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# 52014SC0407

**COMMISSION STAFF WORKING DOCUMENT Assessment of the 2014 national reform programme and stability programme for ESTONIA Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on Estonia’s 2014 national reform programme and delivering a Council opinion on Estonia’s 2014 stability programme /\* SWD/2014/0407 final \*/**

  

CONTENTS

Executive summary. 3

1. Introduction. 5

2. Economic situation
and outlook. 6

3. Challenges and
assessment of policy agenda. 7

3.1 Fiscal policy
and taxation. 7

3.2 Financial sector 13

3.3 Labour market,
education and social policies. 14

3.4 Structural measures
promoting sustainable growth and competitiveness. 19

3.5 Modernisation of
public administration. 24

4. Conclusions. 25

Overview table. 27

Annex... ... 32

Executive summary

Estonia’s
economy relies heavily on exports as a source of economic growth. This makes
the country vulnerable to weaknesses in foreign demand and to external
competition. Estonia’s economy is expected to regain
momentum in 2014 and 2015 as external demand recovers progressively and
capacity utilisation closes in on its long-term average. Nonetheless,
competitiveness and corporate investment could be affected if wage growth
further accelerates. Estonia’s economy grew by only 0.8 % in 2013, yet unemployment
fell to 8.6 % as a result of both strong growth seen in 2012 and the effect of
a shrinking population. Real wages rose significantly, driven by persistent
skill mismatches and the consequent growing number of vacancies, recent minimum
wage increases and pay agreements for health workers and teachers. In addition,
wages have been rapidly catching-up with those in neighbouring Finland in some traded services sectors. The budget outcome was a small deficit of 0.2 % of
GDP.

Overall,
Estonia has made some progress in addressing the 2013 country-specific
recommendations. Some progress has been made in the areas of fiscal
policy and labour market policies, social inclusion, and in energy
efficiency. Some progress has been made in improving the relevance of education
and training for the labour market. Estonia has
made substantial progress in reducing both unemployment among young
people and long-term unemployment, mainly by continuing to
implement active labour market policies. Estonia has also made substantial
progress in waste management and in reducing the volume of municipal waste
being sent to landfill sites. Progress has been limited with respect
to the local government reform.

Nevertheless,
a number of challenges remain. These include the availability
of qualified labour and the reintegration of the lower-skilled long-term
unemployed and the inclusion of disabled workers into the labour market, the
energy-intensity of the economy, regional disparities and inefficiencies in
local government.

The
national reform programme submitted by Estonia is ambitious, with a focus on educated
and inclusive society, competitive business environment, sustainable economy
and energy sector as well as adaptative public sector. However, the document is
relatively generic and lacks the necessary elements to allow a quantitative
assessment of the policies considered. The attached Estonia 2020 action plan
provides a list of relatively detailed measures, albeit not quantified, that
nevertheless offer a more precise picture of the measures that are considered.

Fiscal
policy: in adopting the new State Budget Act that
includes a rule on the structural budget balance,
Estonia has broadly fulfilled the commitments made under the Treaty on Stability,
Coordination and Governance. The four-year expenditure ceiling is not
binding within the medium-term budgetary framework however, and no
progress has been made towards introducing a multiannual expenditure rule.
Labour
market, education and social policy: despite substantial
progress being made in addressing unemployment among young people and
long-term unemployment, production capacity constraints are increasing. Long-term
unemployment remains relatively high among lower-skilled workers and the combination
of limited labour force with a lack of qualified workers has started to exert
upward pressure on wages. In addition, Estonia still faces some
poverty-related challenges. Improving the skills of people in a weak
position in the labour market, re-training them for work in a different
field and improving workers’ overall ability to adapt will require significant
measures to be taken in the areas of lifelong learning and vocational
education and training. Estonia is still facing the broader and longer-term
issue of the shrinking labour force, a consequence of the ageing
population, emigration and the growing trend of people leaving the labour
force for health reasons. As a result, it is necessary to improve work-incentives
for low-wage earners, make family policy more cost-effective and to adopt
and implement the planned work capacity reform. Internationalisation and
synergies between research, development and innovation are also of high
importance for promoting technological development, increasing productivity
and strengthening competitiveness.
Energy
efficiency and waste management: Estonia’s economy remains one of the most energy-intensive in the EU. The transport sector is
a key area where efforts could be made to ensure more resource-efficient
mobility and reduce carbon dioxide emissions, by improving the
effectiveness of the sector and providing incentives for the utilisation
of more energy-efficient vehicles and transport modes. Significant steps
have been taken in the areas of waste management and landfilling of
municipal waste, but further efforts are needed to ensure that recycling
will be economically viable. Promising developments have occurred in cross-border
energy connections.

·
Modernisation
of public administration: the provision of quality services at local
government level, especially of social services encouraging employment remains
problematic. Local governments are not able to generate sufficient revenue to discharge
their devolved responsibilities and currently there are no incentives for
municipalities to cooperate or promote entrepreneurship in the regions. The
fragmented structure of local government and the uneven population density
across the country meanwhile result in limited economies of scale, which has an
impact on the quality and availability of public services.

1. Introduction

In May 2013, the
Commission proposed a set of country-specific recommendations (CSRs) for
economic and structural reform policies for Estonia. On the basis of these
recommendations, the Council of the European Union adopted five CSRs in the
form of a Council Recommendation in July 2013. These CSRs related to public
finances, the fiscal framework, the labour market, social inclusion and
education issues, resource efficiency and cross-border energy connections,
research and innovation, and modernisation of public administration. This staff
working document (SWD) assesses the state of implementation of these
recommendations in Estonia.

The SWD assesses
policy measures in light of the findings of the Commission’s Annual Growth
Survey 2014[1] and
the third annual Alert Mechanism Report,[2]
which were published in November 2013. The Annual Growth Survey sets out the
Commission’s proposals for building the necessary common understanding about
the priorities for action at national and EU level in 2014. It identifies five
priorities to guide Member States to renewed growth: pursuing differentiated,
growth-friendly fiscal consolidation; restoring lending to the economy;
promoting growth and competitiveness for today and tomorrow; tackling
unemployment and the social consequences of the crisis; and modernising public
administration. The Alert Mechanism Report serves as an initial screening
device to determine whether macroeconomic imbalances exist or risk emerging in
Member States. The Alert Mechanism Report found positive signs that
macroeconomic imbalances in Europe are being corrected. To ensure that a
complete and sustainable rebalancing is achieved, 16 Member States
were selected for a review of developments in the accumulation and unwinding of
imbalances. These in-depth reviews were published on 5 March 2014 along with a
Commission Communication.[3] Estonia was not among the Member States selected.

On the basis of
the 2013 Council Recommendation, the Annual Growth Survey and the Alert Mechanism
Report, Estonia presented its stability programme and its national reform
programme (NRP) on 29 April 2014. The former had been approved earlier in the
day, while the latter was adopted by the government later on 8 May. These programmes
provide detailed information on progress made since July 2013 and on the future
plans of the government. The information contained in these programmes provides
the basis for the assessment made in this staff working document.

The programmes
submitted went through a limited consultation process involving the national
parliament and stakeholders. As regards the consultation with stakeholders, the
draft NRP was sent for written consultation to social partners on 17 April, but
there has been no discussion or any dedicated event. The draft NRP was presented
to the EU-Affairs Committee of the parliament on 21 April.

2. Economic situation and outlook

Economic situation

Economic growth
in Estonia slowed to 0.8 % year-on-year in 2013 from 3.9 % in 2012, as it was
severely affected by the phasing-out of some large public investment projects
and the relative weakness and lower demand from Estonia’s main trading
partners. This resulted in a slowdown in construction work and reduced exports
in some traded services (in particular in the construction and transport
sectors). Private consumption maintained its position as the main driver of
growth, as household income rose due to strong real wage growth (4.2 %).
Unemployment fell from 10.0 % in 2012 to 8.6 % in 2013, a result of both the
stronger growth seen in 2012 and the shrinking population. The 2013 budget
outcome was a small deficit of 0.2 % of GDP.

Economic outlook

According to the
Commission’s 2014 spring forecast, GDP growth in Estonia is likely to regain some
momentum and is forecast to reach 1.9 % in 2014 and 3.0 % in 2015 due to a
recovery in exports, but also to increased private and public investment: with
capacity utilisation now close to its long-term average, an increase in
production capacity can be expected from 2014; furthermore, public investment
is expected to recover in 2015 as the EU funds for 2014-20 will be gradually
released allowing investment programmes to be implemented. In 2014 and 2015, Estonia's budget deficit is projected to widen to respectively 0.5 and 0.6 % of GDP.

Continued capital
accumulation and an increase in productivity will be needed to offset rapid
wage rises. The possibility of Estonia’s economy suffering a loss in
competitiveness cannot be excluded, as evidenced by losses in export market
share (3.3 % year-on-year) and a rather large increase in nominal unit labour
costs (4.3 % year-on-year) in 2012. Rapid wage increases in recent quarters have
resulted from persistent skill mismatches and the consequent increase in
vacancies, successive increases in the minimum wage and recent pay agreements
for healthcare workers and teachers. Also, employees in the traded services sectors
are in a strong position to negotiate and obtain higher wages.

A number of
factors could, in combination, lead to a risk of inflationary pressures
re-emerging once domestic demand has fully recovered. The purchasing power of
the average wage is now back to pre-crisis levels while the Beveridge curve[4] shows
that current labour market conditions are now similar to those seen at the
start of the last bubble (2005). In view of this, and despite the fact that
banks have remained cautious so far, attention will need to be given to the
private sector debt stock. This has once again started to grow, moreover, from
the relatively high level that has been maintained over recent years. At the
same time, relatively loose monetary conditions have contributed to increased
housing affordability and not inconsiderable increases in nominal house prices.

The potential
fallout from the Russian-Ukrainian crisis is expected to
weaken Estonia’s growth, due to a direct negative
impact on exports and a smaller impact on imports. Foreign
direct investment could also be affected. The crisis
highlights the need for Estonia to diversify its energy sources and possibly
ensure almost total energy independence.

The
macroeconomic outlooks presented in the SCP and NRP are relatively close to the
Commission’s economic forecasts of spring 2014 for most of the main
macroeconomic indicators, i.e. in terms of growth expectations for GDP,
consumer prices, employment and wages. However, the
latest developments point to a downward risk as regards the 2014 growth
outlook. The
SCP and NRP do not include the estimated macroeconomic impact of the considered
structural reforms. The latter are therefore not quantified and no indication
about the methodology used is available.

