economic, social and territorial disparities, EU Cohesion policy funding also plays a significant role in addressing structural challenges in Estonia. The Cohesion Policy programmes for Estonia have allocated EU funding of €1.00 billion for smart growth, €1.1 billion for sustainable growth and sustainable transport and €1.3 billion for inclusive growth. In 2019 following a performance review ( III ) €202.4 million have been made available within performing priorities for Estonia. EU Cohesion policy funding is contributing to major transformations of the Estonian economy by promoting growth and employment via investments, among others, in research, technological development and innovation, competitiveness of enterprises, sustainable transport, employment and labour mobility. By 2019, investments driven by EU Cohesion Policy funds have already led to building or modernisation of 201 km of roads, both at regional level and in connection with the Trans-European Transport Network, support was already decided for 10763 enterprises including 449 start-ups, generating 1178 new jobs. Funds contributed also to the reduction of greenhouse gas emissions by 35 198 tons of CO2. Using the resources of European Regional Development Fund and Horizon 2020 project Tartu opened bike-sharing system in 2019. The system includes 69 electrically provided bike stations and 750 bikes (500 of them are electrical). The biggest bike-sharing network in the Baltics has 36,000 registered users. The European Social Fund is focusing on boosting jobs opportunities and tackling youth unemployment. The Work Ability reform helps, with the support of ESF, to activate persons with reduced work ability. By the end of 2018, more than 21 500 persons with reduced work ability have taken up a job. Also 557 ex-prisoners were re-integrated into the job market since 2015, with more than half of them having found a job. 120 600 young people and 48 500 adults have participated in career counselling. 46 000 adults have benefitted from upskilling trainings. 1 000 childcare places have been created. Agricultural and fisheries funds and other EU programmes also contribute to addressing the investment needs. Combined with national co-financing, the European Agricultural Fund for Rural Development (EAFRD) makes available in total €0.9 billion to promote improved competitiveness in the agri-food sector, to deliver on environmental priorities and to address development disparities in rural areas while the European Maritime and Fisheries Fund (EMFF) contributes €129.13 million. Estonia benefits from other EU programmes, such as the Connecting Europe Facility, which allocated EU funding of €221.8 million to specific projects on strategic transport networks, Horizon 2020 which allocated EU funding of €178.2 million (including 113 small and medium sized enterprises with about €43.9 million). EU funding contributes to mobilisation of important private investment. By the end of 2018, European Structural and Investment funds ( IV ) supported programmes to mobilise additional capital by committing about €218.4 million in the form of loans, guarantees and equity ( V ), which is 4.8% of all decided allocations of the European Structural and Investment funds (ESIF). EU funds already invest substantial amounts on actions in line with the Sustainable Development Goals . In Estonia, European Structural and Investment Funds support 11 out the 17 SDGs and up to 95% of the expenditure is contributing to those. 3. Reform priorities 3.1.Public finances and taxation 3.1.1.BUDGETARY developments and Fiscal framework Estonia’s public finances have kept the debt ratio at a very low level, but fiscal policy has been pro-cyclical. Public expenditure growth was rapid in recent years, when real growth outpaced potential growth. Public finances were in a higher-than-planned deficit over the economic upturn years. In 2018 and 2019, Estonia increased expenditure increased on healthcare, education, social funding, the financing of local government mergers, and transport infrastructure. Social expenditure (pensions, parental benefits) has grown relatively rapidly due to an indirect automatic link to overall wage growth. At the same time, Estonia's public debt was 8.4% of GDP in 2018, by far the lowest level in the EU. Pro-cyclical policy in good economic times has reduced fiscal leeway in the current cyclical economic moderation. Estonia's fiscal position recorded a nominal deficit of 0.6% of GDP in 2018, during the peak of the economic cycle, which corresponded to a structural fiscal deficit of over 2% of potential GDP. While the less favourable economic outlook is set to affect revenues, there is also the need to correct for previous fiscal slippages, putting additional pressure on the budget. The 2020 budget foresees some expenditure restraint, especially regarding locally-funded investments and some categories of central government wages. On the back of slower revenue growth, the budget is projected to remain in a small nominal deficit of 0.2% in 2020 and 2021, according to the Commission 2019 Autumn forecast. Given that economic growth is forecast to slow down and to operate well below its potential in 2020 and 2021, the structural fiscal position is projected to improve from a deficit of around 1½% of GDP in 2019 to about 1% of GDP in 2020 and ½% of GDP in 2021.

Estonia’s fiscal framework is based on a budget balance rule defined in structural terms, but does not make use of expenditure rules. The exclusive focus on the structural balance rule in Estonia has limited the importance and visibility of other relevant indicators. Most notably, expenditure rules, or binding expenditure targets have not been used and the medium-term budgetary framework does not provide sufficient protection against expenditure volatility. This reduces the framework’s counter-cyclical properties. The rapid growth in public expenditures in 2018 and 2019 could not be assessed against any domestic expenditure constraint, such as an expenditure rule, medium-term ceiling or target, reducing the ability to control expenditure dynamics. As a way to mitigate possible risks, a regular assessment of developments on the expenditure side of the budget could inform the national budgetary process ( ). Changes to the pension system The current pension system stands on three pillars: the public pay-as-you-go system (first pillar), mandatory pension funds (second pillar) and voluntary pension funds (third pillar). The second and third pillars are funded. The pension system is financed from the 33% social tax rate, of which a 20% rate is designated for pensions. For people who do not participate in the second pillar, the 20% social tax goes entirely into the first pillar state pension insurance. For second pillar participants, the 20% social tax is split into 16% to the first pillar and 4% to their personal second pillar account. In this case, employees pay an additional 2% of their salary into the second pillar. The functioning of the second pillar is hampered by low returns, which undermines trust in the system. The second pillar is mandatory for people born after 1983, or for people who have at some point in time opted to join the second pillar. The management of investments has been outsourced to private pension funds. Since their creation in the early 2000s, Estonia’s second pillar funds have delivered one of the lowest nominal and real returns (adjusted for inflation) in the EU (OECD, 2019b). The low returns are explained by relatively high management fees and investment restrictions into riskier (but potentially more profitable) asset classes (Piirits, Laurimäe, 2019). The legislative changes entered into force in January 2019 to lower the pension fund’s management fees and reduce investment restrictions with the aim of improving investment returns ( ). In November 2019, the government submitted a bill to the Parliament that would make participation in the second pension pillar voluntary. The government did not carry out any impact assessments prior to these fundamental changes and launched only a week-long consultation of social partners. Under this legislative proposal, as of 2021 current second pillar savers have broadly three options: 1) to continue saving through pension funds; 2) to manage their own pension savings in an ‘investment account’ without leaving the second pillar system ( ); 3) to leave the second pillar, either by cashing out the accumulated savings or by ending contributions while keeping accumulated savings in the pension funds. New entrants