The fall in exports is hurting GDP
Economist at Eesti Pank
Data from Statistics Estonia show that the Estonian economy shrank by 1.3% last year, with the economy declining by 4.1% over the year in the fourth quarter. Consumption by households was smaller in the fourth quarter than a year earlier, but the main source of the decline was the exporting sector. The economy is in a weaker position than previously, but looking further back its position is close to the average for the business cycle, and the peaks it reached recently were more indicative of overheating.
Various factors lie behind the fall in exports, including higher energy prices, reduced access to raw materials, and weaker demand in external markets. High inflation has kept the pressure on wages to rise even as the economy has shrunk, and so unit labour costs have risen fast. The growth in profits does not however lag far behind that in wages, meaning that production costs in Estonia have gone up a long way, potentially threatening competitiveness and economic growth in the future.
More detailed data on manufacturing companies show that manufacturing has affected the economy most through the decline in wood processing and related branches. Options for importing wood have been curtailed at the same time that demand has changed in external markets. Higher interest rates are stifling development in construction, where demand has also fallen for certain products that became popular during the pandemic. Branches of manufacturing that are doing better are those related to electronics.
Indicators for the business cycle show the economy is performing at close to its historical average despite the contraction. Corporate surveys show that labour shortages were still a serious problem for firms quite recently, though they have now receded to their historical average level. At the end of 2021, 37% of manufacturing companies felt that a shortage of labour was their greatest problem, and a quarter of companies in services felt the same. This figure had fallen though for both manufacturing and services companies to an average of 16% by early 2023. Similarly, the production capacity of manufacturing companies was being used very intensively at the end of 2021, but that indicator is now at a level that suggests stable growth. This all shows that business activity has clearly declined, but the earlier level hinted more at the economy overheating. The current state of the economy is less good than before, but is still around its historical average. This is also shown by unemployment, which the labour force survey in the fourth quarter found to be still quite low.
The contraction in the economy in the fourth quarter was well aligned with the most recent forecast by Eesti Pank, but the larger total contraction than expected for the year arose because Statistics Estonia had revised the GDP of previous quarters downwards. There were unforeseen falls within GDP of around 10% for agriculture, over 20% for the energy sector, and over 40% for forestry in 2022. These branches of the economy gained competitiveness as the war caused prices to shift, and they might have been expected to do well out of the crisis. Accommodation and food service made a relatively large contribution to growth in the economy last year as it recovered from the pandemic.
The key issue for further development in the economy is how tightly the competitiveness problems in the exporting sector will restrict growth as production becomes more expensive. Inflation has so far mainly been driven by the sharp rise in energy prices, but these have fallen recently and are no longer the main cause of inflation. What happens next will increasingly be a consequence of higher production costs and reduced competitiveness. Higher prices for commodities pushed a lot of prices up steeply in Estonia in 2022, and so the fall in those commodities prices on global markets should now be followed by other prices coming quickly down. Prices remaining higher than those of competitors for a long time will make Estonia less competitive.
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