3. Challenges and assessment of
policy agenda
3.1 Fiscal policy and taxation

The new rule on
the structural budget balance to comply with the Treaty on Stability,
Coordination and Governance would be more effective were additional binding
expenditure targets introduced, especially multiannual
expenditure targets. Given the need to maintain a stable fiscal position in
the face of increasing expenditure pressures, the efficiency of public spending
could also be improved, in particular by better targeting public spending on
social security.

In 2013, Estonia received a recommendation on fiscal policy, the expenditure rule and the efficiency
of public spending. The analysis in this staff working document leads to the
conclusion that Estonia has made some progress in addressing
this recommendation (for the full CSR assessment, see the overview table in section
4). Measures appear relevant and credible.

Budgetary developments and debt
dynamics

The main goal of the Estonian
budgetary strategy, as expressed in the 2014 stability programme, is to be at
its medium-term objective (MTO) and to build sufficient fiscal buffers for
difficult economic times. The MTO, unchanged compared
with the previous programme, is a structural surplus.[5] The
MTO more than adequately reflects the objectives of the Pact. According to the
programme, the MTO was achieved as of 2009. Other fiscal objectives include
increasing flexibility of the budget to change the structure of revenue and
expenditure and reducing the tax burden to the pre-crisis level by lowering
labour taxes. During the budget year the government intends to avoid adopting
expenditure-increasing supplementary budgets, using windfall revenue to
accumulate reserves.

Estonia achieved a headline budget
deficit of 0.2% of GDP in 2013, which was somewhat
better than expected in the Draft Budgetary Plan and in the Commission 2013
autumn forecast (0.6% and 0.4% of GDP respectively). Overall, disappointing
economic growth did not have a significant negative impact on tax revenue as
lower real GDP growth was compensated by higher deflators. Moreover, the lower
deficit outcome was driven by better-than-expected tax revenue collection. In
particular, the corporate income tax revenue was exceptionally high due to
dividend distributions in the private sector. In parallel, social expenditure
and investment were lower than projected.

The structural fiscal position
worsened by 0.4% of GDP in 2013 from a balanced
position in 2012, thereby deviating from the MTO of a structural surplus. The
worsening of the structural balance was mainly caused by the postponement of
the dividend distribution from state-owned companies from 2013 to 2014 and 2015
which was announced in the Draft Budgetary Plan for 2014. The growth rate of
government expenditure, net of discretionary revenue measures, exceeded by 2.1
pp. the reference medium-term rate of potential GDP growth of 2.3% in 2013,
thereby contributing to a deterioration of the structural balance by more than
0.5% of GDP, which suggests a significant deviation from the expenditure
benchmark. Two-year averages show only limited deviation from the expenditure
benchmark. Expenditure benchmark calculations for 2013 were negatively affected
by the abovementioned discretionary cut in property income from state-owned
companies in the amount of 0.4% of GDP during the 2013 budget year with a
positive effect in 2014 and 2015. Following an overall assessment, with the
structural balance as a reference, including an analysis of the expenditure net
of discretionary revenue measures, the deviation from the MTO in 2013 is not
significant.

The 2014 stability programme
forecasts a headline deficit of 0.7% of GDP in 2014,
which is larger than projected in the 2013 programme (0%) and in the 2014
Budget (0.4%). The Commission 2014 spring forecast foresees a deficit of 0.5%
of GDP for this year. Although the 2014 Budget was adopted as planned, the
growth outlook has worsened since autumn and could deteriorate further as
external uncertainties are building up. Moreover, implementation risks have
materialised for VAT-enhancing measures that were initially planned to take
effect in mid-2014 and which will be postponed to 2015 according to the programme.
The positive effect of these VAT-enhancing measures in the amount of 0.2% of
GDP is still included in the Commission forecast for 2014.

|| Box 1: Main measures Main budgetary measures ||

|| Revenue || Expenditure ||

|| 2012 ||

|| · Abolishing reduced excise rates for special-purpose diesel (0.11% of GDP) · Restoration of second pillar pension contributions (-0.4% of GDP) || · n.a. ||

|| 2013 ||

|| · Lowering unemployment insurance contributions from 4.2% to 3% (-0.3% of GDP) · Abolishing the land tax on residential land for plots up to 1500 m2 in densely populated areas and up to 2 ha in rural areas (-0.1% of GDP) · Rescheduling dividends from state-owned companies from 2013 to 2014 and 2015 (-0.4% of GDP) || · n.a. ||

|| 2014 ||

|| · Increasing excise duties on tobacco and alcohol (0.1% of GDP) · Compensation of second pillar pension contributions (-0.3% of GDP annually during 2014-17) || · n.a. ||

|| 2015 ||

|| · Lowering the tax burden on labour and capital: cutting the income tax rate from 21% to 20%; Raising basic allowance from personal income tax by 7% to EUR 154 per month; lowering unemployment insurance contribution rate from 3% to 2.4% (-0.6 of GDP) · Introduction of VAT INF, digital invoice collection (0.1% of GDP) · Limiting VAT deductibility for company passenger cars used for private purposes to 50% (0.2% of GDP) · Increasing excise duties on alcohol (0.1% of GDP) || · Raising child benefits (0.4% of GDP) ||

|| Note: The budgetary impact in the table is the impact reported in the programme, i.e. by the national authorities. A positive sign implies that revenue / expenditure increases as a consequence of this measure. ||

The programme targets a nominal
deficit of 0.5% of GDP for 2015, down from a
surplus of 0.2% set in the previous programme. Next year's fiscal target
includes a number of new measures reflecting priorities of the new coalition
before the March 2015 general elections. While the overall budgetary impact of
the new measures is broadly neutral, the worsened fiscal target mostly reflects
a negative base effect from 2014. On the expenditure side, new measures among
others aim at reducing child poverty, increasing salaries for targeted groups
and increasing the flexibility and efficiency of government expenditure. On the
revenue side the main focus is on reducing the tax burden on labour, while
increases are planned for consumption taxes, including for the excise duty
rates of alcohol, tobacco and for fuels used for special purposes.

For 2016-18, the programme targets a
gradual improvement in the fiscal position and reaching a nominal balance in
2017 and a surplus of 0.5% of GDP in 2018. Revenue as a share of GDP is set to
decline by 1.8 pps. of GDP between 2013-2018 as a result of the phasing-out of
EU structural funds and reductions in income taxes, which would be partially
offset by increases in consumption taxes. The improvement in the government
balance is mainly caused by the downward trend in government consumption and
public investments as a share of GDP. While fiscal risks are neutralised by the
national structural budget balance rule, the government's commitment to further
lowering the tax burden could create pressure on the budgetary position as this
would need to be offset by expenditure growth lower than potential GDP growth
or by other revenue measures.

Estonia’s (recalculated) structural
balance[6]
is expected to worsen to -0.5% of GDP in 2014,
leading to a 0.3 pp. gap compared to the required adjustment toward the MTO and
pointing to a risk of significant deviation when assessed over two years.[7]
According to the programme the (recalculated) structural balance is expected to
improve by 0.4% of GDP in 2015 and to remain close to balance in 2016-2017. The
improvement in the structural balance in 2015 is not confirmed by the
Commission forecast, where on a no-policy-change basis the structural deficit
is projected to deteriorate by another 0.2 pp of GDP, pointing to a risk of
significant deviation from the required adjustment toward the MTO. The
difference to the (recalculated) structural balance is mostly caused by a
positive net effect of the measures announced in the programme (+0.2% of GDP)
and by the one-off measures (-0.3% of GDP), which are not classified as
one-offs according to the methodology used by the Commission.[8] After
introducing the announced measures to the Commission forecast, the structural
deficit in 2015 would stay at 0.5% of GDP, unchanged compared to 2014, which
still points to a significant deviation from the required adjustment toward the
MTO. According to the information provided in the programme, the growth rate of
government expenditure, net of discretionary revenue measures, in 2014 is
expected to contribute to worsening the structural deficit. The conclusion is
different under the Commission forecast scenario, because of a higher impact
from discretionary revenue measures in the Commission forecast, but also
reflecting the volatility of public investment. In 2015, the growth rate of the
government expenditure, net of discretionary revenue measures, is not expected
to contribute to the improvement in the structural balance nor to the adjustment
towards the MTO. The breach of the expenditure benchmark is therefore
significant according to the programme and the Commission forecast. This is
because the growth rate of this expenditure is above 0.9%, the lower rate under
the expenditure benchmark. This conclusion is also confirmed by the calculation
of two-year average changes in the government expenditure.

Following an overall assessment of Estonia’s budgetary plans, with the structural balance as a reference, including an
analysis of the expenditure net of discretionary revenue measures, a
deviation from the adjustment path towards the MTO is to be expected in 2014
and 2015 which could be assessed to be significant.

Box
2:
Estonia`s status vis-à-vis the Stability and Growth Pact

Estonia
is subject to the preventive arm of the Pact and was at its Medium Term
Objective in 2012 with a deviation from it in 2013-2015. Therefore, the country
should ensure sufficient progress towards correcting its deviation from the
Medium Term Objective.

According to the programme, the general
government debt-to-GDP ratio is projected to decrease from 10% in 2013 to
close to 8% in 2017-18; these projections are in line with the Commission 2014
spring forecast. The central government is using its previously accumulated
financial assets for financing its deficits. The deficit of the local
governments and an additional contribution to the EFSF are the main reason
behind the small increase in nominal debt in 2014-15, while the nominal GDP
growth is expected to exceed the nominal debt growth and contribute to the
decreasing debt-to-GDP ratio.

Fiscal framework

Estonia’s
fiscal framework has been further strengthened in order to
comply with the Treaty on Stability, Coordination and Governance and with the
2011 package of legislation introducing additional coordination and
surveillance of budgetary processes for euro area Member States. The new State
Budget Act entered
into force on 23 March 2014. It sets out general requirements for the
structural fiscal balance of the government as a whole and establishes an
independent fiscal council attached to the Bank of Estonia. The fiscal council
will assume the function of an independent fiscal supervisory body and will be
responsible for monitoring compliance with national fiscal rules and for
endorsing the Ministry of Finance’s economic forecasts. The Act stipulates that
annual state budgets must be compiled in such a way that the government’s
structural budgetary position is at least in balance. The government can only
deviate from the budget rule if a correction mechanism has been triggered or in
exceptional circumstances beyond government control, as referred to in the
Stability and Growth Pact (e.g. during an economic recession, or if economic
growth remains below potential GDP growth over a long period). Although the
annual state budget is the main tool for ensuring compliance with the
structural balanced budget rule, specific regulations for central government
entities and other general government subsectors, already in place or set in
the Act, also contribute to maintaining the fiscal balance. These restrictions
include rules on debt levels and rules requiring a balanced current budget.[9]

The binding
nature of expenditure ceilings in the medium-term budgetary framework has not
been strengthened and no expenditure rules have been introduced. In
general, expenditure rules show an appropriate balance between budgetary
discipline and macroeconomic stabilisation, allowing automatic stabilisers to operate
in difficult economic times and helping dampen spending pressures in prosperous
times. Although the new State Budget Act stipulates that expenditure ceilings
will be put in place in the medium-term state budget strategy for the next four
years, it contains no provisions for making them binding. Expenditure ceilings
set in the budget strategy are the starting point for the following year’s
state budget, but these can be revised during the state budget preparation
process. Moreover, the expenditure limits are also prone for revision in the
following year’s update on the budget strategy.