to the labour market and those currently out of the 2nd pillar would be free to decide whether to join the second pillar or not. Overall, these proposed changes do not address the causes of low returns in the second pillar, but give the right to exit the pillar. The number of people who will exit the second pillar is highly uncertain. Surveys have indicated that about 20-45% of people will consider exiting the second pillar, with low-income employees (who generally also have the lowest public pensions) more likely to exit ( ). These choices might also change over the years in reaction to personal life events, economic cycles and the future performance of the funds. Notwithstanding those uncertainties, it is likely that the importance of the second pillar will dwindle and that the adequacy of the overall pensions will become more dependent on the first pillar pay-as-you-go entitlements, which so far have left the elderly population exposed to high risks of poverty and social exclusion (see Section 3.3.2)( ). The changes imply more immediate revenues for the first pillar and additional one-off budget revenues, at the expense of long-term pension funding. For people exiting the second pillar, the 4% social tax is redirected to the first pillar. This raises the revenues of the first pillar and, as one option, can be used to raise current pensions above the usual pension indexation, which is the plan of the current government. Cashed out pension savings are subject to a 20% income tax (or 10%, if the savings are taken out at the pensionable age). For this reason, the short-term effects on public finances are likely to be positive, though at the expense of long-term pension funding. Analysis of the proposed reform has also highlighted macroeconomic risks and challenges for the financial sector and capital markets. The Bank of Estonia’s impact assessment flagged that sharply unwinding the pension funds would increase economic volatility. In 2018, the accumulated assets in the second pillar funds amounted to about €4.5 billion or 17% of GDP. A partial withdrawal of these savings would temporarily boost domestic demand, but cause an opposite effect once the stimulus runs out. The magnitude of this macroeconomic volatility would depend on the share of people exiting the funds in a given year, which is hard to predict (as discussed above). Moreover, as 17% of the current savings are invested in the Estonian economy, withdrawal from the second pillar may have structural effects on the Estonian financial and capital markets. In fact, the financial sector has already started operational adjustments to minimise possible negative effects (see Bank of Estonia, 2019). Shrinking resources in the second pillar would make it more difficult for the local financial market to grow, hampering the diversity of the funding in the economy. Debt sustainability analysis and fiscal risks Government-sector revenues and expenditures are lower than the EU average, with relatively low spending on pensions and healthcare. Estonia’s tax burden has historically been relatively low (see Section 3.1.2), which in turn translates into lower-than-average public spending. Notably, Estonia spends less than the EU average on healthcare and social protection, including old-age pensions (see Graph 3.1.1). Considering Estonia’s relatively weak performance on social cohesion and healthcare (see Section 3.3), this may also mean that some public functions have been under-funded. Medium- and long-term fiscal sustainability risks are limited, given the very low level of public debt and a projected decrease in public first pillar pension spending. Long-term fiscal sustainability risks are currently estimated to be low because future spending pressures related to population ageing are contained (see Annex B). In particular, public first pillar pension expenditures as a share of GDP is projected to fall steadily through to 2070 according to the 2018 Ageing Report, mainly due to a decline in the public benefit ratio, i.e. average public pensions vis-à-vis average wages ( ). The total (public plus private) pension benefit ratio was projected to remain broadly stable as the decline in public pension spending was intended to be compensated by the growing private second pillar pensions. These fiscal sustainability projections do not yet include the potential effects of the upcoming changes to the second pillar pension funds, discussed above. Graph 3.1.1:Public expenditure by function Source: European Commission The adequacy of pension and healthcare expenditure will remain a concern in the longer term. The share of the elderly population at risk of poverty in Estonia is above the EU average (see Section 3.3.2.). Due to population ageing, the ratio of employees per pensioner is projected to decline from 2.2 in 2018 to 1.6 in 2060 (Bank of Estonia, 2019). This would exacerbate the pension adequacy concerns under the current trends, especially if the second pillar unwinds. In the past, low adequacy of pensions and healthcare spending was remedied through consecutive ad hoc increases of pensions on top of the indexation rate and by injections into the healthcare fund. Making participation in the second pillar voluntary implies less prefunding for pensions and more uncertainty in the long term. It undermines the multi-pillar pension approach followed during the past two decades, and reduces the diversification of pension income and risks. Moreover, the envisaged unwinding of the second pillar scheme might result in lower overall replacement rates in the long term, which would be problematic given the already rather low adequacy of Estonian pensions. Strong declines in replacement rates would likely be socially and economically untenable and might require higher public spending and thus higher taxes. 3.1.2.Taxation framework The Estonian taxation framework is characterised by low taxation of income, capital and property and a high reliance on indirect taxes. In 2018, the total tax burden in Estonia at 32.8% was considerably below the EU average of 39.2 % of GDP (Eurostat, 2019). Revenues from labour taxes were low (16.6% of GDP) compared to the EU average (19.64% of GDP) in 2018 (European Commission, 2020). Corporate income taxes and taxation of household capital income are also below the EU average. Estonia has no wealth tax and the taxation of capital is the lowest among all Member States (2.48% compared to an EU average of 8.5% of GDP), with low tax revenues from both capital stocks as well as the various types of capital income. Moreover, Estonia has the lowest revenues from property taxes among all Member States. Revenues from recurrent taxes on immovable property, which are considered to be among the most growth-friendly taxes amounted to 0.2% of GDP in 2018, significantly below the EU average of 1.5% (European Commission, 2020)( ). On the other hand, at 13.8%, revenues from consumption taxes were above the EU average of 11.1% of GDP in 2018 (European Commission, 2019a), which increases budget vulnerability in periods of lesser consumer demand. There is scope to improve the contribution of the tax system to supporting environmental objectives. Estonia collects more revenue from environmental taxation (8.3% of total tax revenue in 2018) than the EU average 6.14% (European Commission, 2019a), but the majority of it comes from a rather narrow base: excise tax on fuels and environmental fees for excavating oil shale. At the same time, revenues from transport taxes (excluding fuel taxes) account for 0.2% of total tax revenue, the lowest in the EU. The Estonian vehicle taxation system does not support environmental objectives (European Commission, 2019a). There is no CO2-based vehicle tax in Estonia (2018). As a result, new vehicles purchased in Estonia are the most environmentally unfriendly in the EU with an average CO2 emissions of 132 grammes per kilometre compared to the EU average of 118.5 grammes in 2017 (European Environment Agency, 2018). In addition, the government’s plan to reduce the tax rate for transport fuels does not provide consumers with an incentive to replace their vehicles with environmentally friendlier alternatives. The 2030 Estonian National Energy and Climate Plan recommends introducing a congestion charge for the capital city and more environmentally motivated parking fees at municipal level, but lacks any country-wide strategy for transport taxes. The income tax reform somewhat reduced income inequality for pensioners. The Commission expected in the 2019 country report that the 2018 tax