The economy is sailing with a tailwind
- The current rate of growth in the economy cannot be maintained for long
- The growth in corporate investment and profits is a positive change
- There is increased upwards pressure on labour costs
- There is a danger of overheating in the construction sector, which may pass on into the rest of the economy
Growth in the Estonian economy was fast in the first half of 2017, and in the second quarter it reached almost 6%. Growth was given a boost by an improvement in the external environment which encouraged exports, but the biggest driver was still domestic demand. Such strong growth is a positive point in the economy, but various indicators show that the Estonian economy is exceeding its long-term sustainable level and growth will soon slow. Production capacity has for some time been used more intensively than usual by companies, and there is heavy pressure on labour costs to rise because of labour shortages, while a rise in the number of vacancies indicates even greater stresses in the labour market than in the beginning of the year. There has also been a noticeable rise in producer prices and consumer prices of late. All of this together indicates that the current rate of economic growth cannot be maintained for long.
There is however no reason to think at the moment that the economy is overheating on a broad basis, because the picture is quite different in different sectors. The acceleration in economic growth has partly been due to improved performance in oil shale production and in energy, sectors that were earlier facing difficulties, where it is more accurate to talk about a recovery in output volumes. Most sectors have seen some growth. The growth cycle has been very strong in the trade sector and there is a threat of overheating in construction, which is running at almost maximum capacity. Cyclical peaks are more noticeable in construction, because increased demand for construction services from companies, households and the general government all coincide.
Having been in the doldrums in the past few years, corporate investment increased in the first half of this year, giving hope that potential growth may pick up again, having earlier suffered. It is worth noting that in the second quarter companies were able to increase their profits despite the substantial rise in labour costs. This was possible partly because inflation has increased in foreign markets and it has been easier to raise the prices of products. Whether the growth in profits will continue depends, however, on how the productivity of companies increases in the near future. If investment continues to increase, it may be assumed that productivity will also increase.
Household spending on residential property and real estate investment has been boosted by rapid growth in incomes. Employee compensation was up by more than 8% in the second quarter, and the average gross monthly wage by 6.8%. Household consumption has been quite restrained though, as deposits have increased more than consumption has. As income tax reform will be introduced at the start of next year, it was possible that the expectation of the rise in net income would cause consumption spending to rise already, as household confidence about the future is very strong. This has not happened though. Behaviour indicating a preference for gradual increases in spending is positive to note, as it helps in keeping economic growth more stable.
The data that are already available for the third quarter do not indicate any significant slowing down of growth, meaning that the economy continues to operate beyond its sustainable capacity. In this case state fiscal policy should focus on the need for balance in the economy, because overheating in some sectors could pass on into the rest of the economy. High volatility in economic growth, for which Estonia has stood out in Europe, has high social costs, leads to capital and labour resources being inefficiently allocated, increases uncertainty for companies and households, and reduces the credibility and long-term growth capacity of the economy.
Eesti Pank publishes a review of the Estonian economy four times a year. The economic review is accompanied in June and December by a forecast for the next two years, and in March and September it is published without the forecast.