Long-term sustainability

Estonia does
not appear to be facing medium- and long-term sustainability challenges.
Government debt (at 10 % of GDP in 2013) is significantly below the Treaty[10]
threshold of 60 % of GDP. Estonia’s very low level of government debt is
projected to rise by 2030 although to remain below the reference rate, assuming
no further policy changes are made. The long-term increase in age-related
expenditure is below the EU average, and recent reform measures undertaken in
pensions have further reduced sustainability risks. As a result, however, the
projected decline in pension benefits as a proportion of salary could pose a
risk to the adequacy of pension entitlements.[11]

Tax system

To solve
environmental problems Latvia received a recommendation to strengthen
environmental incentives concerning vehicles and waste last year, but Estonia
has chosen not to use tax measures to implement the part of the recommendation related
to vehicles (for more details on environment, see section 3.4).
The tax system as such does not entail major challenges for the Estonian
economy. In
2012, the
tax-to-GDP ratio of 32.5% in Estonia was below the
average of 39.4% in the EU. The tax mix by economic function is
considered favourable to growth. However, taxes that are the least detrimental
to growth, such as recurrent property taxes, some consumption tax categories
and environmental taxes, are not intensively used.

Estonia is
continuing its efforts to reduce the tax burden to pre-crisis levels and to
shift the tax burden away from labour and capital. In 2013, Estonia reduced the unemployment insurance contribution rate from 4.2 % to 3 % and the
personal and corporate income tax rate will be further lowered from its current
level of 21 % to 20 % in 2015. In addition, the 2014 Stability Programme and
the NRP include a further reduction in the unemployment insurance contribution
rate by 0.6pp to 2.4% and gradual annual increases in the basic personal income
tax allowance, which will bring it to EUR 184 per month in 2018 from the current
level of EUR 144. These revenue losses will be partially offset by increases in
indirect taxes and by abolishing unjustified tax exemptions. The government has
increased excises on tobacco and alcohol in 2014 and has a medium-term plan to
further increase them over the period 2015-18. In 2015, the natural gas excise
will be increased by 20% and the reduced excise duty rates on special purpose diesel
fuel will be replaced with more targeted subsidies.

The Estonian VAT
system is already relatively efficient: actual VAT
revenue in 2011 was equal to 68.6 % of the theoretical revenue at standard
rates, placing Estonia third in the ranking of EU countries. The VAT compliance
gap in Estonia was in line with the EU weighted average (18 %).[12] The
VAT regime for company cars is planned to be changed in 2015 with a view to limiting
the favourable tax treatment of company passenger cars used for private purposes.
To further improve tax compliance, the government is planning to
introduce digital invoice collection in 2015. This is intended to improve VAT
collection and to limit the scope for VAT fraud. As of 1 July 2014 a database
starts to operate where companies are obliged to register employees in advance
of their official start date, as a way of tackling undeclared employment.[13]

3.2 Financial sector

In 2013, Estonia did not receive a recommendation on financial sector policies, as Estonia’s
banking sector remains stable, implying that the likelihood of banks not being
able to meet their obligations is very small. Estonia is
one of the best performers in the EU in terms of financial soundness, and has
one of the highest capital adequacy ratios and a high return on equity. Estonia has also made substantial progress in resolving the stock of non-performing loans
that peaked following the 2008-09 economic crisis. Estonia’s capital adequacy
ratio was 24.3 % in autumn 2013 and its ratio of non-performing loans to total
loans reached 1.9 % at the end of 2013. The average loan-to-deposit ratio in
the banking sector fell to 104 % by the end of 2013, as deposits were still
growing faster than was the value of loans issued.

Nevertheless, there
are still risks to financial stability in the medium term.
Private sector indebtedness remains relatively high (129 % of GDP in 2012 for
both households and businesses) and may soon start to rise again if credit growth
accelerates. The reserve requirement for banks is low, there is still no rule
setting a maximum loan-to-value ratio for mortgages, and real wage growth is becoming
increasingly positive. Additional incentives to borrow also still
exist, including the partial deductibility of mortgage interest payments from
income tax and loan guarantees. As a result, the risk to the medium-term
macro-financial stability remains. The turnover of housing loans was
almost one fifth higher in 2013 than the previous year and as of May 2013, the value
of new loans has been higher than the amount repaid from existing loans. The median
price of apartments in late 2013 was 20 % higher than a year earlier, while the
number of transactions rose by 18 %. Median apartment prices are still below
the peak reached during the 2005-07 real estate boom, but they are more than 70 %
higher than the lowest point reached in mid-2009 during the crisis. The
housing affordability index remains high and, in 2013, a growing number of
people (11 %) intended to buy a property in the next 2-3 years, signalling the
possibility of a new property boom.[14]
Overall, saving
should continue to be encouraged as the loan-to-deposit ratio still
exceeds 100 %.

Estonia has strengthened
its macro-prudential framework through amendments to the Bank of Estonia Act
and to the Credit Institutions Act in spring this year. In particular, the
adopted amendments provide the bank with the necessary means and authority to
set limits on e.g. loan-to-value and debt-service-to-income ratios (rather than
guidelines, as is currently the case).[15]
Real estate taxation remains almost inexistent, but the new coalition
government intends to proceed with a revaluation of the theoretical land prices,
which date back to 2001 and which are used as a basis for the existing land
tax.

Access to
finance

Corporate demand
for credit has remained low to date, but may soon rise. Capacity
utilisation is relatively high and business confidence is increasing, meaning
that corporate investment is likely to increase as a proportion of GDP in the
coming years. At present however, the business sector as a whole is able to be financed
by cash flows, as profitability is high and investment low. As a result, total
corporate debt liabilities in the first three quarters of 2013 remained at around
the same level as at the end of 2012. Foreign debt as a proportion of the corporate
sector’s total liabilities has grown rapidly in recent years (from 21.6 % at the
end of 2008 to 36.5 % in the third quarter of 2013). This is true of each of
the types of lending included in foreign debt: intercompany lending, other
foreign loans and foreign debt securities. Equity growth has allowed leverage
to fall to its lowest level in ten years. This means that companies should be
better protected against possible risks. Estonian companies have a relatively
low level of leverage and liquidity is high in comparison with other euro area
countries. In manufacturing, the level of leverage has fallen even further from
the already low levels seen before the 2005-07 boom.

Access to
finance
for small and medium-sized enterprises (SMEs) has
improved recently. Estonia has made some progress in improving
SME access to finance and steps are being taken for increased reliance on financial
instruments instead on grants. Banks are more willing to provide loans, albeit not
to high-risk projects. There is good access to public financial support,
including to the loan financing, guarantees and lines of credit provided by
KredEx, and to EU funds that can be used for credit enhancement. The Baltic
Innovation Fund[16]
is encouraging the much-needed cross-border investment and with the multiplier
effect contributes to better coverage of private equity and support to riskier
projects including for start-ups. In addition, the activities of private bodies
such as Finance Estonia Cluster and the Estonian Private Equity and Venture
Capital Association are contributing to the development of capital markets in Estonia. While these measures are expected to be effective, their results in terms of actual
investments by companies will only be seen in the medium- to long-term.

3.3 Labour market[17], education and social policies

Labour supply
shortages continue to be seen in certain sectors, and long-term unemployment remains
relatively high among notably the lower-skilled and in regions outside Tallinn and Tartu.
Concerns relating to the labour market are heightened by the ageing population,
emigration and the growing number of people leaving the workforce on health
grounds. The continued shortage of childcare in certain municipalities and of
long-term care services and the long parental leave system make the (re-)entry and
positioning of women more difficult in the labour market.[18]
Also, the gender pay gap and segmentation might prevent higher qualified women
from fully contributing to efficient labour market outcomes. Regional
differences are widening[19]
and inefficiencies in the fragmented system of local government are preventing Estonia from achieving its potential in terms of economic development (see also subsection
3.5). In addition, Estonia still faces some poverty-related challenges.[20]

The
high proportion of the population not holding professional qualifications
combined with the high structural unemployment rate, has resulted in shortages
of qualified labour, which have started exerting an upward
pressure on wages. The number of people without any professional qualification
is rising even among the 25-35 age group. According to the findings of the
Commission, the country is currently seeing a particular shortage of graduates
in science, technology, engineering, mathematics and In particular in the ICT
sector, where productivity is one of the highest (2.5 times higher than in
other sectors).

Labour market
and social policies

In 2013, Estonia received a recommendation on incentives to work, the delivery of social services,
the reintegration into the labour market of unemployed people and people with disabilities
and on regions affected by high unemployment. The analysis in this staff
working document leads to the conclusion that Estonia has made some
progress in addressing this recommendation. Measures appear relevant, ambitious
and credible.

In response to this recommendation, Estonia
amended the Parental Benefit Act so as to increase the incentive
for parents to take up work. The new coalition plans to raise child benefits to
45 euros for the first and second children and to 100 euros as of the third
child.
In parallel,
Estonia is
continuing its efforts to shift the tax burden away from labour (see under
subsection 3.1 "Tax system") through a further reduction in the contribution
rate to the social security system in 2014 and through the already agreed
reduction in the income tax rate in 2015. The gradual increase in the basic personal
income tax allowance by approximately 7% annually over the 2015-18 period is
only aimed to compensate for the expected average wage increases over the
period. All in all, these changes are likely to reduce the tax wedge by approximately
1 pp.[21]
while structural unemployment in Estonia is estimated to be high at around 10% of
the total labour force and the sensitivity of structural unemployment to the
tax wedge is found to be large.[22]-[23] Higher
increases in the basic allowance could prove several times more cost-effective
in this respect than the across-the-board measures foreseen by the government.[24] The
successive increases by about 10% annually in the minimum wage over the 2013-15
period will also strengthen work incentives for low-wage earners. However, they
will also contribute to raising labour costs, accelerate an already strong wage
growth and could affect labour demand. In 2013, the reservation wage of the low-skilled
increased by 11% up to 60% of the average wage, making it harder for companies
to recruit employees who will work for low wages.[25]-[26]

The ongoing
reform of policies on working capacity[27] aims
to facilitate the return to work of people receiving disability
benefits or incapacity pensions. However, the
reform package is yet to be discussed by the government. If adopted and implemented
without delay, it will increase labour supply and contribute to the
sustainability of the pension system.[28] Since
the reform is not expected to enter into force before July 2015, progress so far
is considered to be limited in this area.