reform would have a limited effect on reducing income inequality as measured by the Gini coefficient, because the income of the poorest households depends on pensions or subsistence benefits. However, the preliminary estimates suggest that the reform somewhat reduced the previously relatively high tax wedge for low and middle-income earners. According to the Ministry of Finance of Estonia, based on the tax returns filed by employers and social security bodies for the first 11 months of 2018 ( ), the effective tax rate decreased for 64% of income earners and remained the same for 23% of income earners. The effective tax rate increased for 13% of income earners. The effective tax rate decreased for 55% of old age pensioners who do not work, increased for 1% and remained the same for 44%. For old age pensioners who work, the effective tax rate decreased for 63%, increased for 35% and remained the same for 2% ( ). This seems to suggest that the 2018 tax reform generally improved the situation of about half of the old age pensioners who do not work. Besides that, it encouraged individuals to earn more, but provided a disincentive for higher earning old-age pensioners to be active on the labour market. There is no data about the effect of the tax reform on other types of low-income deciles. However, since the subsistence benefits did not constitute taxable income before or after the tax reform, the 2018 tax reform did not affect the situation of recipients of such benefits. The corporate income tax is favourable for investment in general (European Commission, 2019a). There are no special provisions to favour R&D activities, but companies can deduct business-related R&D expenses and do not have to pay income tax on the income that they reinvest in R&D. The obligation to pay advance corporate income tax for Estonian resident credit institutions seems to put small resident credit institutions at a competitive disadvantage. As of 2018, Estonian resident credit institutions need to make an advance payment of corporate income tax. The tax rate is 14% and the amount is calculated and paid quarterly on accrued profits. Small resident credit institutions claim that the obligation to make advance payments of corporate income tax hampers their ability to compete with large foreign-owned credit institutions.

Estonia performs well on measures related to tax administration efficiency. According to PricewaterhouseCoopers and the World Bank (World Bank Group and PwC, 2019), in 2018 it took 50 hours a year for a medium-sized company to comply with tax obligations, which is the most efficient outcome in the EU. The time it takes to comply with and obtain a value-added tax refund and the time it takes to comply with corporate income tax audits are among the lowest in the EU. E-filing of tax returns is wide-spread and pre-filling data of personal income tax returns is widely used. Tax compliance is relatively good; however, undeclared work, particularly the partial declaration of salaries, remains an issue. The value-added tax gap was 5.4% of the total value-added tax liability in 2017, which marked an approximate 9 percentage point decrease over a 5-year period. It was considerably below the EU average of 11.2% in 2017. According to the Tax and Customs Board of Estonia, undeclared work has decreased in Estonia, but the partial declaration of salaries (‘envelope salaries’) remains an issue. At the same time, the preliminary results of the Eurobarometer survey from September 2019 (to be published in February 2020) show that undeclared income in Estonia is estimated at 13% of the total income over the last 12 months. This is above the EU average of 10%. The national authorities estimate that in 2018 the foregone labour tax revenue was €86 million, consisting of €21 million for totally undeclared wages and €65 million for partially undeclared wages. Undeclared payments concern in particular sectors such as commerce, car service, manufacturing, construction, and information and communication services. The tax authority is planning to take further measures to fight tax evasion, such as introducing online cash registers, cooperating with banks, increasing transparency and facilitating access to tax data. Financing of municipalities The reform of local government has not expanded the fiscal autonomy and environmental taxation possibilities of the municipalities. Estonia launched the local government reform in 2017. The local governments depend mostly on tax revenues from centrally-levied taxes (European Commission, 2019a). Local governments may only decide to establish advertising taxes, taxes for closing roads and streets, motor vehicle taxes, animal taxes, entertainment taxes and parking charges. Although most municipalities invest in infrastructure to facilitate tourism, there is no possibility to set tourism taxes. Similarly, local governments are responsible for local waste and water management but are not able to set any environmental taxes except for motor vehicle taxes. Low autonomy in defining the tax base might limit local governments' ability to provide services and incentives to attract businesses, as well as their ability to address local environmental issues. 3.2. Financial sector The financial position of the Estonian banking sector is strong. Banks remain profitable thanks to high efficiency, good quality assets and low cost funding coupled with relatively high interest rates in a setting of high market concentration. So far, the price of market-based (parent bank) funding has remained favourable, despite the suspicions of money laundering that have affected several banks operating in Estonia and the groups owning Estonian banks. Moreover, despite low interest rates and a negative Euribor, banks have managed to maintain interest income and general profitability. This translates into high levels of return on equity, while the return on assets amounted to 1.1% (Table 3.2.1). The ability of households and companies to repay their loans has remained strong, underpinned by still robust economic activity. As a result, loan losses have been very small; the non-performing loans ratio stood at 1.8 in 2019. This allowed larger banks to reduce their model-implied risk weights and consequently their capital requirements. In 2019, the total capital ratio fell to 27% on average, but remains well above the minimum capital adequacy requirements and the capital buffers currently in force. It consists almost entirely of common equity tier 1, the highest quality capital. All banks meet the minimum required liquidity coverage ratio with a sufficient margin (average of 135%). Table 3.2.1:Financial soundness of banks Source: ECB CBD2 Banks operating in Estonia have become less dependent on their foreign parent banks and now largely fund themselves from domestic deposits and the wholesale funding market. Despite low interest rates, local deposits are still outpacing credit growth, with a consistent average year-on-year growth of about 9% in 2018 and 7% in 2019. This has helped improve the loan-to-deposit ratio to 108% in October 2019. Under a covered bond legislation adopted in February and in force since October 2019 lenders can use mortgage loans as collateral for issuing covered bonds. This is expected to address the small funding gap. The implementation of the Covered Bonds Act could be the first key step towards creating a pan-Baltic legal framework for the issuance of covered bonds to foster the Baltic capital markets and increase financial stability. While household debt is moderate, banks’ exposure to mortgage debt is relatively high, pointing to vulnerabilities. Housing loan demand continues to be supported by favourable labour market conditions, rapid wage growth and strong consumer confidence, as well as rising house prices. Household debt-to-GDP stands at 39%, below the euro area average of 55% (2018 data) and debt-to-disposable income is 70%, still below the euro area average of 94%. However, the share of housing loans in the total assets of the banks operating in Estonia is almost twice the average level in the euro area. This makes the banks vulnerable to any negative change on the real estate market affecting loan servicing by households. In order to ensure that banks have sufficient capital to cover future risks from housing loans, from 30 September 2019, Eesti Pank set a risk weight floor of 15% for Swedbank and SEB. These are the two largest banks in Estonia: they issued 80% of new housing loans in Estonia during the first half of 2019 and both use internal ratings