As
per the recommendation issued in 2013, the lack of consistency between social benefit
systems is being addressed, and some progress has been
made. The exchange of data between the benefit system for social services
and benefits provided by municipalities on the one hand and the unemployment insurance
fund’s service system on the other is expected to be operational as of June
2014. There are also short-term plans to improve the user-friendliness of the former
system and to develop interoperability with the health insurance information
system. The database managed by the social insurance board for benefits paid by
central government is being modernised and is expected to be operational as of
2015. The Ministry of Social Affairs is planning to set up a ‘data warehouse’
for social welfare measures that will provide a full overview of benefits
received from both municipalities and state institutions. This is expected to
be in operation by 2015-16 and could be used for statistical analysis.

Limited
progress has been seen to date in addressing the recommendation to improve the delivery
of social services, including childcare, and to improve the efficiency and
cost-effectiveness of family policy. The quality
and accessibility of social services continues to be hindered by the lack of enforceable
minimum standards and the limited economies of scale in especially small
municipalities (see also subsection 3.5). A number of new
places have been created in childcare facilities but internal migration has caused
continued shortages in some municipalities and particularly for children below the
age of three. The draft Pre-School Act, creating greater flexibility in
the provision of childcare services for the 1.5-3 years age group was approved
by the government in April and will soon been discussed in Parliament.[29] In
October 2013, with the objective to develop and implement a gender
equality policy in Estonia and thereby address the high gender pay gap,[30] a
Gender Equality Council, an advisory body within the Ministry of Social Affairs,
was set up. The green paper assessing family benefits and services is expected
to be submitted to the government in spring 2014. The means-tested
family benefit is in force since July 2013. The relatively low coverage and inadequacy
of social benefits might make it more difficult for Estonia to ensure a more inclusive
growth,[31] as might
the limited awareness of social rights among economic actors. No statistically
significant effect of unemployment benefit and social assistance on the
reservation wage has been found in Estonia. Nevertheless, it has been found
that the eligibility for unemployment benefit/social assistance can increase
the duration of the unemployment period.[32]

Substantial
progress has been made in addressing the recommendation to facilitate the
return of the long-term unemployed to the labour market. Increased
use of active labour market policies has contributed to a reduction of 30 %
year-on-year in the number of long-term unemployed, to 3.8 % in 2013 as a
result of which long-term unemployment as a proportion of total unemployment has
fallen to below 50 %.[33] Reintegrating
the long-term unemployed into the workforce was one of the main focuses of the 2012-13
employment programme and it will be a focus once again in the 2014-15 programme.
The state
contribution to costs incurred by employers in adapting work premises to the
needs of people with disabilities has been increased. In addition, the public
employment services, in cooperation with other bodies and local governments, have
extended their services to people with multiple problems. To date, local
governments have not had the capacity to provide the services needed in this
area, and further improvements are essential. In the healthcare sector, the
combined effect of reduced morale, retirement and emigration has contributed to
the shrinking labour force and the challenges this poses. No direct measures
are planned to reverse this phenomenon.[34]

Co-ordinated
measures are being implemented in response to the recommendation to promote
development in regions affected by high unemployment. These measures aim to
counter the widening differential in regional development and the
increasing flow of people away from the least developed peripheral local areas.[35] In
the Ida-Viru region alone, there are plans to build six industrial parks, covering
a total of 23 hectares. These are to be financed by investment agreements and by
offering loan guarantees to enterprises. Given, however, that no immediate impact
on job creation can be identified at this stage, limited progress has been made
in addressing the recommendation.

Some progress
has been made also in addressing the recommendation on youth unemployment. Youth
unemployment continued to fall, from 20.9 % in 2012 to 18.7 % in 2013,
due in part to the economic recovery and also to ‘activation measures’
(measures obliging people receiving unemployment benefit to accept an offer of
employment or training in order to continue receiving their benefits). In 2013,
the public employment services developed their mobile counselling services,
which specifically target young people not registered as unemployed. The Youth
Development Strategy adopted by the government in late 2013 seeks to address
two major obstacles preventing young people from finding employment: a low
level of education and lack of relevant work experience. As part of this
strategy, an action plan for implementing the Youth Guarantee scheme 2014-17 at
national level was submitted to Parliament in April 2014.

Education
policies

In 2013, Estonia received a recommendation on the labour market relevance of the education and
training systems, measures to tackle youth unemployment and participation of
the low-skilled in lifelong learning. The analysis in this staff working
document leads to the conclusion that Estonia has made some progress in addressing
this recommendation. Measures appear relevant, ambitious and credible.

The new
Vocational Education and Training Institutions Act (VET Act) was adopted in 2013,
to help to better align vocational education with the requirements of the
labour market.[36] Overall,
the country has therefore achieved some progress in the VET area, but
considerable challenges remain as confirmed by the NRP: there is a clear need
to increase participation rates in vocational education and training (the
current objective having been set at 40 % for secondary level),[37] and
to provide more opportunities for work-based learning and apprenticeships. In
this respect, with support from EU funds of the 2014-20 financial framework, Estonia envisages an increase in the number of students in vocational education and
training participating in work-based apprenticeships from the current level of
around 2 % to 10 % by 2020. This would indicate progress in this area, since
the developments expected can be considered as ambitious: this would contribute
to reducing the share of persons without professional qualifications (as much
as 30.3% of the 24-64 age group in 2012, according to the NRP). In addition,
employers are consulted on the content of the VET curricula and participate in
the framework of the VET quality assurance in Estonia. However, at present,
there is no genuine well-functioning national VET governance structure
involving all social partners through which to develop cooperation with
employers particularly in the area of apprenticeships.

Changes
to the Basic School and Upper Secondary School Act took effect in September
2013. These
aim to improve the quality and cost-efficiency of general education and to
better align educational provision with the needs of the labour market. The
legislative changes are expected to contribute to an increased participation in
vocational education and to a reduction in pupils leaving school early.

The
Higher Education Act, which came into force in September 2013, has
changed the financing model of universities, with the aim of
providing financial incentives for attracting more students to science,
technology, engineering and mathematics.[38] The
measures taken seem appropriate and could prove effective. The Ministry of
Education and Research will be in a position to define the number of
state-commissioned study places per field at each higher education institution.
A system of needs-based study allowances was introduced in the 2013-14 academic
year with the aim of allowing students from financially disadvantaged
backgrounds to take up places in higher education and complete studies of a
specified duration. Attracting international students and highly qualified
specialists from countries outside the EU to Estonia has been facilitated by
amendments to the Aliens Act adopted in autumn 2013. According
to the NRP, although the goal to admit 2,000 foreign students by 2015has been
achieved, measures that support internationalisation will be continued.

Estonia has
continued to make progress in promoting entrepreneurship. Training
in the various aspects of entrepreneurial activities is available at all levels
of education and is being promoted alongside initiatives to increase the
popularity of sciences. Some private entities have been running successful
accelerated programmes and the University of Tartu opened an Entrepreneurship
Centre teaching science, technology, engineering and mathematics and also
collaborating with entrepreneurs in various fields. If these measures continue
to be implemented systematically and continue to receive sufficient funding,
they have the potential to increase the number of successful entrepreneurs and
transform Estonia into a ‘start-up hub’. In February 2014, the government
approved an ambitious but as yet untested coordination system for forecasting
the skills needed by the labour market (by qualification area) and for identifying
how to meet these needs in the context of the training and education system.

Some
progress has been made in addressing the recommendation on participation rates
of low-skilled workers in lifelong learning. In February
2014, the government adopted the national Lifelong Learning Strategy for
2014-20, with the clear objective of, inter alia, increasing the
relevance of education for the present and future labour market, especially in
respect of older and low-skilled workers. The action plan for training and
re-training is yet to be launched however and progress in this area therefore
remains limited. The draft Adult Training Act is not expected to be submitted
to the Parliament before 2015. Finally, according to the NRP, the participation
in lifelong learning has remained stable at 12.5% in 2013, in comparison with
12.9% in 2012.

3.4 Structural measures promoting
sustainable growth and competitiveness

Energy,
transport, infrastructure, climate change and the environment

Estonia’s
energy and resource intensity remains one of the highest in the EU. Significant
investment has been made in public buildings, but considerable amounts of money
could still be invested to improve energy efficiency of local public buildings
and of residential and industrial buildings. In the transport sector, investment
has been made into the electromobility programme and in the public transport
fleet renewal, but a large part of the rail infrastructure is not yet running
on electric lines. The transport sector remains relatively energy-intensive
(using twice as much transport fuel per unit of GDP than the average EU Member
State).[39] Motorisation
levels are increasing, while new passenger cars are
among the most polluting in the EU (150.1 g of CO2/km compared with
the EU average of 132.2 g/km). Some progress has been made in the area
of energy interconnections notaby with Finland, however, Estonia’s energy security, diversity of energy supply and price competition continues to be limited
by the country’s small size and relative isolation, a consequence of its
insufficient cross-border connections especially with the Baltic states.

In 2013, Estonia received a recommendation on the improvement of energy efficiency and waste
management and the development of cross-border energy connections to diversify
energy sources and promote competition in the energy market. The analysis in
this staff working document leads to the conclusion that while progress in
addressing energy intensity has been limited, Estonia has made substantial
progress in addressing the challenges in the area of waste and some progress in
the area of cross-border energy connections (for the full CSR assessment see
the overview table in section 4). Measures appear relevant and credible.

Some progress
has been made in energy efficiency in buildings: substantial progress
has been made in insulating public buildings, but energy efficiency in
residential and industrial buildings remains problematic. Further progress in
the sector is however dependent on the allocation of EU funds for the period
2014-20. Funding of EUR 102 million is expected to be received in the budget
period 2014-20 for renovation of apartment buildings already planned. Estonia has also introduced a number of measures to improve energy efficiency in power
generation and in centralised district heating systems, and has taken measures
to promote high-efficiency cogeneration.

According to
analysis from the European Environment Agency, Estonia is on track to
meet its 2020 target on reducing emissions in sectors not covered by the
emissions trading scheme. However, the emissions from the transport sector
(representing around one third of these emissions) are projected to increase,[40] especially
when economic growth will regain momentum, so limited progress has been made on
this part of the recommendation.

In 2012-13, Estonia introduced a number of measures to address the energy intensity: energy
efficiency criteria for public procurement, upgrading public transport vehicles,
improving the railway network and introducing the electromobility programme. Importantly,
the usage of urban public transport, which has significantly dropped since
2002, shows the first signs of recovery: new passenger trains (both electric
and diesel) were recently put in service and the first months of 2014 have
already brought along an increase in passenger train usage. While overall
Estonia has already met its Europe 2020 renewable energy target, the use of
renewable energy in transport at 0.3 % in 2012 remains far below the 2020
target of 10 %, but the government intends to introduce a 5-7 % biofuel mixing
obligation for motor fuel and to provide financial support for the production
and utilisation of biomethane in transport.

Additional
structural measures to reduce transport intensity and emissions are outlined in
the Transport Development Plan for 2014-20 recently adopted by the government. In
the transport sector, more ambitious (preferably consumption based)
environmental measures and incentives, including taxation measures, could be
deployed to limit CO2 emissions and support energy savings and
resource-efficient mobility.[41] There
is almost no passenger car taxation and the currently applicable excise duty
rates on diesel and unleaded petrol, although above the required EU minimum
rates, are below the EU average (6 % and 20 % below EU average rates,
respectively). In the face of pressing environmental goals, in view of sizeable
welfare losses due to the misallocation of resources and with a view to
reducing other externalities such as road fatalities, leaving a sizeable share
of the transport sector almost untaxed is counterproductive and leaves unused
the possibility of further shifting the tax burden away from labour to environmental
taxes.[42] The
tax system should however ensure that such measures do not act to deter new car
purchases, which would slow the general process of upgrading private cars.

Some progress
has been made in improving the overall effectiveness of the transport system
and infrastructure of most modes of transport. However, it
remains the case that regional public transport networks, including the bus and
rail transport networks, do not function in a complementary way. Also,
while the downward trend in utilisation of urban public transport has stopped,
regional bus services are fragmented and, in some regions, have entered a
vicious circle of decreasing numbers of passengers and, as a result, of being
in need of increased subsidies. Estonia intends to
create regional transport centres for bus services, with support from EU funds
for 2014-20. The planned extension of the Tallinn airport runway would create a
basis for better transport connections by air. Rail Baltica, the high-priority
project launched as part of the Trans-European Transport Networks policy, is
intended to connect the Baltic states to the trans-European rail network. The
project offers an opportunity to reduce greenhouse gas emissions by encouraging
greater use of rail for freight and passenger transport. The project is
scheduled to be completed by 2023, but a political commitment from all the Baltic states is a precondition for its success. While the potential for international
transit has been recognised as important for the Estonian economy, progress to
date has been limited, and, according to the World Bank logistic performance
index 2014, Estonia ranks only 20th out of the EU Member States.[43]
Improvements in the logistics and customs services are a precondition for the
full utilisation of the potential of infrastructure investments and for the
development of high value-added international freight services. There is also a
need for increased deployment of intermodal connections (in particular in
ports) and for smarter transport systems.

Substantial
progress has been made in waste management, in particular through the
introduction of a progressive increase in the oil-shale waste tax and in reducing
the volume of municipal waste sent to landfill sites. Nevertheless, the absence of a credible strategy and of further
targeted economic instruments may make recycling relatively uncompetitive,
increasing the risk that the 2020 targets will be missed. Estonia has made substantial progress by introducing a strong waste management policy aimed
at avoiding waste being sent to landfill sites. Increases in the landfill tax have
led to a further decrease in landfilled municipal waste (from 60 % in 2011 to
35 % in 2012).
The law on environmental taxation provides, among other things, for
2014 and 2015 a 5% increase in the taxes imposed on the mining of natural
resources and on the water used in the process, and a 20 % increase in the tax
imposed on oil-shale waste disposal.[44] Additional efforts will however be needed to increase recycling
if the 50 % recycling target is to be reached by 2020. Due to the excess
capacity of mechanical biological treatment and incineration facilities, there
is a risk that these will absorb all municipal waste and make genuine recycling
economically less viable. The draft of the new waste management plan has been
submitted to Parliament on 20 April.

Some progress has been made in addressing the recommendation to
continue the development of cross-border energy connections. The integration of the Estonian electricity market with Finland and the other Nordic countries has improved as a result of the Estlink2[45] cable
becoming operational in March 2014 and trading via Nord Pool Spot[46] since
2010. The electricity interconnector linking Latvia and Estonia is regularly congested, suggesting that improved connections are needed. A step has
recently been made towards ending Estonia’s isolation from the EU gas market
and to diversify supply sources. Memorandums of Understanding were signed on 28
February 2014 to build two liquefied natural gas terminals, one in Finland and one in Estonia. The Baltic connector — a gas supply pipeline between Finland and Estonia — is expected to be completed in 2015.

Research and
innovation

Estonia’s labour
productivity remains relatively low and would benefit from a further increase
in capital stock per worker (79 % of the EU-15[47]
average in 2012) and greater investment into technological development (stock
estimated at 63 % of the EU-15 average in 2012). Although Estonia made a large leap forward in innovation in 2012, the country’s
performance is still below average in this area and ranks only 22nd on the new EU
indicator of innovation output. The number of companies
undertaking development and innovation activities is still low. Cooperation
between business and the academic world is improving, but only slowly.
Fragmented R&D measures have had a less pronounced impact than expected in
terms of encouraging companies to use universities’ research facilities and
some measures have reportedly increased the administrative burden on companies.
Both the inadequate legal framework for protecting intellectual property and
the university financing system discourage universities from becoming more
active in R&D and from increasing the number of contracts entered into with
companies.

In 2013, Estonia received a recommendation on research and innovation systems and cooperation
between businesses and the academic world. The analysis in this staff working
document leads to the conclusion that Estonia has made some
progress in addressing the recommendation (for the full CSR assessment see the
overview table in section 4). Measures appear relevant and credible.

Estonia has made
some progress in addressing the recommendation to identify
potential measures to prioritise and internationalise research and innovation
systems and improve cooperation between businesses, higher education and
research institutions. Estonia has identified
the knowledge-intensive sectors that could move the country’s economy up the
value chain and thus allow it to become competitive at global level. The Smart
Specialisation Framework comprises the Entrepreneurship and Growth Strategy
adopted by the government in November 2013 and the Research, Development and
Innovation Strategy adopted in January 2014. Synergy in the
implementation of these strategies remains critical for stimulating private RDI
investment in Estonia. The
innovation vouchers programme – a first step towards fully-fledged R&D
activities – has proved successful in increasing the number of contracts
between research providers and companies.

Business environment

Estonia's highly
developed e-government[48] forms
an essential part of the SME-friendly business environment, which has been
particularly conducive to supporting fast-growing innovative firms. The
number of SMEs accessing e-commerce and foreign markets is not however rising
fast. Among the measures taken, the most appropriate and effective are those
supporting internationalisation and offering advice on the export market, and
those supporting start-ups at all stages in creating a company, from the
concept phase to finding the appropriate financing on capital markets. The
Enterprise Development Programme is an initiative that has the potential to be
highly effective: it is designed to provide tailor-made support, based on
diagnosed needs, thus targeting the development projects that could allow
companies to grow rapidly. Nevertheless, the regional development centres,
officially responsible for providing state support to businesses, sometimes
lack ambition and fail to address the real needs of businesses in rural areas.
With respect to Estonia's rental market for housing, the existing legislation
dates back to the privatisation process of the early 90-s when houses were
given back to their initial owners after the collapse of the Soviet regime and
tenants needed a special protection of their rights. Today these provisions are
no longer necessary and could hamper the development of a well-functioning rental
market, possibly affecting the mobility of workers.

Competition in
the energy sector had long been perceived as a major problem by Estonia's civil society, as well as, to a lesser extent, in
medicines, transportation, communications and financial services (see
also Box 3 below).[49] Therefore,
in early 2013, Estonia completed the full liberalisation of its retail electricity
sector. Sectors identified as problematic are generally
capital-intensive and related to the provision of utility services (gas, heat,
water, telecoms). Such utility services generally have high entry and exit
barriers, i.e. low competition results from high capital/knowledge intensity
requirements and from weak infrastructure. In the oil-shale sector where four
major mining companies currently dominate the market, the Estonian Competition
Authority supports the release of new extracting permits to enhance
competition. In parallel, prices in some specific (especially food) sectors likely
suffer from oligopolistic market conditions, partly a result of the small-sized
market, from an environment of accelerated regional convergence of prices, the
extensive use of domestic inputs as well as from high demand from neighbouring
countries (large exports to Russia). Estonia, as the other Baltic States, is
also more sensitive to changes in global commodity prices than more developed
EU economies. This notably reflects a consumption basket rich in food and energy
imports (heating gas), the prevalence of short-term contracts for food exports
as well as the price-taker nature of its economy.

Box 3:
Potential impact of structural reforms on growth – a benchmarking exercise

Structural reforms are crucial for
boosting growth. It is therefore important to know
the potential benefits of these reforms. Benefits of structural reforms can be
assessed with the help of economic models. The Commission uses its QUEST model
to determine how structural reforms in a given Member State would affect growth
if the Member State narrowed its gap vis-à-vis the
average of the three best EU performers on key indicators such as the degree of
competition in the economy or labour market participation. Improvements on
these indicators could raise Estonia's GDP by about 5.2 % in a 10-year period.
Some reforms could have an effect even within a relatively short time horizon.
The model simulations corroborate the analysis of Sections 3.3 and 3.4,
according to which the largest gains would likely stem from reducing mark-ups
on final goods as well as from increasing participation rates among women
andthe elderly. In addition, the simulations support the priority placed by the
authorities on increasing and improving active labour market policies,
including training possibilities.

Table
1: Structural indicators, targets, and potential GDP effects[50]

Source:
Commission services. Note: Simulations assume that all Member States undertake
reforms which close their structural gaps by half. The table shows the
contribution of each reform to total GDP after five and ten years. If the
country is above the benchmark for a given indicator, we do not simulate the
impact of reform measures in that area; however, the Member State in question can still benefit from measures taken by other Member States.[51] \*The
long-run effect of increasing the share of high-skilled labour in the
population could be 0.5% of GDP and of decreasing the share of low-skilled
labour could be 0.8% of GDP. \*\*EU average is set as the benchmark.