to assess their risk exposures. This, alongside the loan-to-value limit, debt-to-service income ceiling and maximum loan maturity should appropriately support macro-financial resilience to potential shocks arising from high household debt levels. Structural changes in the Luminor Group necessitate monitoring risks and developments in all Baltic states in the calibration of macro-prudential policies. Following the conversion of the Latvian and Lithuanian subsidiaries of Luminor Group into branches and their merger with the head office in Estonia, the Estonian financial sector grew by almost half to 145% of GDP and its credit portfolio almost doubled (accounting for branches in Latvia and Lithuania). The three largest banks (Swedbank, SEB and Luminor) now hold a market share of 85%, of which the Swedish banks now account for two thirds. Due to banks’ increased concentration and their strong interlinkages, potential risks (for example associated with the Swedish real estate sector) from parent and neighbouring countries may be transmitted to the Estonian financial sector, hence the importance of holding sufficient capital buffers in order to ensure the loan supply in Estonia and liquidity buffers. Anti-money laundering Estonia has reaffirmed its commitment to fighting money laundering and terrorism financing as key to preserving trust in and the stability of its financial system. First hit by the money laundering scandal involving the Estonian branch of Danske Bank, Estonia has been under pressure to strengthen its anti-money laundering system. Further scandals have since emerged, involving other Nordic credit institutions operating in Estonia. Finantsinspektsioon, the supervisory authority, took action against these institutions: Versobank AS in 2018 has seen its licence withdrawn and Danske Bank can no longer operate in Estonia since 2019. More recently, Finantsinspektsioon cooperated with its Swedish counterpart to investigate alleged misapplication of money laundering measures in the Estonian branches of Swedbank and SEB. Due to parallel judicial investigations, the case against Swedbank was dropped. The licences of three payment institutions were also withdrawn after repeated violations of anti-money laundering requirements. Despite various measures taken by Finantsinspektsioon, there is room to further enhance the effectiveness of supervision and enforcement. On-site supervisory inspections remain limited (during 2014-2018, only ¼ of supervised entities were physically inspected) and Finantsinspektsioon has had to rely heavily on extraordinary inspections of credit institutions (43% of inspections in 2014-2018). Additional resources that were received in 2019 were only partly directed to its anti-money laundering supervisory functions, with limited increases in human resources and skills in this area. In contrast, the Financial Intelligence Unit and the Prosecutor’s Office will receive additional dedicated resources in 2020 to increase their capacity in terms of staff, tools and trainings. Data on exchange of information between the Financial Intelligence Unit and law enforcers signal good information sharing but also show that much information is shared upon request, not proactively. On the prosecution side, the case opened at the end of 2018 involving former Danske Bank employees is still pending. The share of non-resident deposits, which bear a larger risk of money laundering, fell from 19% to 6% between 2014 and 2018. In particular, the share of deposits from high-risk jurisdictions fell from 8.5% to 0.5% over the same period. This trend reversed again in 2019 as the average value of non-resident deposits increased in 2019. However, the share of non-EU deposits remains minor (1%). These deposits are largely held by medium risk customers. Only a minor share of customers are deemed as high risk (0.2%) holding 1.2% of total deposit and require appropriate customer due diligence. Identification of beneficial ownership is key in the case of legal entities. Custody services for non-resident customers also increased in 2019 (+63% compared to 2018) ( ) and account for 60% of all custody services provided by credit institutions operating in Estonia. These products might be exposed to money laundering risks in light of the speed of transactions, the anonymity involved and reliance on checks by institutions operating in other jurisdictions, which may include higher risk relationships. The deficiencies detected in its credit institutions have not yet fed into Estonia’s risk assessment which is to be reviewed. . The government proposed a new set of anti-money laundering legislation, but most is yet to be adopted. In December 2019, Parliament passed stricter rules for licenses to virtual currency providers and wallet providers and enhanced supervisory powers for the Financial Intelligence Unit. Other legislation including transposition of the EU’s 5th Anti-Money Laundering Directive, the higher ceilings for misdemeanours and the introduction of confiscation without conviction powers, have still to be adopted. Delays in legislative changes and policy implementation still hinder progress. The delayed submission of legislation to strengthen the preventive framework and administrative sanctions limits the deterrent effect of the tools currently available to supervisory authorities. The register of beneficial ownership also suffers from shortcomings, amongst which compliance: in October 2019 a quarter of legal entities registered in the country still had to provide information on their ultimate ownership. A revised national risk assessment, planned for 2020, will help to better target resources and reassess risks based on a new methodology while learning from recent scandals. The increased resources of the Financial Intelligence Unit and the Prosecutor Office will allow more staff to be devoted to fighting and repressing money laundering, but more can be done to increase the sanctioning power and the capacity of the banking watchdog, Finantsinspektsioon, to carry out risk-based inspections. Graph 3.2.1:Composite cost of borrowing Source: European Commission based on ECB data Access to finance Conditions for access to finance are favourable overall, but have deteriorated slightly. According to the survey results (ECB, 2019a; ECB, 2019b), while firms appear generally satisfied with the external financing received, the share of companies considering access to finance as their most pressing concern increased to 9% in 2018. As sources of financing, bank loans have been relevant for 41% of small and medium-sized companies, but the share of companies reporting that the fear of rejection prevents them from applying for a loan is much bigger in Estonia than in the EU (14% and 4%, respectively). The percentage of companies for which insufficient collateral represents an obstacle to receiving a bank loan is also higher than the EU average. Public support has been shifting from grants to state-backed loans and guarantees. However, increasing concentration in the banking sector may have made obtaining bank loans more difficult. Estonia has higher a cost of borrowing than the euro area average, and the difference is more pronounced for long-term loans (see Graph 3.2.1). The higher cost of borrowing and stricter conditions for obtaining loans could affect small firms and firms in rural areas, but also innovative firms. Cooperation between the Baltics helps overcoming market constraints on early-stage growth capital, but investment in mature companies is still limited. Cooperation under the Baltic Innovation Fund helped the start-up eco system in the region with more than €435 million raised for investment in young and growing companies. This helped to overcome the small size of the national markets. It is expected that over the next 5 years, the Baltic Innovation Fund 2 will invest €156 million in private equity and venture capital funds further developing equity investments into small and medium-sized companies. Selected fund managers are expected to raise private financing, bringing the total amount for investments to over €300 million. However, despite the steady increase of equity financing since 2015, funding opportunities for more mature companies are still narrow. Moreover, Nasdaq Tallinn’s secondary market ( ) is still too illiquid and is relatively undiscovered by global investors. Special investment vehicles may hence be needed which focus on investments in listed small and medium-sized companies, preferably on a Baltic level, to attract institutional investors.