3.5 Modernisation of public
administration

Local
governments are small, fragmented and the population density uneven across the
country. Their fiscal capacity does not match devolved
responsibilities. The efficient provision of quality services at local level,
such as transport, enabling and activation services, early childhood education
and -care and long-term care services, remains a challenge. The availability of
appropriate support services at local level is conducive to ALMPs and/or
education being effective and therefore to a good labour market performance.

The
financing of municipalities does not ensure economies of scale, such as would
be possible through joint provision of services. Moreover, the
funding principles of the Equalisation Fund[52] create
disincentives for municipalities to attract enterprises or support job
creation, thereby limiting the possibilities for a better matching of revenue
to the devolved responsibilities. As a consequence, funding from the EU has
become the main source of investment at local level.[53] In
this respect, Estonia will need to deploy efforts to increase the
administrative capacity of municipalities and ensure effective systems of
service delivery before allocating resources from the 2014-20 European
Structural and Investment Funds to local authorities.

In
2013, Estonia received a recommendation on the efficiency of local government
and effective provision of services at local level. The analysis in this staff
working document leads to the conclusion that Estonia has made limited progress
in addressing this recommendation (for the full CSR assessment see the overview
table in section 4). Nevertheless, the measures already taken appear relevant
and credible.

 The
National Audit Office of Estonia suggested in its 2012 audit[54] that
the state should establish service standards that must be guaranteed by local
authorities[55], in
order to improve the quality of services offered. According to the NRP,
legislative changes are being considered to ensure the efficiency and quality
of the provision of local public services, in particular changes to the
legislation necessary to ensure minimum standards in social services. However,
the necessary draft adjustments to the Social Act are unlikely to be adopted by
the government before June. The Regional Development Strategy for 2014-20 was
endorsed by the government in March 2014 paving the way for the creation of
functional centres for the delivery of quality services. The updated OECD
Action Plan to improve public governance will soon enter into inter-ministerial
consultation, with adoption by the government expected later this year.

4. Conclusions

As a small and
open economy, Estonia is particularly vulnerable to external shocks and relies
to a large extent on its export markets. Adverse
developments in the international economic environment and in the country's
competitiveness can thus have a relatively large impact on Estonia's economy and public finances. In addition, the country continues to be dependent
on a single external supplier for its gas imports and consumption, further
increasing its vulnerability. In view of this, the government must pay
particular attention to the adequacy of labour supply and to developments in
real wages. Furthermore, the government needs to ensure that its education and
training sectors are able to meet the needs of the labour market and that its
research, development and innovation systems are conducive to growth. Finally,
the government must ensure that sufficient investment is made in energy efficiency
in buildings and transport and in energy networks in order to reduce the
country’s energy bill and improve competitiveness. These issues were all
addressed in the 2013 country-specific recommendations.

The analysis in
this staff working document leads to the conclusion that, overall, Estonia has made some progress in addressing the country-specific recommendations issued in
2013.

Estonia has
made some progress in addressing country-specific recommendation on
fiscal policy. The recent adoption of the State Budget Law, which includes a structural
budget balance rule, broadly meets the commitments made under the Treaty
on Stability, Coordination and Governance. The 4-year expenditure ceiling is
not binding within the medium-term budgetary framework however and no progress
has been made on introducing a multiannual expenditure rule.

Estonia has
made substantial progress in addressing country-specific recommendation on
long-term unemployment and improving incentives to work. Progress in improving
the provision of childcare and encouraging economic development in regions has
been limited. A credible and comprehensive reform of policies on working
capacity has been prepared with the aim of helping more people with
disabilities and people with lower working capacity to return to the labour
market, but it has yet to be adopted and implemented.

Some progress
has also been made in addressing the education-related country-specific
recommendation and substantially in addressing youth unemployment. Also, Estonia has adopted comprehensive, appropriate and adequate reforms in a number of areas of
education, aimed inter alia at aligning education to the needs of the
labour market. However, the results of these measures are yet to be seen. The
lifelong learning strategy will need to be effectively implemented if its aim
of improving workers’ skills and re-training them in new fields is to be
achieved, but participation of the low-skilled in lifelong learning has much
improved. Research internationalisation and innovative activities remain
limited, which is hampering competitiveness.

Limited progress
has been made on measures to restrict carbon dioxide emissions in
sectors not covered by the emissions trading scheme, especially the transport
and the building sector (country-specific recommendation 4). Substantial
progress has been made on waste management and some progress has been made in
developing cross-border energy connections.

Limited progress
has been made in addressing country-specific recommendation 5, relating to matching
local revenues and responsibilities and ensuring efficient provision of good
quality and affordable services at local level. Measures already introduced or
currently under consideration do not appear sufficiently advanced or
comprehensive at this stage.

The NRP
submitted by Estonia is ambitious and the policy plans described in the
programme address most of the challenges identified in the staff working
document. However, the document remains relatively generic and lacks the
necessary elements to assess the quantitative impact expected from the reforms
considered. Systematic information would be welcome on precise achievements,
ongoing legislative procedures and sometimes even on precise targets (e.g. on
apprenticeships). The attached Estonia 2020 action plan provides a list of
relatively detailed measures, although again not quantified, that nevertheless
offer a more precise picture of the measures that are considered.

Overview table

2013 commitments || Summary assessment[56]

Country-specific recommendations (CSRs)

CSR 1: Pursue a growth-friendly fiscal policy and preserve a sound fiscal position as envisaged, ensuring compliance with the medium-term budgetary objective over the programme horizon. Complement the planned budget rule with more binding multiannual expenditure rules within the medium-term budgetary framework and continue enhancing the efficiency of public spending. || Estonia has made some progress in implementing the budgetary plans mentioned in the CSR and on the fiscal framework issue. · The draft 2014 Budget was adopted as planned, however, the deterioration of the growth outlook and the lowered fiscal targets compared with the previous programme could pose a risk of a significant deviation from the Medium Term Objective in 2014 and 2015. · The State Budget Act entered into force on 23 April 2014, hence the commitments made under the Treaty on Stability, Coordination and Governance have broadly been met. The new law includes a 4-year expenditure ceiling but this is not binding within the medium-term budgetary framework. No progress on introducing a multiannual expenditure rule.

CSR 2: Improve incentives to work by making the various existing social-benefit systems more consistent and by increasing the flexibility and targeting of benefit allocation. Improve the delivery of social services, including childcare, while increasing the efficiency and cost-effectiveness of family policy. Strengthen activation measures to facilitate the return to the labour market of the long-term unemployed and people receiving disability benefits and incapacity for work benefits. Establish coordinated measures for fostering economic development in regions affected by high unemployment. || Estonia has made some progress in implementing the CSR. · Some progress in improving incentives to work: parents’ return to the labour market is more flexible, needs-based family benefits are in place with rates to be increased twofold and the inter-operability of the benefit system is being improved. · Limited progress in delivering childcare for children 1.5-3 years of age but the government approved the draft new Pre-School Act on 10 April and the Parliament is reading it. · Substantial progress in addressing long-term unemployment by means of ‘activation’ measures. · Limited progress so far on the major reform on working capacity: adoption of the necessary legislation foreseen for 2014 and entry into force as of mid-2015. · Limited progress in promoting economic development in regions; projects, including industrial parks, to be financed from 2014 onwards, with impact on job creation yet to be expected.

CSR 3: Continue efforts to improve the labour-market relevance of education and training systems, including by further involving social partners and implementing targeted measures to address youth unemployment. Significantly increase the participation of the low skilled in lifelong learning. Intensify efforts to prioritise and internationalise the research and innovation systems and enhance cooperation between businesses, higher education and research institutions. || Estonia has made substantial progress in implementing the CSR. · Substantial progress in addressing youth unemployment by means of ‘activation’ measures and thanks to the favourable economic environment. · Substantial progress in reforming general upper secondary school, vocational education and training and higher education, where all reforms are in the implementation phase. Delays in adjustments to the Adult Training Act. · Some progress in improving the relevance of education for the labour market: the national strategy on lifelong learning was adopted in February 2014. Creating closer links between the education sector and labour market needs remains an open issue however, particularly in respect of vocational education and training and apprenticeships. Moreover, the number of graduates in science, technology, engineering and mathematics is still relatively low compared with the EU average and other countries in the region. · Some progress has been made in adopting the new strategy on research, development and innovation for 2014-20, ‘Knowledge-based Estonia’, and the strategy on entrepreneurship for 2014–20, which highlight the importance of improving cooperation between businesses, higher education and research institutions.

CSR 4: Improve energy efficiency, in particular in buildings and transport, and strengthen environmental incentives concerning vehicles and waste. Step up the development of cross-border energy connections to diversify energy sources and promote competition in the energy market. || Estonia has made some progress in implementing the CSR. · Limited progress in energy efficiency in buildings: energy efficiency in buildings is being addressed via EU Structural Funds. Further progress in the building sector is dependent on funding from the EU funds for 2014-20. The Estonian government tightened energy efficiency requirements for public buildings in January 2013, bringing legislation into line with the EU Energy Efficiency Directive, and extended the support scheme for renovations of apartments in August 2013. Planning and preparation of measures relating to residential and industrial buildings are in their initial stages. · Limited progress in energy efficiency in transport: the measures undertaken so far include establishing energy efficiency criteria for public procurement, developing a more energy-efficient public transport fleet, pursuing the ongoing electromobility programme 2012-14 and extending the quick-charging infrastructure for electric cars across the country. No new environmental incentives relating to vehicles have been adopted recently. Estonia still has the second most energy-intensive car fleet in the EU. The new government foresees the partial removal of preferential VAT treatment for corporate cars. There are signs of an increased use of urban public transport and passenger rail. · Substantial progress in the area of waste: economic instruments (e.g. a progressive increase of the landfill tax, the application of extended producer responsibility and deposit-refund schemes) and the entry into operation of new mechanical biological treatment facilities have led to a reduction in the proportion of waste being sent to landfill sites. Environmental taxation provides for a 20 % progressive increase in the tax imposed on oil-shale waste starting from 1 April 2013. The National Waste Management Plan was submitted to Parliament on 20 April. Additional efforts to increase recycling will however be needed if the 50 % recycling target is to be reached by 2020. · Some progress in cross-border energy connections: trading via Nord Pool Spot and the Estlink 2 cable (connecting Estonia with Finland) operational. Agreements reached on 28 February to build regional liquefied natural gas terminals both in Estonia and in Finland and a gas supply pipeline (Baltic connector) connecting the two countries.

CSR 5: Better balance local government revenue against devolved responsibilities. Improve the efficiency of local governments and ensure quality provision of local public services. || Estonia has made limited progress in implementing the CSR. · Limited progress so far on the local government revenue incentives: lack of financial incentives encouraging local initiatives to increase local revenue. The Equalisation Fund still creates disincentives for municipalities to attract enterprises or support job creation. · Limited progress in the provision of good quality and affordable local services: legislative changes to ensure the applicability of minimum standards in social services to all municipalities have been announced, but are not expected to be adopted by the government before summer. The government adopted a new Regional Strategy for 2014-20 on 20 March. The draft new Local Government Act is unlikely to proceed. The coalition agreement of the new government has committed to preparing a government reform programme by 2015.

Europe 2020 (national targets and progress)

Policy field target ||  Progress achieved

Employment rate target set in the 2012 NRP: 76 % || Estonia has already reached its intermediate target for 2015 of 72%. In absolute terms, around 43 000 people must find jobs if the target employment rate is 76 % by 2020. Estonia’s employment rate is continuing to rise as more long-term unemployed,  young unemployed and previously inactive people find jobs. Employment rate (%): 2011: 70.4 % 2012: 71.7 % 2013: 73.3%

R&D target set in the 2012 NRP: 3 % by 2020 || Estonia had an R&D intensity of 2.18 % in 2012, slightly above EU average. Despite a slight decrease from 2.36 % in 2011, the country seems well on track to reach its 3 % R&D intensity target for 2020. R&D intensity in business (businesses’ expenditure on R&D) was at 1.25 % of GDP in 2012, only slightly below EU average, with an overall annual growth rate of 19.7 % between 2007 and 2012. Public expenditure on R&D reached 0.91 % of GDP in 2012, above EU average, with an overall annual growth rate of 10.7 % between 2007 and 2012. The growth of investment in research, development and innovation has been impressive, but questions remain as to whether the current rate of growth is sustainable in view of the role played by one sector (shale oil) in the increase of business R&D expenditure, and of the role played by the European Structural Funds in increasing public R&D expenditure.

Greenhouse gas emissions target: limit the increase in emissions from sectors not covered by the emissions trading scheme (ETS) to no more than +11 % compared with 2005 || Change in non-ETS greenhouse gas emissions between 2005 and 2012: 0 %. According to the latest national projections and taking into account existing measures, the target is expected to be achieved: an increase of 6 % from the 2005 level is expected for 2020 (with a margin of 5 percentage points).

Renewable energy target: 25 % by 2020 Proportion of renewable energy in all modes of transport: 10 % || The proportion of the gross final energy consumption produced from renewable energy sources in 2011 was 26 %. The proportion of energy produced from renewable sources in transport is 0.4 %. Estonia should make greater efforts to increase the proportion of renewable energy in transport.

Indicative national energy efficiency target for 2020: stabilisation of final energy consumption in 2020 at the 2010 level. Estonia has set an indicative national energy efficiency target of 13 % (0.430 million tonnes of oil equivalent - Mtoe). This equates to a 2020 level of 6.5 Mtoe primary consumption and 2.84 Mtoe final energy consumption. || Estonia notified the Commission of the policy measures it plans to adopt to achieve these energy savings.

Early school-leaving target: 9.5 % || Estonia performs beter than the EU average for the early school leaving rate (9.7% vs 11.9% in 2013). It is below the EU headline target for 2020 (10%) and is very close to its national target (9.5%). It is also worth noting that the early school-leaving rate for males has fallen significantly in recent years, but it still remains more than twice as high as the rate for females. As regards the period 2012-13, the ESL rate has all in all decreased by 0.8pp. Early leavers from education and training: 2011: 10.9 % 2012: 10.5 % 2013: 9.7%

Tertiary education target: 40 % || Estonia’s tertiary education attainment rate is far better than the EU-28 average (43.7% compared with 36.8 % in 2013). It already exceeds both its national target and the EU target for 2020. A strong increase in tertiary attainment of females was noted for Estonia. In the period 2012-13 the tertiary attainment rate changed 4.6pps: Tertiary education attainment rate: 2011: 40.3 % 2012: 39.1 % 2013: 43.7%

Target for the reduction of population at risk of poverty: 15 % in 2020 || A reduction in the at-risk-of-poverty rate from 17.5 % in 2010 (income year) to 15 % in 2020 (income year) would equate to a fall in the number of people at risk of poverty of 36 248 in absolute terms. The increase in the number of people at risk of poverty in 2011 stabilised alongside the general improvement in employment and the rise in incomes. At-risk-of-poverty rate: 2011: 17.5 % 2012: 17.5 %

Annex

Standard Tables

Table I.
Macro-economic indicators

Table
II. Comparison of macroeconomic developments and forecasts

Table
III. Composition of the budgetary adjustment

Table
IV. Debt dynamics

Table
V. Sustainability indicators

Table
VI. Taxation indicators

Table
VII. Financial market indicators

Table
VIII. Labour market and social indicators

Table
IX. Product market performance and policy indicators

Table
X. Green Growth

List
of indicators used in Box 3 on the potential impact on growth of structural
reforms.

Final goods sector mark-ups: Price-cost
margin, i.e. the difference between the selling price of a good or service and
its cost. Final goods mark-ups are proxied by the mark-ups in selected services
sectors (transport and storage, post and telecommunications, electricity, gas
and water supply, hotels and restaurants and financial intermediation but
excluding real estate and renting of machinery and equipment and other business
activities[57]).

Source: Commission services estimation
using the methodology of Roeger, W. (1995). "Can imperfect
Competition explain the Difference between primal and dual Productivity?" Journal
of Political Economy Vol. 103(2) pp. 316-30, based on
EUKLEMS 1996-2007 data.

Entry costs: Cost of
starting a business in the intermediate sector as a share of income per capita.
The intermediate sector is proxied by the manufacturing sector in the model.

Source: World Bank, Doing Business
Database. www.doingbusiness.org. 2012 data.

Implicit consumption tax rate:
Defined as total taxes on consumption over the value of private consumption. In
the simulations it is used as a proxy for shifting taxation away from labour to
indirect taxes. The implicit consumption tax-rates are increased (halving the
gap vis-à-vis the best performers) while labour tax-rates are reduced so that
the combined impact is ex-ante budgetary neutral.

Source: European Commission, Taxation
trends in the European Union, 2013 edition, Luxembourg, 2013. 2011 data.

Shares of high-skilled and low-skilled: The
share of high skilled workers is increased, the share of low-skilled workers is
reduced (halving the gap vis-à-vis the best performers). Low-skilled correspond
to ISCED 0-2 categories; high-skilled correspond to scientists (in mathematics
and computing, engineering, manufacturing and construction). The remainder is
medium-skilled.

Source: EUROSTAT. 2012 data or latest
available.

Female non-participation rate: Share
of women of working age not in paid work and not looking for paid work in total
female working-age population

Source: EUROSTAT. 2012 data or latest
available.

Low-skilled male non-participation
rates: Share
of low-skilled men of working age not in paid work and not looking for paid
work in total male working-age population

Source: EUROSTAT. 2012 data or latest
available.

Elderly non-participation rates (55‑64
years): Share
of the population aged 55‑64 years not in paid work and not looking for paid
work in total population aged 55‑64 years.

Source: EUROSTAT. 2012 data or latest
available.

ALMP: Active Labour
Market Policy expenditures as a share of GDP over the share of unemployed in
the population.

Source: EUROSTAT. 2011 data or latest
available.

Benefit replacement rate: Share
of a worker's pre-unemployment income that is paid out by the unemployment
insurance scheme. Average of net replacement rates over 60 months of
unemployment.

Source:
OECD, Benefits and Wages Statistics. www.oecd.org/els/benefitsandwagesstatistics.htm.
2012 data.

[1]     COM(2013) 800 final.

[2]     COM(2013) 900 final.

[3]     Besides the 16 Member States identified in the Alert
Mechanism Report, Ireland was also covered by an in-depth review, following the
conclusion by the Council that it should be fully integrated into the normal
surveillance framework after the successful completion of its financial
assistance programme.

[4]     The
Beveridge curve is the graphical representation of the relationship between
unemployment and the job vacancy rate.

[5]     For the assessment purposes it has
been assumed that the MTO is a balanced structural position (0.0% of GDP).

[6]     The cyclically
adjusted balance net of one-off and temporary measures, recalculated by the
Commission on the basis of the information provided in the programme, using the
commonly agreed methodology.

[7]     However, the programme foresees that despite some worsening in
the position, the structural position will remain, at face value, at a surplus
of 0.2% of GDP, in line with the MTO. The discrepancy is mainly due to a
difference in the assessment
of the cyclical position of the economy between the common methodology and the
approach taken in the programme. At face value, the programme foresees a
gradual closure of a negative output gap by 2016, while according to the
(recalculated) output gap estimations using the common methodology Estonia’s
GDP is already above potential
in 2014-15. The latter is also supported by wage growth exceeding productivity
growth and increasing labour market tensions, suggesting that the unemployment rate is already below
NAWRU rates.

[8]     This namely concerns a temporary increase in the second-pillar
pension contributions in 2014-17 and extra dividends from state-owned companies
in 2014.

[9]     Central government entity's net debt may not exceed 40 % of
annual revenue from main activities and the difference between revenue and
expenditure from the main activities must be in balance or in surplus. A
deficit of up to 30 % of annual revenue from main activities is allowed only if
it is covered by surpluses from previous periods. The central government
entity's balance requirement will not be applied if it is caused by the
creation, restructuring or liquidation of the entity. No changes are planned to
the net debt ceiling on borrowing by local governments and dependent units,
which currently stands at 60 % of revenue from main activities in the current
fiscal year.

[10] Treaty on the Functioning of the European Union (TFEU)

[11] I.e. whether they will, firstly, fulfil individuals’ basic needs
and, secondly, allow individuals to replicate the standards of living they had
while in working life.

[12]    The VAT gap is defined as the difference between the theoretical
VAT liability and the VAT collected. Source: European Commission (2013), Study
to quantify and analyse the VAT Gap in the EU-27 Member States, Final Report,
TAXUD/2010/CC/104, Warsaw, July 2013.

[13]    The purpose of registering all employees is to prevent tax
violations and evasion of social security payments and to make it easier to
check employment conditions.

[14]    Study commissioned by the Estonian Association of Real Estate
Companies.

[15]    The Estonian
authorities are also implementing the Capital Requirement Directive, part of
the Capital Requirement Directive IV package which transposes the Basel III
standards in the EU.