3.3. Labour market, education and social policies 3.3.1.Labour market Strong labour demand has delivered high employment and participation, but challenges lie ahead as the economy slows down. Employment increased further by 0.8percentage points in 2018, reaching a record high of 79.5%, flagging as the best performer in the Social Scoreboard. This increase materialises in the context of an already positive labour environment, with low unemployment (5.4%) and high activity rates (83.8%) in 2018. The recent employment growth has been shared more or less equally between permanent and temporary employment, but self-employment increased the most in 2018 reaching 10.6% of total employment. However, as economic growth is slowing, there are already signs that new job creation will moderate in the short term. Graph 3.3.1:Demographic change 2009-2019 Source: European Commission based on national data The labour supply has not kept up with the changing needs of the economy, creating a potential barrier to growth. While in recent years the total population increased due to positive net migration, population ageing has offset the positive effect on the labour market (see Graph 3.3.1). The working age (20-64) population decreased by almost 32,000 people, or 3.9%, over the past decade. In 2015, net migration to Estonia turned positive, reflecting income convergence. In terms of composition, the share of young people in the working age population has dropped. The population is set to decline further due to low birth rates. The working age population will decrease by around 12% by 2035 compared to 2015 (Puur, Piirits, Sakkeus, Klesment, Eamets, 2018). This will exacerbate the existing labour shortages (European Commission, 2019a; European Commission, 2019b). Skills shortages and high over-qualification indicate room for better use of skills. Shortages have been identified in information and communication technology specialists, teaching and other professions (OSKA, 2016). According to forecasts, half of those entering the labour market will need a higher education degree and a third will need a vocational education qualification (OSKA, 2018a) ( ). However, the number of graduates in either track will not suffice to meet future needs. Employers require more transversal competences, from graduates of vocational education and training and more practical skills from higher education graduates (OECD, 2019d). Nevertheless, the high share of low value-added sectors and the high share of the labour force with tertiary education result in over-qualification: 20% of workers with tertiary education are employed in occupations that do not require it. At the same time, Estonia has experienced an increase in high-skilled tasks relative to middle- and low-skilled tasks (upskilling), and the share of routine tasks has declined. Overall, skills mismatches have declined significantly since 2010, and the level of disparities in the labour market outcomes for different skill groups is one of the lowest in the EU (European Commission, 2019i, Part II Analytical chapter). Box 3.3.2: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is a compass for a renewed process of upward convergence towards better working and living conditions in the European Union. It sets out twenty essential principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion. The Social Scoreboard supporting the European Pillar of Social Rights points to some employment and social challenges in Estonia. Estonia’s economic and labour market performance has remained stable in recent years with h igh employment and activity rates. Nevertheless, inactivity due to caring responsibilities remains high, in part due to the improving but still relatively low share of children aged less than 3 years in formal childcare. This is related to there being no c hildcare below the age of 1.5. While the gender employment gap remains below the EU average, the gender pay gap remains among the highest in the EU. The high self-reported unmet need for medical care, due to long waiting times for both primary and speciali st care, remains one of the pressing challenges for Estonia. Finally, the share of people at risk of poverty or social exclusion and the impact of social transfers on poverty reduction remain points to watch, as they are driven by the at-risk-of-poverty le vel of people aged 65+. High school dropout rates hamper the integration of young people in the labour market and society at large. Despite recent improvements the early school-leaving rate remains high, with large gender disparities. This contributes to the rising share of young people neither in employment, nor in education or training, in spite of good labour market developments overall. Moreover, low education levels significantly increase the risk of poverty or social exclusion going forward. The 2019 modification to the Vocational Education Act made studying in vocational schools more flexible, and introduced testing of innovative study formats in collaboration with local governments. The amendments allow schools to quickly react to the country’s educational and labour market needs. The result-based financing is expected to motivate schools to perform well. Schools are also given the chance to open curricula that are not directly linked to professional studies but which prepare students for selecting a profession. The limited supply of skilled labour is likely to remain a growth bottleneck in the medium-term. This is mostly due to demographic change and to structural problems in the education system (see Section 3.3.3). Participation in adult learning in Estonia remains above the EU average both for employees and unemployed people. While companies have identified the lack of skilled labour as the main constraint to investment (European Investment Bank, 2019a), corporate spending on on-the-job training is among the lowest in the EU (OECD, 2019b). The uptake of public programmes that support investment in human capital has been limited (see Section 3.3.3). The transition to a climate-neutral economy will create further need for investment in skills. The employment impacts of reaching the Paris Climate Agreement are estimated to be positive overall (+0.5% by 2030). In Estonia, more than 10,000 people are thought to be working in sectors that are expected to transform thanks to the transition towards a climate-neutral economy, and another 20,000 are employed in jobs indirectly related to those industries (logistics, services, etc.). Ida-Viru county that is largely dependent on the oil shale sector, will be particularly impacted and therefore additional investments will be key to a successful transition (see Box 3.4.2 and Section 3.5). Over recent years, labour shortages have been eased by activation policies. Though starting from relatively low levels, Estonia has over the course of the last 3 years increased both spending and participation in active labour market policies. This, together with positive economic developments, has helped increasing activity rates across all segments of the population (Table 3.3.1). Major reform initiatives that affect the labour market, such as the implementation of the Youth Guarantee, the work ability reform, or reforms to the parental leave and benefits system, have been introduced to further increase the activity rates. This in turn helped raise activity rates of young people, women and people with disabilities as well as of older workers (see Section 3.3.2). However, challenges remain ensuring sustainable employability. Table 3.3.1:Activity rates of subgroups in Estonia and EU‑28, 