[16]    A Baltic
initiative financed by the European Investment Fund and the governments of Estonia, Latvia and Lithuania and based
on fund-to-fund investments.

[17]   For further
details, see the 2014 Joint Employment Report, COM(2013)801, which includes a
scoreboard of key employment and social indicators.

[18]    With respect to income maintenance benefits in the event of
childbirth, EE ranks among the highest at 1.3% of GDP vs 0.2%
for the EU on average.

[19]    The proportion of GDP created in Tallinn and the Harju County continues to grow (accounting for 61 % of the total in 2009), with
entrepreneurial activity increasing in the regions where it is already higher
than elsewhere. Added to this, structural economic changes are reducing the
demand for labour in the agricultural sector, leading to higher unemployment in
rural areas where there are no opportunities for alternative employment.

[20]    The country
has a relatively high rate of severe material deprivation (9.4 % of the total
population in 2012), and a high proportion of the population is at risk of
poverty or exclusion (23.4 % in 2012).

[21]    Estimates from the Ministry of Finance.

[22]    The employment
rate amongst low-skilled people remains below the EU average (49.6 % compared
to an EU average of 52.1 % for the 20-64 age group in 2012), while the
proportion of total income paid as tax by low wage earners in Estonia (those
earning 50 % or less of the average wage) remains above the EU average (37.9 %
compared with an EU average of 34.7 %) and far higher than in OECD countries. See F. Wöhlbier et al. (2014):
‘Consolidation on the revenue side and growth-friendly tax structures: an
indicator based approach’, European Economy, Economic Papers 513, February
2014. Also, inactivity and unemployment traps remain for certain categories of
low-income earners, i.e. among those earning less than 50% of the average wage.

[23]    The IMF considers the labour tax wedge
in the three Baltic States as a major driver of structural unemployment. Also,
reductions in the tax wedge seem to explain about 30% of the variation in
structural unemployment, implying that a reduction in the tax wedge by 10pps
would lead to a reduction in structural unemployment by 2 to 4 pps, all else
equal. See IMF (2014): 'Baltic
Cluster Report – Selected Issues: Unemployment in the Baltics', pp. 69-90, Washington, April 2014.       See
also: Orlandi F. (2012), NAWRU and its determinants: estimating the long-run
relationship – Updated results for countries with data limitations, Technical
note for the EPC WG on output gaps, European Commission, Directorate General for Economic
and Financial Affairs, Brussels, August 2012. See also OECD (2014), OECD
Economic Oulook - Estonia – Economic forecast summary, May 2014. See also Rutkowski
J. (2007), Fiscal Policy and Economic Growth - Lessons for Eastern Europe and
Central Asia - Taxation of Labor, The International Bank for Reconstruction
and Development/The World Bank Washington. See also Flèche S. et al.
(2012), Reducing poverty in Estonia through Activation and Better Targeting,
Economic Department Working Papers, n°1008, OECD, Paris, December 2012, p. 35.

[24]    See K. Staehr (2008), Estimates of
Employment and Welfare Effects of Personal Labour Income Taxation in a Flat-Tax
Country: The Case of Estonia, Working Paper Series, 2/2008, Bank of Estonia, Tallinn, 2008.

[25]    See Bank of Estonia (2014), Labour
Market Review, 1/2014 pp. 23-24.

[26]    The higher the reservation wage, the
lower the probability of finding a job. See M. Room (2003), Reservation Wages
in Estonia, Bank of Estonia, Tallinn, January 2003.

[27]    In 2013, the new scheme relating to working capacity covered an
additional 14 766 people.

[28]    It is expected
that 50 % of people with partial work capacity could join the labour market and
10-15% of benefit recipients could leave the scheme by 2021.

[29]    The
Ministry of Social Affairs states that EUR 1.2 million will be allocated for
this purpose and that, with EU funding for 2014-20, there will be EUR 46
million available in total for these measures.

[30]    30% in 2012
vs. 27% in 2011, one of the
highest in the EU. The gender
pay gap reflects the high sectorial and occupational
segregation that is partly due to high care
responsibilities mainly held by women.

[31]    The non-coverage rate of jobless poor (child benefits excluded)
was 30.4 % in 2011, making Estonia the 8th worst performer in the EU (EU
statistics on income and living conditions 2011). At the end of 2013 about 45 %
of people registered as unemployed received no unemployment benefits. The net income
of people on social assistance relative to median income was 32.3 % in 2011,
the 5th lowest in the EU (EU statistics on income and living conditions 2011).
In 2014, both the unemployment assistance benefit (EUR 112) and the subsistence
benefit (EUR 90) were below the estimated subsistence level (EUR 196 in 2012),
but close to the estimated food basket (EUR 89 in 2012).

[32]    See M. Room (2003), Reservation Wages
in Estonia, Bank of Estonia, Tallinn, January 2003.

[33]    The proportion of very long-term unemployed people fell from a
third to a quarter of the total number of people unemployed between 2012 and
2013.

[34]    There was net emigration of 6 629 people in 2012 (10 873
emigrated and 4 244 immigrated), rising from 2 500 people in 2010 and 700 per
year over 2008-09. Statistics Estonia.

[35]    According to the forecast by Geomedia (2012), by 2030 the number
of people living in peripheral local administrative areas will fall by 38 % and
the number of elderly people in these areas will rise from 22 % to 30 %.

[36]    Employment in jobs requiring lower-level qualifications is
projected to rise by 17.8 % by 2020, while demand for high-level qualifications
is expected to increase by only 6.5 % over the same period, according to
Cedefop.

[37]    The performance indicators in the draft Partnership Agreement
prepared in accordance with the 2014-20 European Structural and Investment
Funds programming period is not very ambitious, since, in 2011, 34.4 % of
students were already in vocational education or training at secondary level,
compared with an EU average of 50.3 % and higher in some countries, e.g. around
70 % in Finland. See also www.hm.ee/index.php?popup=download&id=10227.

[38]    Estonia had only 11.9 tertiary graduates in science and
technology per 1 000 inhabitants aged 20-29 years in 2011 in a very
technologically intensive country, compared with an EU average of 16.8 and
higher in some countries, e.g. 21.2 in Finland.

[39]    Report on Sustainable Development,
http://www.seit.ee/failid/782.pdf.

[40]    According to
EEA data, Estonia's total greenhouse gas emissions from the transport sector
are expected to increase about 12% by 2020 compared to 2010 (using existing measures), while transport
emissions are expected to remain stable on average within the EU.

[41]    The implicit
tax rate on energy is relatively low (148.5 % in 2012), compared with the EU
average (222.8 %). The revenue from environmental tax was slightly above the EU
average (2.8 % compared with 2.4 % of GDP), due for the most part to Estonia's
high energy consumption. The revenue earned from taxation on transport
(excluding fuel taxes) was the second lowest in the EU, at 0.1 % of GDP.

[42]    See Lamine & Lohmuste (2014), Do
the Baltic States need to tax passenger cars more?, Country Focus, Volume 11, Issue
7 (forthcoming), ECFIN, European Commission, Brussels, May 2014.

[43]    http://siteresources.worldbank.org/TRADE/Resources/239070-1336654966193/LPI\_2012\_final.pdf.

[44]    The price for landfill has risen from
EUR 8 per tonne in 2001 to EUR 25 per tonne today and, with the tax increase,
the landfill price is expected to increase to EUR 30 per tonne by 2015.

[45]    Second submarine
cable between Estonia and Finland.

[46]    Nord Pool Spot runs the largest market for electrical energy in the world, measured
in volume traded (TWh) and in market share. It operates in Norway, Denmark, Sweden, Finland, Estonia, Latvia and Lithuania. More than 70% of the total consumption of electrical energy in the Nordic market is traded through Nord Pool
Spot. It was the world's first multinational exchange for trading electric power. Nord Pool Spot offers
both day-ahead and intraday markets.

[47]    The EU-15 Member States are those that
were already part of the European Union in May 2004, when 10 others joined.

[48]    E-government relates to how the
government itself operates via the internet (e.g. allowing companies to submit
documentation or register).

[49]    See Lindpere et al. (2011), How
does the Estonian Food Market Serve Market Participants?, Estonian Economy and
Monetary Policy, 1/2011, Bank of Estonia, Tallinn, July 2011.

[50]    Final goods sector mark-ups is the difference between the
selling price of a good/service and its cost. Entry cost refers to the cost of
starting a business in the intermediate sector. The implicit consumption tax
rate is a proxy for shifting taxation away from labour to indirect taxes. The
benefit replacement rate is the %
of a worker's pre-unemployment income that is paid out by the unemployment
scheme. For a detailed explanation of indicators see Annex.

[51]    For a detailed explanation of the transmission mechanisms of
the reform scenarios see: European Commission (2013), "The growth impact
of structural reforms", Chapter 2 in QREANo. 4.
December 2013. Brussels; http://ec.europa.eu/economy\_finance/publications/qr\_euro\_area/2013/pdf/qrea4\_section\_2\_en.pdf

[52]    The Equalisation Fund is an
equalisation mechanism for the transfers from the state budget. It is applied
if expenditures exceed revenues and it covers 90% of the missing resources gap.
The decision on the amount of money available for the Equalisation Fund is
negotiated annually between the central and local government representatives,
and it is linked to the overall situation of the central government budget.

[53]    The National Audit Office carried out a
follow-up audit of local government investment, which covered 13 of the 30
local authorities that were audited in 2007. Planning and implementation of
investment by municipalities, towns and cities from 2010-12 were also reviewed.
In comparison with 2007 when ca 70% of investment at local level were made with
own funds, in 2012 the level was only 36% in 2013.

[54]      Assumptions for provision of
public services in small and remote local authorities. National Audit Office,
2012.

[55]    Availability of state services in regions. National Audit
Office, 2010.

[56]    The following categories are used to assess progress in
implementing the 2013: No progress: The Member State has neither
announced nor adopted any measures to address the CSR. This category also
applies if a Member State has commissioned a study group to evaluate possible
measures. Limited progress: The Member State has announced some measures
to address the CSR, but these measures appear insufficient and/or their
adoption/implementation is at risk. Some progress: The Member State has announced or adopted measures to address the CSR. These measures are
promising, but not all of them have been implemented yet and implementation is
not certain in all cases. Substantial progress: The Member State has adopted measures, most of which have been implemented. These measures go a
long way in addressing the CSR. Fully addressed: The Member State has adopted and implemented measures that address the CSR appropriately.

[57] The real estate sector is excluded because of statistical difficulties
of estimating a mark-up in this sector. The sector renting of machinery and equipment
and other business activities is conceptually part of intermediate goods
sector.

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