2018 Source: European Commission based on Eurostat data Migration and labour mobility to Estonia has also helped fill labour and skills shortages. In 2015, net migration to Estonia turned positive, reflecting in part the improved economic situation in the country that saw wages in Estonia grow from 35% to 51% of the EU average between 2011 and 2018. The number of fixed-term residence permits is subject to an annual quota of 0.1% of the Estonian native population. The 2020 quota stood at 1,378 people, which was already filled in January. The government has also pursued a coordinated talent policy to attract top specialists to the Estonian labour market. The increase in foreign short-term workers ( ) in particular has eased the labour shortage in sectors like construction, agriculture, and manufacturing industry. The Work Ability reform has helped increase the activity rate of people with disabilities. The activity rate of people with disabilities increased from 63% in 2016 to 68% in 2017, overtaking the EU average of 61%. On average, 44% of newly registered jobseekers with reduced work ability find a job within 12 months, resulting in 8,453 people in 2017 and 10,204 people in 2018 becoming employed. The Work Ability reform has brought down the equilibrium unemployment rate, indicating the success of the reform (Eesti Pank, 2019). Around one third of people in Estonia with reduced work ability suffer from mental illnesses, giving rise to the analysis on mental health challenges in the workplace that was carried out in August 2019 (Sotsiaalministeerium, 2019). There is further scope to support the labour market participation of vulnerable groups and people on long-term sick leave, and for measures to prevent loss of ability to work and to preserve good health and safety at work. To this end, available and affordable quality services are key. The gender pay gap in Estonia remains one of the highest in the EU. The gap was considerably higher than the EU average in 2017, 25.6% versus 16.0%, indicating that Estonia requires still some efforts to achieve sustainable development goal 5 (gender equality). Measures to tackle the gender pay gap are part of Estonia’s 2016-2023 Welfare Development Plan. The government has abolished earlier plans to introduce the requirement for wage transparency into legislation. The government is preparing digital tools aimed at improving pay transparency and the understanding of the causes of the gender pay gap. A national target of 2.5pp reduction of the gap by 2023 would close it in 40 years. Simulations by the European Commission, based on the Euromod model, show that reducing the gender pay gap to 3.3% would reduce the overall at-risk-of-poverty rate by 1.3 percentage points, particularly for households with one adult and children, which would see it reduced by 6.2 percentage points (more than two thirds of these households are headed by women). It would in turn reduce the spending on subsistence benefits by around 4% and generate over €250 million in revenues from personal income tax and around €400 million in additional social security contributions. The parental leave and benefit system reform is expected to increase the need for childcare provision. Estonia used to have a generous parental leave system but with many built-in rigidities; this was reformed and is implemented in phases starting in 2018 (European Commission, 2019a). In 2018, the impact of parenthood on women’s employment was almost three times the EU average (25.2% vs 9.0%). As a result, 6.9% of women in Estonia in 2018 were inactive due to personal and family responsibilities compared to the EU average of 4.7% that affects the sustainable development goal 8 (decent work). This accounts for over a third of all inactive women in Estonia. Only 27% of children below the age of three took part in formal childcare in 2017, far below the EU average (34.2%). Additionally, the lack of obligatory childcare provision for children under 1.5 years of age mutes the impact of the new parental leave flexibility. The involvement of social partners in reforms and policies in Estonia has improved but remains limited. Gaps in the quality of social partners’ involvement in legislative procedures are apparent, notably in relation to the preparation of changes to the second pillar pension scheme (Eurofound, 2020, forthcoming). At the same time, social partners are involved in the discussions on the overarching 2035 strategy in the European Semester process. In November 2019, social partners also agreed on minimum wage for 2020 of €584 per month. Nevertheless, the capacity of social partners has been weak, and trade union coverage has remained very low (4.7% in 2017). 3.3.2.Social policy

Poverty remains high, especially in certain regions and among vulnerable groups. Overall, poverty has further increased in 2018 and the persistence of poverty remained above the EU average. The at-risk-of-poverty or social exclusion rate increased to 24.4% against an EU average of 21.9% in 2018, with strong regional disparities (see Box 3.4.2) in particular for the elderly (see Graph 3.3.3)( ). This trend was driven by the at-risk-of-poverty rate as the continued rapid increase in wages outperformed the increase in benefits. Though the share of people in low intensity households is declining, in 2018, the at-risk-of-poverty rate among unemployed people aged 16-64 was 51.9% in Estonia (48.9% in the EU). Possible changes to the unemployment benefit system to improve coverage and adequacy are in sight as a response to a study from 2019 (Laurimäe, Piirits, Koppel, Melesk, Masso, 2019). Estonia’s performance in terms of material deprivation and child poverty was better than the EU average in 2018 ( ). Compared to 2016, the child poverty rate has decreased by 3.4 percentage points, thanks to substantial increase in child benefits. This has helped to move towards achieving sustainable development goal 1. The high activity rate of the elderly helps them avoid poverty. The average old age pension was 41% of the average monthly net wage in 2018. Hence, in 2018 a total of 26.3% of 65-74 year olds were working in order to increases their income and ability to save. A pension increase was approved by Parliament in November 2019. Starting in 2020 the base amount of pensions will be increased by €7 in addition to the annual rise from indexation (€38). The authorities estimate that this will lower the at-risk-of-poverty rate for people 65+ by 0.6 percentage points and for pensioners living alone by 0.4 percentage points. These changes will be partly offset as more pensioners will earn above the income threshold of €500 and will need to pay income tax. For example, in 2020 the average old-age pension will increase to €528.10 (up from the €483 of average old age pension in 2019), making approximately 61% of pensioners liable for income tax (37% in 2019) (see Section 3.1.2). Graph 3.3.2:At-risk-of-poverty or social exclusion rate, age groups, Estonia Source: Eurostat, EU-SILC Income inequality decreased to around the EU average in 2018. The ratio of the richest 20% to the poorest decreased from 5.4 to 5.07, slightly below the EU average of 5.17. At the same time, the income of the poorest 40% amounted only to 20.1% of the overall income, which is below the EU average of 21% and still below pre-crisis levels. Social benefits in Estonia are less effective than average in the EU in reducing the incidence of poverty. In 2017, social transfers reduced the at-risk-of-poverty rate by 27%, and the poverty gap by 43% (compared to an EU average of 34% and 55% respectively). As of 2020, benefits to children with disabilities will increase two- to threefold depending on the level of disability. The maximum will be €241 compared to €80.55 in 2019. On average, family benefits had the largest effect on reducing the poverty rate (18%), followed by sickness and disability benefits (12%)(European Commission, 2019i). The adequacy of the minimum income scheme in supporting people is around the EU average, but has decreased from the previous year ( ). Serious challenges in the areas of social and long-term care remain. The affordability of long-term care is a serious challenge as registered by the high out–of-pocket payments needed to access this type of care (almost 200% of a care user’s disposable income in case of severe needs) (OECD, 2020b, forthcoming). The number of people in need of services is high and increasing and care workforce requires continued training and upskilling ( ). The current system is fragmented as the social and healthcare services are not integrated to take the needs of the person into account (World Bank, 2017). Such integrated provision is necessary given the differences in the capacity of local authorities to provide services ( ) (see Section 3.1.2). With no compulsory minimum standards for long-term care, local governments lack incentives to meet quality and quantity indicators for long-term care provision ( ). The system is inefficient and lacks prevention, monitoring and evaluation mechanisms (ESPN, 2019, forthcoming). As regards the delivery of services for children, the need for assistance is often identiﬁed too late, and support is fragmented between different institutions and services (social services, healthcare, education). Social enterprises in Estonia have the potential to contribute to alleviating the stretched social services (OECD, 2020a, forthcoming). Work is ongoing to develop and implement a framework for a more integrated and person-centred provision of services. The government took a decision on a future management and financing model in January 2020 with earliest implementation from 2022. Based on the results of various pilot initiatives in this area and inputs provided by technical support from the EU Structural Reforms Support Programme. More broadly, the Estonian authorities are developing a new framework for a more integrated provision of social and health care services. Limited measures to improve social care have already been taken: care homes have been made more energy efficient, homes made more accessible and social transport has been improved. Further efforts leading to an improved system of care include the launching a pilot project for the integrated care of children with support needs. A dementia competence centre is also being developed. Priority was given to alleviating disparities between local governments. Healthcare Health continues to be a challenge and the high rate of unmet need for medical care is likely to impact poor health outcomes and thereby reduce labour productivity. Health outcomes in Estonia have improved over the last few years, but remain low compared to the EU average. While life expectancy increased rapidly to 78.4 between 2000 and 2017, it is 2.5 years below the EU average. Premature mortality before the age of 65 is higher in Estonia (20%) than in the EU on average (16%), meaning that a big part of the workforce is lost due to poor health status. People’s health skills are low, shown by the fact that a big proportion (50%) of preventable mortality is caused by lifestyle related risk factors(). Poorer health outcomes can also be attributed to other factors that stem from long waiting times linked to shortages in the healthcare workforce, the uneven regional distribution of healthcare personnel, and the low public funding of the healthcare sector. The level of self-reported unmet need for medical care is among the highest in the EU. It increased to 16.4% in 2018, significantly higher than the EU average of 1.8%, with the situation flagging in the Social Scoreboard as critical. Dietary habits, accidents, tobacco smoking and alcohol consumption contribute to a high rate of preventable mortality, one of the highest in the EU in 2017, and socioeconomic inequalities have a large impact on health risks. Lower educated Estonians tend to smoke and consume alcohol much more than those with higher education. Despite considerable health challenges Estonia’s public healthcare expenditure remains one of the lowest in the EU. Notwithstanding efforts to increase public funding for healthcare, it remains one of the lowest in the EU with 4.8% of GDP in 2017 compared to the EU average of 7.8% of GDP (see Section 3.1). This, together with high unmet needs for medical care has led to one of the highest out-of-pocket payments. In 2017 people paid 23.6% of their medical bills out of pocket, one of the highest rates in the EU (EU average is 15.8%). Income inequality plays a role as medicines are the largest single driver of spending for people in the poorest quintile, while richer quintiles, spend more on dental care. Estonia is implementing reforms in order to lower out–of-pocket spending both on pharmaceutical and dental care. In 2017, 0.7% of beneficiaries received additional cost reductions on pharmaceuticals; these were increased to 15.6% in 2018 (EHIF, 2019). The healthcare system does not cover the whole population. The system currently only covers around 94% of the population, though it grants the right to emergency care services to uninsured people. The high share of uninsured people in combination with organisational challenges related to the lack of family doctors and poor integration of services, has caused overuse of emergency care departments. Almost half of patients seeking emergency care could have received care from family doctors at a more cost-effective setting (OECD, 2019a). A recent study (Koppel et al., 2018) found that since health coverage in Estonia is linked to employment, individuals with part-time work, unstable jobs or in informal employment may experience insecure coverage. Furthermore, there are over 50 criteria defining eligibility for health insurance, which makes it difficult for citizens to navigate the system. Gaps in coverage also create barriers to access (WHO, 2019). Substantial health disparities exist depending on gender, region, education and income. On average, women live 9 years longer than men, and the disparity between urban and rural areas is 4.5 years. Estonia has one of the biggest gaps between low and high income earners in the EU with more than three quarters of people in the highest 20% income bracket considering themselves to be in good or very good health compared with less than one third of those in the lowest 20% income group (OECD, 2019a). One of the main causes of high income-based health inequalities is high out-of-pocket payments mentioned above, as high unmet needs for medical care force people who can afford it to pay to have their medical needs met. Regional disparities stemming from the impact of environmental risks to health are quite remarkable. In particular, the residents in the oil shale mining region of Ida-Viru report higher rates of respiratory symptoms and several serious chronic health issues, including cardio-vascular diseases. Shortages of medical workers persist, in particular concerning nurses. These shortages are due to the insufficient number of graduates, but also lower remuneration and worse working conditions in the health sector, which makes it difficult to attract and retain young people. The shortages have been particularly pronounced as regards family doctors in rural areas, while accessing specialised medical care is reported to be more difficult in cities. This situation is expected to worsen in the coming years due to the ageing of doctors, as every fifth family doctor has already reached retirement age in Estonia. The shortage of doctors has negative consequences for the ongoing reforms — especially efforts to improve the primary care. Estonia is seeking to facilitate access to healthcare. A pay-for-performance system for family doctors from 2015 tries to improve the recruitment and retention of health workers. Furthermore, the need to strengthen primary care is being addressed by creating multidisciplinary healthcare centres, with 19 out of the 54 already fully functional. However, the authorities continue to encounter challenges in finding staff, the lack of established procedures within the healthcare sector and the reluctance of family doctors to change their current working methods. Access to services is facilitated by the digitalisation of services (e.g. e-consultations, e-prescriptions, e-referrals, central digital registration system) and the networking of hospitals. However, there is a need for further investments in a number of specific areas to enhance the quality of healthcare and improve the access to health coverage to reach the sustainable development goal 3 good health and well-being. 3.3.3.Education and skills The education system is performing well, but the reported skills shortages suggest that the link with the labour market remains a challenge. Estonia tops the 2018 PISA ranking of EU countries in mean performance in reading, mathematics and science, and has the lowest shares of low achievers in all three domains. Estonia has above average results when it comes to the population’s digital skills ( ) and significant progress has been made in expanding the availability of digital learning resources and information technology learning (European Commission, 2019b). The latest PISA results confirmed Estonia’s excellent performance in terms of low performers in reading, and a low gap when considering socio-economic status. However, an above-average share of pupils leave education and training early and many students drop out from higher education (Graph 3.3.3). This leads to an insufficient number of tertiary graduates, whose competences are furthermore insufficiently aligned with labour market needs. Similarly, lifelong learning and vocational education do not yet meet the changing needs of the labour market. Moreover, the good quality of the education system is endangered by the emerging teacher shortages. Higher education is insufficiently aligned with labour market needs and dropout rates are high. Although tertiary educational attainment in the 30-34 age group is currently above the EU average (47.2% compared with 40.7%), it may worsen if the high dropout rates from higher education and falling enrolment rates ( ) persist. The gender gap in tertiary attainment is significant (57.5% of women compared to 38% of men). The actual number of graduates in science, technology, engineering and mathematics is insufficient to meet the needs of the labour market (OSKA, 2018a). The performance-based funding system introduced in 2017, accompanied by incentives to increase enrolments in certain study fields aim to increase the quality and labour market relevance of higher education, but their impact is yet to be seen. Graph 3.3.3:Education and labour market for youth Source: Eurostat, LFS The take-up of vocational education and training was not responsive to the needs of the labour market ( ). With 40.7% of enrolled students attending vocational programmes, Estonia is below the EU average of 47.8%. The share of apprenticeship students has increased but it is still only at 5%. The level of employability of recent vocational education and training graduates saw a notable decline in 2018, dropping to 76.6% as compared to 86.2% in 2017 (EU average of 79.5%). Measures are under way to improve the quality of work-based learning and to further strengthen career counselling ( ) and related services offered to young people.

The participation of adults in learning continued to increase. In 2018, 19.7% of adults aged 25-64 in Estonia had had a recent learning experience during the last 4 weeks, almost double the EU average of 11.1% (Eurostat, Labour force survey, 2018). The public training provision for adults relies largely on the EU Structural Funds. Since autumn 2019, quality evaluations of institutions providing non-formal training against the requirements set by the Adult Education Act have started. The Estonian school education combines excellent performance with a high level of equity. The 2018 PISA results show that the mean scores in science, mathematics and reading have increased since 2009, and the share of low achievement has remained the lowest in the EU in all three domains ( ), putting Estonia on top of the PISA ranking among EU Member States. At the same time, Estonia also has one of the most equitable education system, with the smallest impact of socioeconomic background on pupils’ performance ( ). As a consequence Estonia is making progress on sustainable development goal 4 (quality education). However, this positive performance is affected by the chronic issue of early school leaving that hinders future access to higher education (Graph 3.3.3). Overall 11.3% of 18-24 year-olds leave education and training without completing upper secondary education (EU average 10.6%), and this rate has stagnated in recent years. It affects men in a disproportionate way (16.1% compared to 6.4% of women), which helps explain their future low tertiary educational attainment (see above). The main factors appear to be weak learning outcomes and lack of motivation, suggesting that the focus should be put on prevention (MoER, 2018). Wellbeing at school could also be a reason, as 25% of 15 year-olds pupils in Estonia report being bullied at least few times a month. This is above EU average (OECD, 2019e). The performance gap between Estonian and Russian-medium basic schools persists and strengthens regional disparities as well as hindering the mobility across the country because of the language barrier. The proficiency in Estonian of students with a different mother tongue remains low: less than 61.4% of graduates from basic schools where Russian is the language of instruction master Estonian at intermediate (B1) level, well below the national target of 90%. To support Estonian language learning from an early age, a pilot project providing Estonian-speaking teachers in pre-school education groups was launched in the two Russian-speaking regions. The project is expected to be further expanded in 2020 to cover basic schools too. The emerging teacher shortages and the unattractiveness of the profession risk affecting the quality of education. Half of all teachers in primary and secondary education are over 50 years old and almost every fifth teacher is over 60. In the next decade, around half of the current teachers in secondary schooling will therefore have to be renewed. (European Commission, 2019b). Many schools report difficulties in hiring teachers in specific subjects ( ) (OSKA, 2018b), while teacher education programmes are generally undersubscribed. At the same time, only 26.4% of Estonian teachers believe that their profession is valued in society (OECD, 2019d). While the number of candidates for teacher training increased strongly in the past year, in general, teaching is considered stressful, salaries are uncompeti